I’ve been bearish on Snap Inc (NYSE:SNAP) since its March IPO. But I haven’t had the same level of animosity toward the company or SNAP stock that some observers seem to hold.
Indeed, I’ve long argued that Snap’s biggest problem was that expectations are too high. Stepping back from the hugely covered public offering — and the still-high valuation — Snap Inc is an intriguing company. Founded just six years ago this month, it already has 173 million daily active users (DAU). Revenue has tripled — tripled! — in the first half of the year.
Sure, Snapchat isn’t profitable. And, yes, the company lacks the ability to monetize those 173 million DAUs. But, again, it’s a six-year-old company. It’s not necessarily supposed to be profitable or to have perfected execution.
Nor is it Snap Inc’s fault that SNAP stock was valued at $25 billion coming out of the IPO. Should the company, and its founders, have taken less?
Still, I’m not yet bullish on SNAP stock, and as I argued last month, I believe that the recent post-earnings rally will come to an end. Indeed, the stock already is fading after touching $15 — and it has further to fall. Because while there are some intriguing aspects to the Snap story, even those expectations still are too high. What investors are pricing into SNAP stock is an outcome that looks more and more unlikely by the day.
Snap’s Competition Problem
The most pressing concern for Snap has to be competition. Pre- and post-IPO analysis calling Snap “the next” Facebook Inc (NASDAQ:FB) ignored one major problem: Facebook itself. The social network’s growth came as Myspace was declining. But, Snapchat has to compete with an already-dominant platform that now has over two billion users.
And while Facebook may seem mature by social media standards, it’s important to remember that it is only 13 years old. And it isn’t done growing. As I’ve pointed out, FB has added more users in the past year than Snapchat has — ever.
Certainly, Facebook and Snapchat can share users — to some extent. But monetization is based on engagement, and a part-time user is far less valuable than a full-time one. Snapchat needs to grow around Facebook. And while there is data that shows it’s having some success in taking younger users, quickly decelerating user growth shows that success isn’t enough. That 4-5% growth in users is not going to support anything close to the current ~$16 billion valuation for SNAP stock.
That’s not the only problem. Facebook’s Instagram is trying to copy Snapchat out of existence. Even Apple Inc. (NASDAQ:AAPL) is mimicking Snapchat features in its updated iMessenger platform. Everyone is gunning for Snapchat, it seems. And if they’re successful in stunting the platform’s growth, SNAP stock is going to crater.
The Monetization Problem
The reason the focus remains so heavily on Snapchat’s users is that the company still is in the early stages of learning how to monetize them. Nowhere more so that outside of the U.S.
But Snap Inc is getting better, quickly. In the first half, international revenue rose to $61.9 million from $11.5 million in 2016. U.S. revenue skyrocketed 170% in the same period. Snap is developing new ad campaigns, improving its ad tech, and gaining some favor with the larger advertisers it needs to compete with not only Facebook, but Twitter Inc (NYSE:TWTR) and Alphabet Inc (NASDAQ:GOOGL).
That momentum is starting to slow, however. Deutsche Bank AG (USA) (NYSE:DB) analysts downgraded SNAP stock earlier this month, citing “waning” advertiser interest in the platform. Last month, Aegis Capital warned of a potential ‘ad recession’ in the U.S. Viacom, Inc. (NASDAQ:VIA, VIAB) reportedly has ended its Discover Channel on Snapchat.
If big advertisers, in particular, can’t quite figure out how to drive — or even measure — return on investment through Snapchat, monetization is going to be difficult. And if Snap Inc doesn’t improve per-user revenue, then SNAP stock is going to have to pull back.
SNAP Stock Is Just Too Expensive – Still
SNAP stock still trades at roughly 25x trailing revenue even backing out its cash, and the company remains sharply unprofitable on even an Adjusted EBITDA basis. It has to grow into its valuation, and to do so it needs to grow users and grow revenue per user.
But there are major challenges on both fronts — which create a tough path for Snapchat to even support the current valuation of SNAP stock. It needs to take at least some share from Facebook in terms of users. It also needs to either take ad dollars — or see enough growth in the online advertising space as a whole to drive growth for itself.
With user growth slowing, and monetization concerns rising, that combination just looks too tough. And it means SNAP stock is likely to disappoint again.
As of this writing, Vince Martin has no positions in any securities mentioned.
