SNAP's Competitive and Legal Woes Continue To Pile Up

Our new Seeking Alpha article on SNAP's structural deficiencies can be found here and the extended version is copied below.

(Note: the original image appears to have transposed the logo (or the data) for Instagram and Snapchat)

(Source: Priori Data)

Given that Facebook (NASDAQ:FB) already owns a majority of the top 10 most downloaded apps on the Google Play store (see right chart), and that it has already added SNAP-like features to many of its other apps (see chart below), it was really no surprise when Facebook recently added SNAP-like features to its core Facebook app.

While this development is directly a net negative for Snap Inc. (NYSE:SNAP) stockholders, we also see this as a sign that a sale of SNAP to FB is becoming increasingly unlikely. At any price. Despite market expectations of a possible $20+ billion deal.

(Source Statista)

However, SNAP's biggest challenge may not ultimately be the competitive landscape. After all, the company co-founders have made it clear by their use of non-voting shares that maximizing the SNAP stock price is not their primary objective.

To be sure, differential voting rights are nothing new; although they typically provide public stockholders with some degree of Class A voting rights (see, for example, Berkshire Hathaway, Google, Facebook, etc). In SNAP's case, Class A shares have no voting rights and even Class B shares - issued to early SNAP Linvestors and to SNAP executives - lose their voting rights upon a transfer or sale. Which raises a number of additional corporate governance concerns.

Several of these concerns were highlighted in a recent note by law firm Gibson Dunn in their Securities Regulation and Corporate Governance Monitor. the key issue raised by Gibson Dunn is that the SNAP voting structure may have several unintended legal consequences:

one practical effect of Snap’s voting structure is that it may serve to hamper the company’s ability to seek shareholder ratification from disinterested shareholders or other procedural safeguards (e.g., obtaining a “sterilized vote” - from a majority-of-the-minority) that could otherwise help shield the directors’ actions from heightened judicial scrutiny.
— Gibson Dunn

We have commented previously that, rather bizarrely, the SNAP IPO prospectus invites non-voting stockholders to the Annual General Meeting ("AGM"). This invitation seems purely cosmetic and, according to legal experts we have spoken to, even if the Class C stockholders attend the SNAP AGM and are asked to "cleanse" any transactions requiring disinterested shareholder approval, their "vote" will not be considered a stockholder ratification. This would apply not just to judicial scrutiny but also to NYSE listing rules on issues ranging from some change of control transactions to certain stock issuances.

In other words, the SNAP co-founders may have created a legal rod for their own back.

As the competitive landscape heats up for SNAP it may want (or need?) to resort to more creative financing and monetization alternatives. And yet it could ultimately be limited in its search for alternatives by the initial decision to issue non-voting Class C stock.

Could SNAP implement a bonus share issuance of voting shares to existing non-voting Class C stockholders if, and when, it requires disinterested stockholder approval for a proposed corporate action?  It is difficult to imagine a court would view this course of action as a legitimate business purpose for issuing bonus stock.  

(Ironically, such an issuance of voting bonus shares would be, in many ways, the exact opposite of what Facebook recently implemented to allow Zuckerberg to maintain effective control of Facebook even as he sold down voting stock to fund his philanthropic endeavors)

None of which is going to enhance the company's public profile after several other negative "perception" issues, including:

  • Reduced the employee IPO "lock-up" period to bring it into alignment with the 150 day "lock-up" applied to pre-IPO investors and the company's founders; and
  • The Board of Directors fired its auditors following identification of a material accounting weakness.   

All of which is going to make August 2017 an interesting time for the SNAP stock price.

Unfortunately, the burden of such legal limitations (and uncertainty) will in all likelihood fall not just on the company co-founders but also on the public stockholders who have purchased, in effect, non-convertible, non-redeemable, non-cumulative preferred stock with no liquidation preference and no fixed dividend entitlement.