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Is Line a Buy After Its IPO Pop?

Image Source: Line.

As unicorns (the start-up breed) are easier to find than ever these days, where have all the tech IPOs gone? The recent explosion in private funding has allowed game-changing companies like Uber, AirBnb, and many more to remain private for longer than ever, enabling them to prioritize growth and monetization over less-central tasks, like IPOs.

With IPOs from high-profile start-ups like Snapchat and Spotify still distant on the horizon, Japanese messaging app Line's (NYSE: LN) IPO this week stand as 2016's largest public offering. But as Line goes public, does it look like a buy after it soared on its first day of trading?

What is Line? 

Line operates one of the world's most-popular messaging apps, riding the same wave of popularity that lifted competitor services like Facebook (NASDAQ: FB) Messenger, WhatsApp, Tencent's (NASDAQOTH: TCTZF) (NASDAQOTH: TCEHY) WeChat, and others.

Controlled by the South Korean parent company Naver, Line operates almost exclusively in Southeast Asia, counting Japan, Taiwan, Thailand, and Indonesia as its primary markets. Of equal importance, Line is blocked in China, where Tencent's WeChat remains the market leader. All told, Line enjoys 218 million monthly active users (MAUs), to whom it primarily provides communications services like free, IP-based calls, and messaging services.

As one might imagine, free VOIP calls and messaging doesn't necessarily produce much in the way of revenue. As such, Line funds its operations by selling games and its incredibly popular digital stickers, as well as advertisements. The company reportedly plans to move into additional growth areas in mobile services, including taxi hailing and streaming music.

Line previously planned to price its IPO in late June, but opted to delay its public debut until the market turmoil related to the U.K.'s Brexit vote subsided. With its IPO this week, Line's shares will trade in both New York and Tokyo. But are Line shares a buy after their significant IPO pop?

Examining Line's post-IPO valuation

As is the case with many technology stocks, the valuation of Line's shares imply the company must grow appreciably in order to merit investment today. After Line's stock soared 26% in its first day of trading, its valuation breaks down in the following ways.

Financial MetricValuation Metric
Market Capitalization $7.2 billion
Price-to-Sales 6.6x
Price-to-Earnings N/A
Price-to-Adjusted Earnings 80.0x

Image Source: Line SEC IPO Prospectus filing. 

While its lack of GAAP profits raises a slight flag of caution -- though one typical of young tech companies, overall -- Line's valuation doesn't seem so extreme to the point of calling it patently overvalued. That isn't to say it appears a screaming buy, either.

Because no real pure-play messaging service is publicly traded, performing a comps-based analysis proves somewhat challenging. However, though the bulk of its profits stem from its non-messaging businesses, Facebook's 71 times and Tencent's 47 times price-to-earnings ratios aren't necessarily far from Line's valuation at its pre-IPO share price -- especially Facebook's.

Granted, these are rich valuations in an absolute sense. However, given the size of the market in which Line operates, there's a case to be made that Line's valuation lies within the realm of sanity going into its IPO.

Line generates the overwhelming majority of its revenue -- over $1 billion in 2015 -- from the sale of paid consumer content, like digital stickers and games. According to IDC research, the market for such paid digital content is expected to increase from $75.6 billion in 2015 to an impressive $256 billion by 2020. The company can also move into increasingly important services like e-commerce and customer service interfaces, a move that others, including Facebook's Messenger, has already moved into.

Roughly 2.5 billion people today use at least one mobile messaging app, a number that is expected to grow to 3.6 billion by 2018, according to researcher Activate. This places Line in one of the more-favorable growth markets in tech today. However, with Facebook's Messenger and WhatsApp enjoying far more than 1.6 billion MAUs, and Tencent's WeChat's 650 MAUs, it's conceivable that Line could face challenges continuing to grow through geographic expansion.

That being said, the company does face plenty of opportunity to continue to increase its revenue per users, as messaging services layer different services into their products. So while Line's first day of trading was a success, it isn't particularly apparent that its shares are a buy after their IPO pop.

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Andrew Tonner has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.