Former Snap, Inc. Employee Says Company's "Valuation Is Built On a House of Cards"

By Evan Niu, CFA Markets Fool.com

Just two months before Snap (NYSE: SNAP) went public, former employee Anthony Pompliano filed suit against the company and alleged that Snap was misrepresenting various operating metrics. Pompliano had been poached from Facebook over a year prior to head up Snap's growth efforts, only to be let go after less than a month. The ex-employee believes he was hired specifically so that Snap could obtain confidential information, not for the stated reason of leading the company's growth ambitions.

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Business Insider reports that Snap is now trying to bring the case back to private arbitration while sealing the lawsuit, hiding it from public view. Snap maintains that these are little more than the ramblings of a "disgruntled former employee" and that Pompliano is effectively making the whole thing up. BI caught a glimpse of documents that Pompliano's lawyers filed yesterday evening, which include some pretty harsh allegations.

Image source: Snap.

Pulling no punches

Pompliano's lawyers say that Snap's "outsized valuation is built on a house of cards" and that Snap's leadership team has been making concerted efforts to enrich themselves "by maliciously manipulating metrics [and] suppressing metrics that put the company in a negative light." The documents even allege that Snap has gone as far as to "blatantly mislea[d] professional investors, employees, advertisers, and now, retail investors." That includes user metrics, and possibly more.

Those are some pretty damning allegations if they're remotely true, particularly as Snap is now subject to far greater regulatory scrutiny from the SEC as a public company. The original suit, much of which has been redacted, alleges that Snap fired Pompliano because he was unwilling to share confidential information with his then-new employer. Presumably, Facebook has various non-disclosure agreements regarding confidential information, which is standard stuff at any large company.

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The case is notable for a few reasons, since you can potentially see both sides.

For Snap

Pompliano's brief stint at Snap was in August and September of 2015, or a little over a year before Snap's most recent operating data that covers the end of 2016, when Snap says it had 158 million daily active users (DAUs). At the end of Q2 2015, which was right before Pompliano's employment, Snap's prospectus says that Snapchat had 86 million DAUs; this figure would grow to 94 million by the end of Q3 2015. So Snap's data suggests that DAUs nearly doubled since Q2 2015, but there's been a meaningful slowdown in sequential growth that hasn't gone unnoticed by investors.

Simply considering the timing, it's quite conceivable that any data that Pompliano had access to is now outdated.

Against Snap

On the flip side, if you consider Snap's short record in terms of ethics, transparency, and corporate governance, maybe the company is in fact culpable. I'm a rather vocal critic of Snap, and I do believe that Snap's IPO was a thinly veiled way for insiders and early investors to cash out. Easily the strongest evidence of this is the fact that Snap isn't giving public investors any votes whatsoever, which sends a pretty clear signal that Snap just wants investors' money and little else.

At the same time, Snap has opted not to disclose monthly active users (MAUs), which is a pretty critical figure when we're talking about the social media sector. To be clear, Snap is not required to report MAUs, but omitting this data makes you wonder what Snap is hiding. If you wanted to assume the worst, perhaps Snap has significantly more MAUs than DAUs, and a low ratio of DAUs could imply poor and/or declining engagement within the overall user base.

There are other examples of Snap employing dubious ethics, too. CEO Evan Spiegel refused to apologize for a major security breach in 2014 for some reason; Snapchat rose to popularity among younger demographics in part because it facilitated inappropriate and potentially illegal sharing of sexual content among minors; the ephemeral nature of the service makes it easier to invade other people's privacy in other contexts without recourse, potentially encouraging harassment and cyber stalking; Spiegel's preferred use of Snapchat for internal corporate communications calls into question the company's compliance with federal record retention laws.

As a critic of Snap, it's entirely believable that the company hoped to glean confidential information by hiring Pompliano, and was offended when he declined. The case is just beginning, but how it unfolds may potentially tell investors an awful lot about the freshly public social media company.

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Evan Niu, CFA owns shares of FB. Evan Niu, CFA has the following options: long January 2018 $120 calls on FB. The Motley Fool owns shares of and recommends FB. The Motley Fool has a disclosure policy.