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The Story Behind the SNAP

You thought that this conversation had disappeared, didn't you? Well, lucky for you, Snap Inc.'s IPO is more of a story than a single snapshot (I know, I know--I'm hilarious). When we last spoke, Snap was rumored to have been exploring the possibility of going public and had been running at a valuation of $25 billion. Well, here we are in February and the SEC has finally released the public version of their S-1 Registration Statement, which is a sort of pre-preliminary prospectus (which we will touch on shortly). Since we talked about the reasons why a company would go public, let's talk this time about how a company goes public--within the context of our beloved Snap.

As mentioned above, Snap Inc. filed their S-1 with the SEC, which is the first in a long line of sprawling documents that are required of companies that are looking to sell their shares on a national exchange. The S-1 is, in the simplest terms, a 360 degree view of the company as it was, as it is, and as it will progress (save for financial projections). The filing is prepared by the company's team of underwriters, a group of investment banking firms who specialize in bringing companies public (i.e.- drafting documents, building pitch decks to sell clients on the company, etc.). In the case of Snap, the underwriting team consists of 24 investment banks, which is lead by Morgan Stanley and Goldman Sachs.

The S-1 is full of all the juicy stuff that you've been wondering about since the first time you heard about the company. In fact, the S-1 is so juicy that it might as well feature the CEO's diary--just head over to the "Risk Factors" page (or pages, really) and see what the executives are worried about. For example, Snap is worried about changes in the app-ecosystem, their reputation, and the almighty power of Google (because, let's be honest, who isn't?) Accompanying this information is their consolidated financials and other information to give potential investors a better idea of what the company is all about--and whether or not they want to invest in them. Now that they have issued their documents, Snap now has to wait 21 days for the SEC to respond with any issues, or give approval to move forward. In the meantime, they're going to get their money's worth out of their underwriters--and it's a lot of money.

Returning to our investment banking friends, Morgan Stanley and Goldman Sachs are known as the issue's "Lead Underwriters" (LU), who take on the administrative tasks, as well as majority of the risk in the underwriting process compared to the rest of the team. That risk comes in the form of trying to sell the shares to the general populous; but, in regular finance-style, there are ways for them to mitigate that risk, which comes in the form of "underwriting commitments." There are four main underwriting commitment forms:

  • Firm Commitment: the underwriters agree to buy all of the stock and will sell it off of their own books (AKA- it's their problem now).
  • Best Efforts: the good ol' college try (pretty self-explanatory: they sell as much as they can and give the rest back to the issuer).
    • Mini-maxi: a variation on best efforts, in which the firm is obligated to sell up to a certain number of shares, or else they must buy them.
  • All or None: this is when the issuer is very...particular. They require that all shares are sold, otherwise the whole issue is canceled.
  • Standby: a combination of Firm Commitment and Best Efforts in which the firm agrees to buy the remainder of the issue.

Before they can start selling, however, they will start talking to their large, mostly institutional, clients about the issue and gage interest in it. Using the information in the S-1, they'll find out how many of their clients would be willing to buy the issue, which is known as preliminary placing. Perhaps most importantly, however, they will get an idea of the price that their clients are willing to pay-per-share in order to compare it to their initial idea for the issue price (which is not public). The price isn't set because, as you know, the market changes every second of every day; Snap might be the cool thing today, but a security breach could cause millions of users (and their ad-clicks) to "disappear" tomorrow. To protect against that, the price of an issue isn't set until the bitter end--even up to the day before it goes public.

The next step in Snap's IPO process is to gather all of their intel and build a preliminary prospectus, also known as a Red Herring. The name comes from all of the disclosures written on the face of the document in red ink, indicating that the information is subject to change up-to the point of the IPO. The red herring is more of a sales tool than anything; it is shipped to prospective clients or taken on the "road show" with the banks and the issuer in order to give some color to potential investors and entice them to buy.

As mentioned earlier, the LU's will take on the administrative task and will bear the brunt of the risk--but only initially. After the issue is set (which is a few weeks from where Snap is now), the LU's will divide-up the shares among the rest of the team in a Sun Tzu-style divide-and-conquer attack. Though there is a bit of a hierarchy, to keep it simple we'll just say that each firm gets an allocation of shares that they must sell to their respective clients (but the ultimate burden still falls on the LU's if they don't sell them all).

Taking a step back from how the underwriters sell the issue, let's look at why they sell it: money. Banks are paid handsomely for bringing all of that money into a company's pockets because, after all, it allows them to survive and thrive. Let's say that Snap has an initial offer price of $10, as shown below. This means that Morgan Stanley and Goldman Sachs would get $0.10 off the top of each and every share sold, regardless of who sold it. The syndicate (the group of underwriters who organize the contact to the brokers who sell the shares) are give $0.20 off of every share that is sold by the affiliates under them; the brokers are given $0.50 on each share. That leaves the issuer with $9.20 on each share--lotta money for everyone, huh? Well, it can get even better for the LU's, if they decide to cut out the middle-men and sell the whole issue themselves, the firm will get the entirety of the spread, or $0.80 per share.


So, as we eagerly await Snap Inc.'s IPO, there are, of course, a few "homework" questions that we should ponder as more information is released--you know, to see if we've been wasting our time following their story. From their S-1 and various analysts, I drew three main questions/concerns that I have with the company:

  1. Can they turn their financials around from a tough year of losses?
  2. Can they continue to attract top talent? (AKA- can they afford it)
  3. Are they cool now, for us? Or will they be cool to all 18-34 year olds? (think Dragon Ball Z versus Hello Kitty)


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