Snap's Corporate Governance Setup Has Issues

Shares of Snap (NYSE: SNAP) soared after the release of the company's most recent earnings report. Some of its metrics and trends are definitely going in the right direction, but that's far from the whole story for Snap's future.

In this clip from Industry Focus, analyst Dylan Lewis and Motley Fool contributor Evan Niu explain some of the many major issues with Snap's corporate governance setup, and why they make Snap a stock you'll probably want to avoid.

A full transcript follows the video.

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This video was recorded on Feb. 23, 2018.

Dylan Lewis: Evan, looking at the 10-K, I know you wrote a piece pulling out some of the most important stuff from the 10-K. It's on Listeners, if you want it, just write into the show. Anything else from the 10-K that really stood out to you?

Evan Niu: One news item when they filed, a lot of people were pointing out that Evan Spiegel got a $640 million bonus, but that wasn't really news because that was disclosed at the time of the IPO. Snap gave Spiegel a gigantic bonus for taking the company public, which is valued at about $640 million. That's not really new news, but it popped up again in news feeds, the news cycle. And the weird thing about that bonus is that Snap recognized it all immediately and it vested immediately. So, he could leave the company and still have all those shares, which is kind of a weird thing.

We've also always known that public investors get zero votes, which is ridiculous from a corporate governance standpoint. But, they gave another update in terms of, Evan Spiegel and Robert Murphy are the two co-founders, CEO and CTO respectively. They have a combined voting power of 95%. [laughs] Which is just insane. So, their grip on this company is so absolute. You have no way to change anything. Which is hilarious, because in their filing, they even have these statements like, "Our board of directors thinks corporate governance is really important." It's like, no you don't! [laughs] That's just not true.

Lewis: Yeah. If you're a Snap investor, you really need to buy into the long-term vision that Spiegel and Murphy have, because they are going to be able to basically exert their will on the company.

Niu: Yeah, you have to absolutely trust them. And with what they've done so far, I don't know if they deserve that trust. It doesn't really seem like they have shareholders' best interests in mind. There's other yellow flags. For example, their general counsel left last year, and then they hired a guy from Spiegel's dad's law firm. And they're paying him $500,000 a year to be general counsel, which is way above market rates. He got a $200,000 signing bonus. There's all these things that, in my mind, feel like Snap is only trying to enrich Spiegel, his friends and family and insiders, and not public investors. I would not touch this company.

Lewis: And when you put all of the corporate governance on top of a business that really hasn't made the case that it's investment-worthy, at least to me, you have something that I'm not going to touch. I'm kind of in the same camp as you, especially at the valuation it's currently at, given what we're seeing on the user growth side and some of the struggles that they're going to have making costs work and making margins work for them long-term. It will be interesting.

I think the thing to watch for this business in 2018 is, how do things go with programmatic ads? If they get to a point where the auction system is working, they're getting good volume and prices find a floor and wind up being pretty competitive, they might avoid a lot of the problems that Twitter has had on the revenue growth side.

Niu: Yeah. They're definitely making some progress, specifically with these financial numbers. But it's hard to believe anything that this company says, because everything they say is basically not true. Spiegel, in an internal memo a few months ago, was like, "We're scaling our business really well." But, but it's like, no, you're not. You're scaling a little bit, but your costs and revenue are not heading in the right direction to argue that you're scaling. They say they like corporate governance, but that's not true. They say that the capital-light model works better for them, that's not true. There's all these things that they say that are demonstrably false if you break it down and look at the numbers. And when you're asking investors to trust you completely and you keep sending these messages that just aren't really believable, it just doesn't add up.

Dylan Lewis has no position in any of the stocks mentioned. Evan Niu, CFA has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends TWTR. The Motley Fool has a disclosure policy.