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Snapchat is facing 2 big growth barriers and the stock is sinking because of it

Alexei Oreskovic
Evan Spiegel Bobby Murphy Snap IPO

(Evan Spiegel (center) and Bobby Murphy (right) at during Snap's initial public offering on March 2.Reuters)
Snap's stock is taking a beating after a splashy IPO last week.

For all the buzz surrounding the maker of the popular Snapchat messaging app, there are two very big obstacles that threaten to stifle Snap's future growth.  

Investors are spooked because:

  1. A new risk just appeared that could take off the table a big growth catalyst for the stock
  2. The company's total addressable market has a ceiling and Snap hasn't explained how it plans to break through it

In other words, Snap's stock price and its business are each facing a big barrier. Result: after plunging for two consecutive days, Snap's stock is now 11% below its $24 opening price.

Let's take a look at each of the problems:

1. Snap could be barred from the big indexes

The first problem comes from the no-vote Class A shares that Snap sold in its IPO. The decision to sell stock that doesn't give shareholders a say is not sitting well with everyone. As Reuters reported on Monday, a group representing large institutional investors is lobbying the major stock index makers to exclude Snap's stock from the big indexes, such as the S&P 500 and the MSCI USA Index. 

Snap

(Yahoo Finance)
Being part of these indexes is a big deal. And it's not just about bragging rights. When a company is added to the S&P 500, it triggers a wave of buying from other funds that track and mimic the holdings of the index — a nice little tailwind to boost the stock.

When the news broke in 2013 that Facebook would be added to the S&P 500, the stock immediately got a boost in after-hours trading. Two months later, Facebook's stock was up 31%, and one year later it was up 57%.

Google's stock popped 8% after hours when news of its inclusion in the S&P 500 was announced in 2006. It was up 10% two months later, and a year later, the stock was trading 36% higher.

If Snap is barred from the indexes because of its capital structure, shareholders will be forfeiting a big potential growth catalyst for their investment.

To be fair, Snapchat warned investors in its prospectus that the no-vote Class A stock could result in a lower trading price for the shares or lead to other "adverse consequences." Consider this one potential consequence.

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2. Snap has not articulated how it will "grow up"

Teenagers

(Lisa B./Getty Images)
Then there's Snap's business. The app is all the rage among teenagers and 20-something millennials. But the product is famously impossible to use for older users who find its interface baffling and its content of puking-rainbow filters juvenile. 

Snap CEO Evan Spiegel and his entourage did nothing to appease those worries during the pre-IPO roadshow. As Business Insider reported, the company told investors it did not plan to craft any kind of special strategy to appeal to older users. 

Young users with disposable income are the dream demographic for all marketers. But if that's as big as the business will ever get, the potential for growth has a clear set of boundaries. The majority of Snapchat's users are also concentrated in developed markets, because the app runs better on higher-end devices such as the iPhone.

Spiegel has said Snapchat will start to cater more to users of Android phones, which are widespread in emerging markets. But the road may be bumpy, with Snap already blaming a recent deceleration in its user growth to technical problems with its Android app. 

Snapchat points to the gigantic $652 billion worldwide advertising market in its prospectus, and says that its young users are particularly tied to the $66 billion mobile ad market, which is projected to reach $196 billion in 2020. That's a massive opportunity, but the question is, how much of it will Snap shut itself out from by focusing only on the cool kids in developed markets?

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