Why Snapchat is actually undervalued

By Alex Park , written on November 20, 2013

From The News Desk

Snapchat made headlines last week after rejecting multiple multi-billion-dollar, all-cash acquisition offers from Facebook, Google, and Tencent.

The news sparked a great deal of conversation in the tech/startup/venture communities. It was apparent that people weren’t sure who was more out of their minds: Snapchat's founders for turning down the offers, or the suitors for making them.

But the biggest question on my mind was what Mark Zuckerberg, Larry Page, Sergey Brin, Eric Schmidt, and China’s giant, Tencent, saw in Snapchat that I, and seemingly the majority of the world, missed. Why did they see billions when I didn’t?

Then, moments after I fired off a few Snapchats to some friends, it hit me.

Consider the conversations you have with your closest friends versus those with your mom. Unless your mother is super hip, they’re different. Your friends know things about you that your mom might be better off not knowing. (And vice versa.) Between my best friend, my mom, that one classmate I’ve exchanged three words with four years ago, and my coworker, there are a lots of stories from my life that I would share with some and not with others. This isn’t to say there aren’t stories with broad appeal, like getting married or graduating from college, but a fundamental truth about human relationships is that we relate with different people differently at different times and in different contexts.

Okay, let’s go back to the basics for a moment, and simplify this. Like any other form of media or expression, it’s important we consider our audience when using social media. Someone pretty smart described it this way:

"The essence of social media is knowing your audiences and engaging them in something they love."

It gives us a platform to be storytellers. A good storyteller shares things that interest people. Otherwise, why share them? Why tell an irrelevant, uninteresting, meaningless story? Nobody has time for that.

That’s why being able to speak to (or select) your audience is important, and this is where Snapchat nails it and Facebook fails it.

When I share something on Facebook, I have little idea who will see it and who won’t. I don’t really know who my audience is. It’s whoever Facebook’s predictive algorithm decides to show it to, at the intersection of whoever happens to be looking at their news feed at the particular time it’s served up. That's a whole lot of serendipity.

Enter Snapchat, the only major social network that allows the user to select with great precision which friends he shares each story with. You get to choose exactly which friends see what.

Think about the last time you sent an ugly-faced Snapchat to a friend, or some pictures from a party. After you finished with the picture, you went through a process of choosing who to send it to. Undoubtedly you chose some people to send to, and others not to send to. This makes sense because I don’t want to send this picture to someone I haven’t seen in six years.

How does this make Snapchat worth more than $4 billion? Well, let’s take a feature like a check-in, which Facebook supports. When you check in to a location, you’re really telling a story. You’re saying “I’m here, with these people, experiencing this.”

But the act of telling that story is not limited to the medium of a Check-In, is it? It can be expressed many different ways. Snapchatting a picture of me at a coffee shop basically accomplishes the same thing except I can choose who I want to tell it to.

In other words, Snapchat allows me to share the same story, but in a better way (because I can choose the right audience to share the story with). It’s preferable, more intimate, and so, its better. It also means I’m going to post more. This means I won’t be checking in on Facebook as much.

Now say the same thing happened across the rest of Facebook’s sharing features. What would the Facebook experience become if fewer people were sharing check-ins, status updates, photos, videos, links?

The more Snapchat continues to become a primary mode for people to express themselves, the less likely they will be going to Facebook to share their stories, which means Facebook will become less interesting. That means I and many others will spend less  time on Facebook. Eventually, people may stop sharing altogether on Facebook (it's already happening) and its activity begins to fade. Then it encounters a negative feedback loop, with people fleeing the platform.

Now let’s say you’re a $100 billion company like Facebook that makes its money primarily on two fronts, selling advertisements and user data. This means your customers (the advertisers) see the value of advertising on your platform as directly correlated to how engaged your users are. If another product suddenly begins stealing that engagement, the value of advertising on your site goes down.

What’s more, the value of that user data drops. Revenues fall off a few percentage points, and suddenly, Facebook stock drops 3, 4, 5, 10 points. If you’re a $100 billion company, those 3, 4, 5, 10 points represent 3, 4, 5, 10s of billions of dollars in value. Suddenly Snapchat’s valuation starts making sense.

There’s little doubt that Mark Zuckerberg realizes this, and so does Evan Spiegel, Snapchat's CEO.

The reality is, Snapchat is not being valued for the money it can make, but for the money it can take away (from Facebook).

Now, I don’t think Facebook is going anywhere or that Snapchat will become the foremost social network. There will likely be multiple players making different products that people can use in different contexts. Facebook will continue to be the anchor, but it has the most to lose by not buying Snapchat.

That’s exactly why Google, owner of Google Plus, Facebook’s direct competitor, has reportedly bid even more. It realizes this could be an effective way to hurt Facebook. In fact, Google must realize that if it buys Snapchat and lets it do its thing but with Google’s resources, Snapchat could inflict serious damage. It’s also why, Chinese company, Tencent, sees it as a serious opportunity to break the US’s control over technology and communications platforms the majority of the world uses.

Traditionally startups have been valued by investors for their expected future value. In Snapchat's case, it may be more about how much value it can steal from other companies.

[Image via Thinkstock]