Why $10 billion isn’t a crazy valuation for Snapchat—and may turn out to be a bargain

July 30, 2014
Obsession
Mobile Web
July 30, 2014

Snapchat is raising a new round of funding that could value the company at $10 billion, Bloomberg reports, citing sources. This is a significant increase in theoretical value, since Snapchat reportedly turned down a $3-billion buyout offer from Facebook last year. And it puts Snapchat in some impressive company, with other fast-growing, highly valued startups. But it’s not crazy.

Why not? First, it’s important to note that Snapchat’s would-be investor, reportedly the Chinese internet giant Alibaba, is likely buying preferred shares in the company—not common stock. Henry Blodget, a former securities analyst, explained why this matters in a recent post about Uber’s last funding round—which valued the company at an eye-popping $18 billion:

When you buy preferred stock, your downside is usually limited. Preferred investors are higher in the capital structure than common investors (thus the “preferred”), so in a liquidity event, they usually get all their money back, even if the company sells for a much lower valuation than the one at which they invested. In many cases, including, possibly, this one, preferred investors also get a guaranteed return.

Second, there could be other potential benefits to the investment for Alibaba, besides future increases in the value of its Snapchat shares. In particular, the deal could offer Alibaba another strong foothold into the US tech startup market. (Alibaba has also invested in other US companies, including the messaging startup Tango.) Conversely, Alibaba could potentially help Snapchat with distribution outside the US.

Third, and most important: An investment in Snapchat at a $10-billion valuation may prove to be a great deal. When Microsoft invested $240 million in Facebook—at what seemed like a mind-blowing $15 billion valuation in 2007—many scoffed. But Microsoft did great on that investment. Facebook’s market capitalization today is $195 billion, according to Yahoo Finance.

Is Snapchat the next Facebook? No one knows. But it’s still growing rapidly and has become a top-10 app in 20 markets, according to AppAnnie. And Snapchat seems to be doing a great job at fending off competition, notably from Facebook. So there’s also a chance it could be worth many times more in another year or two.

Yes, there is plenty of risk involved—Snapchat could easily be the next MySpace, or worse—but that’s exactly why investments are made. And for a company like Alibaba, the balance of potential reward versus possible catastrophe here seems an appropriate gamble.

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