Squeezed Snap raises questions over bank research
Shares in the messaging app have fallen sharply after Morgan Stanley slashed target price
Reality caught up with Snap this week.
Shares in the owner of the Snapchat messaging service plunged through its $17 initial public offering price on Tuesday to below $16.
To the sceptical observer, it was all but inevitable that Snap’s share price would fall from its peak of $27, hit just days after its March float. The company has never made a profit. Its IPO prospectus warned of slowing user growth as well as stronger competition for advertising from well-funded rivals, notably Instagram’s stories feature.
Indeed, the stock has been a magnet for investors who bet that its price will fall: the short interest is equal to 28 per cent of the company’s free float. And that is after short sellers made profits of up to $396m in just under six weeks in June and July, according to estimates of S3 Partners, a financial analytics group.
This week’s sell-off was prompted in part by a change of heart at Morgan Stanley, the investment bank that led Snap’s IPO. Analysts there had gushed in March about the company’s potential to monetise its engaged, young audience through advertising. This week, they slashed their target share price from $28 to $16, writing “we have been wrong about Snap’s ability to innovate and improve its ad product this year”. Analysts at Citi, which also participated in the float, rated Snap a buy until mid-June, well after the company’s first, disappointing results as a public company.
S&P Capital IQ, which tracks Snap research from 30 analysts, calculates the average rating on Snap is still “Buy”, with a price target of $20. One analyst continues to predict the shares will rise to $31.
Some tech groups do pull themselves into profit after post-listing teething problems. While Facebook leads that list, there are plenty of counter-examples. GoPro shares are down by three-quarters since their first day of trading in 2014. Twitter’s share price has dropped by nearly 60 per cent since its 2013 IPO.
But the early hype and continuing enthusiasm in some quarters for Snap reignites longstanding questions about sellside analyst research. Many — but not all — analysts seem to have misfired on the most basic questions: how unique is this company’s product, how will it make money and how does that translate into a share price.
The question is why. The cynics will remember the dotcom era when 12 Wall Street banks paid more than $1.5bn to settle allegations that they had slanted their research to favour investment banking clients. Though the banks claimed to have learnt their lesson back then, incidents keep cropping up.
In 2014, US regulators fined 10 banks that “offered favourable research coverage” to gain work on an IPO. This week, the French markets regulator disciplined Société Générale for failing to disclose how it arrived at a price target, and disclose that the bank had previously worked on an IPO. Then again, sometimes bank analysts simply get it wrong.
Whatever the reasons, new European rules may finally tip the balance in favour of no-holds-barred research. Starting in January, fund companies must tell investors how much they are paying for research, rather than bundling with other costs. That means they will expect to get value for their money. Overly sympathetic analysis is unlikely to survive the inevitable cull. Reality is catching up with investment banking research, too.