For the first time since going public, social-media-turned-camera company Snap Inc (NYSE:SNAP) reported blowout quarterly numbers. And SNAP stock is up more than 37% as a result.
But can one quarter really change the whole narrative surrounding this troubled company?
Maybe. It pays to remember that all Facebook Inc (NASDAQ:FB) needed was one quarter to turn its whole growth narrative around. Since that critical July 2013 quarter, FB stock has never looked back on its way from $26 to $180.
SNAP stock won’t increase by seven-fold in value over the next several years. But the quarter proved that SNAP stock also isn’t graveyard bound. The numbers imply that there is upside potential from here for Snap as a niche digital advertising player with a tremendous value prop for small to medium sized businesses. From that perspective, even a former bear like me thinks SNAP stock can trend towards $40-plus over the next 5 years.
Here’s how I get there.
Why One Quarter Was All Snap Inc Needed
Even though I have been an outspoken bear on SNAP stock, I have also said time and time again that all this stock needed to turn itself around was one really good quarter.
Just look at Facebook. FB stock struggled as much, if not even more, than SNAP stock when it first went public. But all those struggles went away after a blowout July 2013 quarter that underscored the ramp in the company’s all-important mobile business. After that report, FB stock surged more than 30% higher, an almost identical move to the one SNAP is making today.
In that July 2013 quarter, Facebook managed to turn a secular headwind (lack of mobile presence) into a secular tailwind (booming mobile business). In the most recent quarter, Snap is proving it can do the same thing.
Before this quarter, slow user growth stuck in the 5 to 8 million new users per quarter level was a major headwind for SNAP stock. But the company added 9 million new daily users this quarter, its best mark since the third quarter of 2016 (before Instagram Stories). The ramp in user growth is largely attributed to the company’s improved Android app, as Android users drove record high contribution to total net adds.
With Android ramp now in the picture, Snap’s user growth runway just got a lot more promising. No longer is this a company with a maxed out user base. An improved Android app will significantly help this company grow its international presence and thereby boost the total user base.
Snap also turned its slowing ad revenue growth headwind into an accelerating growth tailwind. Revenue growth accelerated from 62% last quarter to 72% this quarter. The acceleration can be attributed to demand ramp from small- and medium-sized businesses thanks to the company largely completing their transition to an auction ad model (which allows for pretty much anyone, not just big players, to buy ads).
The result of this transition was that for the first time in the company’s history, revenue from advertisers outside of the Ad Age Top 100 exceeded revenue from those advertisers in the Top 100.
This is how things will play out into the foreseeable future. The Top 100 players will continue to allocate ad dollars to Facebook and Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) because they need more reach. But small- to medium-sized businesses don’t necessarily need max reach. They need max engagement, and highly targeted advertising. Snap offers that. So small- to medium-sized businesses will continue to flock to Snap.
In this sense, Snap is crafting a future for itself as a niche, digital advertising player perfect for small- to medium-sized businesses seeking maximal engagement in a specific, teen-centered demographic. That has tremendous value. Not Facebook level value, but more value than what the current stock price reflects.
How SNAP Can Get to $40-Plus
I think there is now clear runway for Snap to keep adding just under 20 million new users per year and get to 300 million daily users by 2023. At that point in time, I also believe that small- to medium-sized business demand ramp will drive quarterly average revenue per user to $6.50, slightly above current Facebook levels. That ARPU ($26 annually) on 300 million users implies a total revenue base of $7.8 billion.
Facebook operates at 40%-plus operating margins. It will take Snap some time to get there, but I don’t think a 25% operating margin is out of the question by 2023. That would put operating profits at $1.95 billion by 2023, which after a 21% tax rate and on ~1.4 billion shares, equates to roughly $1.10 in earnings-per-share.
I also think that around this point in time, earnings growth will look something like 30% per year (driven by 10-15% revenue growth and big margin drivers). The forward multiple on SNAP stock should look something like 39, which would represent a market-average 1.3 price-to-earnings/growth (PEG) ratio.
Putting all that together, I think that by the end of 2022, SNAP stock should be trading at 39-times forward estimates of $1.10-per-share. That gets me to a $43 price target in 5 years. Discount that back by 15% per year, and I get to a present value of over $20.
Bottom Line on SNAP Stock
In the social media world, all you need is one really good quarter. Snap just had that good quarter, and successfully showed Wall Street that they are turning headwinds into tailwinds while crafting a sustainable future for themselves as a go-to ad destination for small- to medium-sized businesses.
That is a winning strategy that should turn SNAP into a winning stock.
As of this writing, Luke Lango was long FB and SNAP.
