How Snapchat’s IPO Became One of Wall Street’s Biggest Flops

Two weeks ago, stock market pundits, tech analysts, and the bulls in general were hailing the IPO of Snapchat owner, Snap Inc. (SNAP), as a triumph. Since then, the bash has given way to a wicked hangover.

And as the haze has lifted what’s become clear is this: The Snap IPO was an epic fleecing, made even more glaring by the past two weeks. The lone big winner is the maestro that orchestrated the entire travesty and should be no surprise to anyone: Wall Street.

The three other groups involved in the Snap IPO—the inside institutional buyers; the folks who were seduced by the first days’ euphoria; and the company itself—have been huge losers. Let’s count the ways.

First, the institutional investors, sometimes on behalf of retirees in pension funds that purchased their shares directly from the underwriters at a privileged price of just $17 have watched their gains in Snap’s stock, which was as high as $27, drop a third. Not all the institutions rode down the hill. Since trading volumes were immense on the opening days of trading, when 365 million shares changed hands (exceeding the total offering of 230 million) we know many asset managers quickly dumped big portions of shares.

The flippers sold to our second group, those who gorged during the euphoria that lifted Snap in the mid-$20s––including many ordinary folk, who like this Uber driver bragged about getting in on the IPO, and smaller funds that invest on their behalf. In contrast to the inside crowd who started at a virtually no-lose price, those who pounced in the aftermarket frenzy have already suffered real losses in brokerage accounts, mutual funds, and 401(k)s.

But by far the biggest loser is Snap.

The seven underwriters led by Morgan Stanley (MS) and Goldman Sachs (GS) apparently advised Snap before the IPO to tell big asset managers that the company was willing to sell its shares in the mid-teens. As a result, the investment banks received orders for around ten-times as many shares as Snap had to sell. Yet, instead of raising the price to mine that surging demand, the investment banks sold Snap’s IPO at $17—only one dollar above the range the stock was marketed at.

All told, Snap will likely—because of the odd workings of IPOs Wall Street banks still have a window to buy even more shares at the below market $17 price—end up selling 160.35 million shares. Executives and VCs are unloading an additional 70 million. Based on that, after fees paid to underwriters and other expenses, Snap raised $2.6 billion. However, had the company priced its shares at what the institutions were really willing to pay, exemplified by the $24.48 close on opening day, the photo sharing company would have collected $3.76 billion. That’s a difference of $1.16 billion in foregone cash.

Leaving all that money on the table left Snap’s owners poorer, in three respects. First, by selling at $24 or $25, it would have bolstered its balance sheet by adding almost $1.2 billion in book value. A company with that raises its assets, especially cash, relative to liabilities should be worth more by the same amount, in this case, $1.2 billion or 5% more. That translates into a dollar a share—at least. What’s more, perhaps the knowledge that Snap’s executives had figured out how not to be taken by Wall Street may have boosted investor confidence in the company even more.

Second, although Snap boasts a giant, and probably inflated, market cap, its actual business doesn’t look so good. It is burning massive bonfires of cash. For 2016, it posted negative free cash flow of $677 million. Of course, Snap appears to have plenty of liquidity right now from the proceeds of the big offering, and projects that its losses will quickly shrink. But a larger cash cushion is far preferable to a smaller bank account. Had it reaped full value, Snap would have had 35% more cash following the IPO. That’s enough to fund almost two years of losses at today’s enormous rate.

Third, Snap will now face a wave of negative publicity, and sentiment. The wildly optimistic investors, who are likely users of Snap as well, who thought they were lucky to get the company’s stock at $25 or higher, are not going to search around for reasons as to why Snap’s stock is falling. They are not going to say, “But the stock is still trading at a price-to-sales ratio of 51, more than 5 times Google, so things are still pretty good.” No, they are going to say the company’s stock is falling. I lost money. This company is a dog. A falling stock price will also make it harder for Snap to recruit new employees. Any positive buzz they were hoping to get from the IPO is quickly disappearing and being replaced with the opposite.

The sole victor, as usual, in Snap’s IPO is Wall Street.

Surprisingly, the banks received relatively modest compensation for their efforts. The seven collected $98 million in “discounts and commissions,” accounting for 2.5% of the proceeds raised, well below the 4% to 6% fees investment banks frequently demand. But don’t be fooled. The banks will generate hundreds of millions of dollars in extra commissions and fees on stock and bond trades via the Snap deal. Big institutions that got a big bump, keep in mind the stock is still up 17% in two weeks, will reward them with a flood of lucrative business.

So why would the brilliant entrepreneurs who founded Snap and top VCs who backed it, agree to effectively provide almost $1.2 billion in free money for Wall Street to shower on its best clients? The pitch is that when the backers get ready to sell big blocks of their stock after the Snap “lock-up” period ends in late July, they will get a better price from institutions, in other words, those grateful asset managers will demand a smaller discount to buy lots of shares. Those money managers, so say Wall Street, will harbor positive feelings about the photo-sharing purveyor, nurtured by their rich gains on the IPO.

But those institutions aren’t nearly as sentimental or grateful as Wall Street claims. All that will matter when those blocks come to market is obtaining the cheapest price possible. The big institutions don’t give money away. But they benefit richly from the IPO candidates who do just that, time after time.

Wall Streeters may not be as great as they claim at trading, but they’re the greatest at persuasion—specifically, persuading brainiac entrepreneurs that doing the wrong thing is right.

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