For only the second time since its March IPO, Snapchat owner Snap Inc (NYSE:SNAP) is rallying. SNAP stock has gained 33% from its nadir of $11.28 earlier this month.
The rally seems likely to reverse. It’s probably not a coincidence that SNAP is showing strength. The initial rally in SNAP stock — which rose from near $18 to $22 over three weeks in May — came after its first-quarter earnings report missed expectations. The same thing is happening again. Disappointing Q2 numbers sent SNAP stock down below $12 and now investors, seeing a cheaper price, are stepping in.
Of course, those investors who bought the dip post-Q1 are still sitting on rather significant losses, even with SNAP back at $15. And investors who go long SNAP stock now likely will see a similar fate, victims of another “dead cat bounce” mistaken for a rally. And the drivers of the recent optimism simply aren’t strong enough, or real enough, to keep SNAP stock higher for good.
Snapchat Isn’t Stealing Users From Facebook
One major driver for SNAP stock this week was a report by eMarketer that suggested Snapchat is taking users from Facebook Inc (NASDAQ:FB). Teens, in particular, seem to be more interested in Snapchat and Instagram, as opposed to the legacy Facebook platform. SNAP stock jumped about 6% on the news.
There’s a big problem with the argument that Snapchat is stealing users. Snap Inc reports those users and after both Q1 and Q2, it was disappointment in those user numbers that sent SNAP stock lower.
In other words, investors buying the eMarketer news are ignoring the news coming from the company itself. User growth began to decelerate in the fourth quarter, according to Snap Inc’s S-1 filing. It then rose 5% quarter-over-quarter in Q1, and 4% on the same basis in Q2.
The eMarketer report doesn’t negate those concerns. Even if Snapchat is more popular among teenagers, that alone isn’t enough to support a $17 billion valuation. If overall user growth is in the mid-single-digits, that suggests that Snapchat is having effectively zero success in growing its adult user base.
That’s a big problem because that base is where the money is. Snap Inc still is struggling to monetize its users in the same way that Facebook, Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) and even Twitter Inc (NYSE:TWTR) do. If it can’t broaden its base, that will continue to be a problem, creating more headwind for SNAP stock.
The eMarketer report might be modestly good news for Snapchat. But focusing on an external report over Snap Inc’s actual numbers seems like fitting the facts to the investment case and not the other way around.
We’ve Been Here Before With SNAP Stock
Meanwhile, as noted above, SNAP stock has been here before. The same “fill the gap” rally that occurred after Q1 earnings is happening again — this time at lower levels.
The problem is that the recent buying isn’t likely coming on fundamental strength. Certainly, there’s some short-covering of SNAP stock, which is expensive to borrow and heavily shorted relative to the number of shares available to borrow. No doubt, traders began to close profitable shorts after the post-Q2 earnings dip, and that covering has probably continued. Other short-term-focused traders could also be jumping in.
This sure looks like a bit of a suckers’ rally as the May gains turned out to be. The idea that SNAP stock has bottomed after a pretty rough Q2 earnings report seems optimistic, to say the least.
Snap Inc Still Has Work To Do
The broader issue is that the recent gains don’t change the underlying problems with SNAP stock. To be fair, I don’t necessarily think Snap Inc is a bad company. I’ve long argued the problem with SNAP stock is more that its expectations were too high, rather than its execution being too poor. It’s an unprofitable, early-stage company whose growth already was slowing before the IPO. It’s not Evan Spiegel’s fault that the IPO was valued at $25 billion. (Was he supposed to take less?)
Still, I’m far from convinced that ~$14 billion (plus the company’s cash) is noticeably better. That figure still values SNAP stock at about 8x next year’s revenue. The company likely won’t turn a profit until after 2020. And while its execution hasn’t been as poor as the performance in SNAP stock would suggest, Snap Inc does need to do better with both older and international users.
The broader point is that Snap Inc is priced as a growth stock — but I’m not terribly sold on the idea that there’s all that much growth left. Revenue increases look huge: +153% in Q2, for instance. But that’s coming off a relatively small base, and during a time where Snapchat still is learning how to sell advertising.
As that process matures, Snap Inc is reliant on Snapchat user growth for revenue increases and profitability. Given that growth is slowing — no matter what eMarketer says — that seems like a dangerous place to be.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.
