I’ve written several times that I don’t necessarily think Snap Inc (NYSE:SNAP) is a bad stock. Is SNAP stock overvalued? Yes. Is SNAP a good buy? No.
But it’s not, intrinsically, a bad stock, or a bad company. It’s an early-stage growth company that’s still learning to monetize Snapchat users through advertising which is the major reason why Snap Inc remains unprofitable.
That growth admittedly has disappointed, particularly on the user front, leading SNAP stock to fall ~19% from its $17 IPO price and 53% from its all-time high above $29. Still, there is some growth. And Snap Inc is getting better as a company.
It’s monetizing those users more effectively, with ARPU (average revenue per user) growing 39% year-over-year in the third quarter according to the 10-Q. International revenue has nearly quadrupled so far this year, if off a small base. The growth drivers SNAP bulls cited at the time of the IPO have disappointed – but they still exist.
And now, as promised after Snap’s Q3 earnings report, Snap Inc is taking another step. The company has redesigned its platform to improve the user experience. Investors seem to be willing to give the new look a chance, with SNAP stock having bounced about 12% since its post-earnings sell-off.
But the problem with SNAP remains, as I’ve argued for some time, that expectations are just too high. Even with a much cheaper price for the maker of Snapchat stock, and even assuming some success from the redesign (which isn’t guaranteed), that’s still the case.
The Benefits of the Snapchat Redesign
William White detailed the Snapchat redesign on this site earlier this week. In an op-ed written on Axios, Snap CEO Evan Spiegel explained some of the changes, notably that the company was “separating the social from the media.”
Snap is going a different way, with the CEO saying it would use algorithms to recommend content, a process he compared to that of Netflix, Inc. (NASDAQ:NFLX).
From a consumer standpoint, the changes make some sense, and it’s possible they could limit the very-real “fake news” problem on social media. From an investment standpoint, the odds of success are more questionable.
Remember that there are two potential drivers for Snapchat revenue growth. The first is to increase the user base. On that front, the redesign appears a way to mimic other sites. For instance, it has moved to vertical scrolling from horizontal and making the site look more like Facebook and Twitter.
In theory, this should attract users beyond Snapchat’s core, younger demographics and hopefully accelerate what’s been disappointing user growth in the process.
That weaker-than-hoped user growth has been a key reason why SNAP stock has struggled so far. An acceleration could change the narrative here.
The Risks to SNAP Stock
The second growth driver is revenue per user. There, the news looks potentially more concerning. The separation of news and communication could lower engagement on the content side. And it’s precisely on that side that user monetization (i.e., ad sales) is most effective.
Social concerns aside, there’s a reason why Facebook and Twitter are so content-heavy. More broadly, there’s still the question of whether even a successful redesign is enough to support the current valuation. This remains an unprofitable company trading at roughly 16x 2017 revenue on an enterprise basis.
User growth has been in the mid-single-digits at best going back to Q4 2016, before the Snap IPO. As a point of comparison, Shopify Inc (US) (NYSE:SHOP), admittedly a very different company, trades at roughly 14x revenue on the same basis.
It’s turning profitable, dominates its niche, and is posting very high revenue growth rates of its own. And yet that stock remains dogged by valuation concerns while trading at a discount to SNAP, at least on an EV/revenue basis.
There’s simply so much growth baked into SNAP stock, even 50%+ off the highs. And I’m skeptical a redesign is anywhere close to enough to fix that problem. The redesign is likely to have some success. Monetization will improve. User growth isn’t over.
And yet, those expectations remain too high and there’s a real risk that Snap’s strategy changes will help the platform and hurt profits. At the end of the day, the story remains the same. Snapchat is improving and SNAP stock is too expensive.
As of this writing, Vince Martin has no positions in any securities mentioned.