Shares of Snap Inc. (SNAP) popped 40% on its first day of trading.
Opening at $24 a share, the parent company of popular ephemeral messaging app Snapchat has a market valuation of around $33 billion, which positions it to be the largest US tech IPO since Facebook (FB) in 2012 — the social network was valued at $104 billion after pricing at $38 a share.
A source told Reuters that Snap received 10 times as many orders as it had for sale, showing investors’ ravenous appetite for the company. Snapchat has achieved something incredible: the app’s core demographic of teens and 20-somethings are willingly advertising products on the platform.
Given that so many millennials use the app, companies like Pepsi (PEP) and Taco Bell (YUM) quickly seized the colossal opportunity to tap into young minds—and wallets. Plus, the ads get tons of ordinary people to advertise products—whether it’s Gatorade or tacos—for free. Free buzz through young people is the holy grail of advertising.
Snapchat’s core audience isn’t loyal
But, as the company pointed out in its SEC filing last month, “this demographic may be less brand loyal and more likely to follow trends than other demographics.” This risk, like others Snap mentioned, is tied to the reality that the majority of the app’s users are 18 to 34 years old.
“These factors may lead users to switch to another product, which would negatively affect our user retention, growth, and engagement.”
We’ve seen this possibility become a reality with the rapid adoption and popularity — specifically with Instagram’s popularity.
Snap has grown increasingly vulnerable to competition — specifically Instagram, which launched a carbon copy of Snap’s Stories feature last August that’s accrued 150 million daily users, according to the latest numbers. Instagram itself has 400 million daily active users. Most recently, Instagram announced it would put ads between stories, another move directly from Snapchat’s playbook. Instagram CEO Kevin Systrom has even acknowledged that Snapchat “deserves all the credit.”
Snapchat currently has 158 million daily active users. This represents a cool down in growth, and appears to be correlated with the roll out of Instagram stories. The app experienced a meager 3.2% increase in daily active users between Q3 and Q4 of last year. This falls flat compared to the 7%, 17.2%, and 14% quarter-over-quarter growth the company has experienced over the last three quarters.
In its SEC filing, Snap contended that it has also excelled at targeted advertising. It cited an ad campaign with a long-form video attachment to promote deodorant for men. Snapchat said it wanted to ensure that the message reached males between the ages of 13 and 34, and market research firm Millward Brown verified that a whopping 88% of the people who saw the ad fell in the advertiser’s target demographic.
Additionally, over 60% of all Snap ads are watched with the sound on, confirming that the advertisements are highly engaging to users.
Meanwhile, the company, in an effort to monetize its playful Lenses feature, has given brands an opportunity to create their own sponsored lenses. By partnering with brands like Spotify, Kraft (KHC) and bareMinerals, Snap enables users to interact with advertisers directly.
“The genius behind the sponsored lens is that Snapchat has created an advertising product that people actually want to see, use and share,” notes Jefferies’ US internet research team.
Other risks to Snapchat’s advertising strategy
However, the fact that advertising is Snap’s sole money maker may worry investors. In the risk factors section of its SEC filing, Snap pointed out that most of the company’s advertising commitments are short-term and may not be renewed.
According to its SEC filing last month, Snap noted that it generates substantially all of its revenue from third-party advertising. In 2016, advertising revenue accounted for 96% of Snap’s total revenue.
The company recorded revenue of $404.5 million and a loss of $514.6 million in 2016, compared to revenue of $58.7 million and a loss of $372.9 million for the year ending December 2015. This represents a year-over-year increase of more than six times.
The filing acknowledged that it relies heavily on a teen and young adult user base that tends to be app agnostic and may quickly adopt the next big thing, whether that’s musical.ly or something else that hasn’t even been invented yet.
“Falling user retention, growth, or engagement could make Snapchat less attractive to advertisers and partners,” the filing noted, “which may seriously harm our business.”
Melody Hahm is a writer at Yahoo Finance, covering entrepreneurship, technology and real estate. Follow her on Twitter @melodyhahm.