If you’re interested in the tech sector, you’ve probably heard urban legends about some unlikely early investors in internet giants. These include:

  • The janitor at Alphabet’s (Nasdaq: GOOG) first office
  • The painter at Facebook (Nasdaq: FB)
  • And the gardener at Microsoft (Nasdaq: MSFT).

According to these legends – at least one of which is true – a wise blue-collar worker stumbles upon a nascent tech titan.

[ad#Google Adsense 336×280-IA]He asks to be paid for his services in equity instead of cash.

And, years later, the company becomes a blue chip, making the day laborer a millionaire overnight.

These stories reflect a common dream among investors. We all fantasize about picking up cheap shares in the next monolithic tech company.

Startup IPOs have become major media events. And rumor has it that another big one is coming up…

Snapchat is a photo- and video-sharing app that allows users to send short-lived visual messages to their friends. Since launching in 2012, it has become wildly popular among high school and college students.

The company’s rapid user growth has given it the prestigious title of “unicorn.” That’s Silicon Valley slang for a fledgling company that is valued in billions of dollars.

And according to information that leaked out of the company last week, Snapchat is planning an IPO. It’s allegedly aiming for a $25 billion offering as early as March 2017. Is a Snapchat IPO the modern equivalent of buying Microsoft shares in the ‘80s? It’s far from certain.

Despite all the fanfare, big startup IPOs are not always goldmines. And there are notable examples of social media stocks going downhill after struggling with some of the same problems Snapchat has.

Let’s take a look at what could go right – and wrong – with the Snapchat IPO.

The Case for Investing in the Snapchat IPO

In many ways, Snapchat has a leg up on other big names in the social media space.

One of its advantages is the nature of its product. “Snaps,” or pictures and videos sent through Snapchat, are short and temporary. They are displayed for a maximum of 10 seconds. And once someone views a snap, it is deleted from their phone forever.

In a world of consumers who are increasingly concerned about internet privacy and the “stickiness” of social media information, this transience is an appealing feature. Another privacy perk of Snapchat – snaps aren’t public, unless you explicitly mark them as such. Most users just send snaps to their friends, and they never pass under another set of eyes.

Snapchat also looks promising because of its cult following among young people. I’m not just talking about millennials but also the generation after them. Today’s teens and tweens aren’t signing up for Facebook, and that has left tech analysts scratching their heads.

As the first generation of social networks stop being new and cool to kids, a new wave of companies is slowly replacing them. The biggest names among the second generation of social media include Instagram, Pinterest and of course, Snapchat. Buying shares in the next social media standard could lock in returns similar to those enjoyed by early Facebook investors.

But the news about Snapchat isn’t all rosy. The company bears a resemblance to another publicly traded social network with a less flattering story.

The Case for Sitting Out the Snapchat IPO

Just because a social network is popular, that doesn’t guarantee it can make a lot of money. Growing a user population and monetizing that population are two very different goals.

One household name that learned this the hard way is Twitter (NYSE: TWTR). The service has become the gold standard for keeping up with current events, entertainment and your friends’ lives. The problem is its business model was built on a vague plan to sell ads. And that hasn’t really panned out.

Twitter’s stock price has been declining for almost its entire life. In spite of the social network’s ubiquity, the company’s executives are currently trying to sell out.

Snapchat suffers from similar uncertainties about how it will cash in on its popularity. The company has dabbled in selling video ads that play in between viewings of snaps. But many analysts aren’t convinced that can generate a steady revenue stream. And according to the same anonymous source who leaked the IPO plans, Snapchat is still financially in the red as of now.

That means that a flashy IPO could quickly turn into a Twitter-sized letdown for investors.

So is the Snapchat IPO your chance to join the ranks of “the janitor at Google” or “the painter at Facebook?” Maybe. Maybe not. The company certainly has the popularity to become the next Facebook. But it also has the business model vulnerabilities to become the next Twitter. Only time will tell where Snapchat ends up.

— Samuel Taube

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Source: Investment U