Snap Inc (NYSE:SNAP) stock has bounced back after a 20%+ selloff following Q1 earnings last month. And there’s some reason for that rebound. As I wrote at the time, the Snap earnings ‘miss’ was more a matter of expectations than execution. The core Snapchat platform continues to grow. And Snap Inc is learning how to monetize its base of 166 million daily active users (DAUs). Those earnings provide a multi-year runway for advertising revenue growth.
That said, I’m hardly jumping into Snap stock above $20. A ~$23 billion valuation (even excluding the company’s ~$3 billion in cash) incorporates years, if not decades, of roaring growth.
While the knee-jerk bear case for SNAP is too simplistic — yes, Snap Inc is losing money, and that’s no surprise — the bull case going forward is reliant on several key factors. And I don’t have quite enough confidence in Snap Inc, its flagship app or management to be optimistic enough on SNAP stock.
Snapchat Imitators
It’s no secret that Facebook Inc (NASDAQ:FB) is trying to strangle Snapchat in its cradle. Both the namesake platform and the company’s Instagram have copied Snap features, most notably “Stories.”
But Facebook isn’t the only one. The new version of Skype from Microsoft Corporation (NASDAQ:MSFT) has a number of features that look suspiciously like Snapchat, including a “Stories” feature of its own.
It’s probably overly pessimistic to suggest that Facebook and Microsoft can obliterate Snapchat. SNAP is still first, it still has 160 million-plus users and it remains hugely popular among younger audiences. But the moves by Facebook and, to a lesser extent, Skype, still represent a competitive problem for the company.
Snapchat has to grow its user base. It perhaps doesn’t have to reach, or even near, Facebook’s billion-plus number. But simply monetizing the current base is not enough to support a $20 billion-plus valuation. And where Facebook, in particular, matters is in North American demographics, Snapchat already seems a bit too ‘young’ for many core (and valuable) social media users. Thirty-something professionals probably aren’t interested in “puppy filters.”
But some of Snap Inc’s required user growth is going to have to come from Facebook in particular. That doesn’t necessarily mean users have to leave Facebook, but they need to join Snapchat. And if FB, in particular, can keep those users by offering Snapchat-like features, suddenly Snap Inc’s addressable market looks much, much smaller.
Snap Inc Management
Some of the early criticism of Snap Inc CEO Evan Spiegel seems a little unfair — and ignorant of history. It was only five years ago that investors and analysts were criticizing Facebook head Mark Zuckerburg. He was in over his head. His decision to wear a hoodie to IPO meetings showed his immaturity. The Instagram acquisition — $1 billion for a company with zero revenue — was like setting cash on fire.
But Spiegel has made a few early missteps, including reportedly dismissing the Indian market as “too poor”. Snapchat has little monetization overseas, which Spiegel on the Q1 call attributed to weak cell service in many developing countries. But Snap Inc also appears to lack a plan for ex-U.S. revenue — and, again, the growth priced in requires Snapchat to be a worldwide platform, not just a U.S. business.
Again, some patience is warranted. Snapchat was released less than six years ago. But Spiegel has one major problem that Zuckerberg didn’t: he’s competing against Facebook. And that competition means Snap Inc desperately needs to have a coherent, detailed, long-term plan. So far, I haven’t seen quite enough from management on that front.
Monetization and SNAP Stock Valuation
The final concern is a combination of the first two: how, exactly, does Snapchat plan to monetize its users? And to what extent? Reports suggest that Snapchat already is offering discounts to advertisers. As noted, international monetization is much weaker – and will require a massive investment in sales force and management to improve.
This isn’t an idle problem — in fact, it’s the biggest problem at Twitter Inc (NYSE:TWTR). Twitter has a massive user base, and as a platform, it quite literally has had a major impact on world politics. But Twitter, to this day, still hasn’t figured out how to monetize its platform in a way that drives consistent profits.
Snapchat’s monetization will improve — and it is already improving. ARPU (average revenue per user) better than tripled last quarter. Snapchat ARPU still is below that of Twitter, so there is more room for improvement, which provides steady, organic revenue growth.
But there’s a roadblock ahead: Facebook and Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL). Those two giants drove an estimated 99% of online advertising growth last year. Similar to user engagement, Snapchat will have to take some of its growth from those rivals.
And that seems too big an ask — at least at the current valuation. Snap Inc can grow its user base. It can improve monetization. But the current valuation requires at least $4-5 billion in incremental revenue (assuming a potentially aggressive 6-7x revenue multiple, discounted back). That, in turn, requires the user base to triple and monetization to do about the same.
I think Snap Inc can and will grow. But with management, competitive, and demographic concerns, I’m skeptical that it can grow that much.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.
