What happens after a stock loses half its value in just three months? Believers in the idea of reversion to the mean would suggest that the next move should be upward. Unfortunately, for Snap Inc (NYSE:SNAP), don’t count on a big bounce. In fact, the next move for SNAP stock should be a trip to single digits.
Just three months ago, I warned readers to “Lock in Your Snap Inc Gains Before They Disappear.” Since then, SNAP stock has tanked from $20 to under $11 today.
Even that dramatic decline is hardly the end of Snap’s troubles, however. While the stock has gotten a lot cheaper, Snap’s competitive position has become even worse. Here’s why SNAP stock is still dangerous, even down under $11/share.
SNAP Continues to Lose Money
Snap’s most recent earnings report was a major fiasco for several reasons. But let’s start with the simplest. This company is nowhere near becoming consistently profitable. As I’ve discussed previously, social media stocks tend to underperform the market until they turn EPS positive.
That’s why I’m avoiding Spotify Technology SA (NYSE:SPOT) for now, and why Snap is also struggling. The big run comes in a name like Twitter Inc (NYSE:TWTR) once it starts guiding to profitability. SNAP is not there yet.
If anything, Snap’s profitability is getting worse. In Q1, the company reported its widest losses on both an EBITDA and free cash flow basis out of the past five quarters.
For a year-over-year comparison, Q1 2018 saw adjusted EBITDA slip from -$188 million to -$218 million. Free cash flow fared even worse, dropping from -$173 million in Q1 2017 to -$268 million this time around. At that pace, Snap is set to blow through about a billion dollars of investors’ cash this year.
To add insult to injury, Snap paid out a gigantic $133 million in stock-based compensation in Q1, despite the distinctive lack of revenue growth or share price appreciation that investors had hoped for.
Analysts Dumping on SNAP Stock
Investment banking analysis of stocks is often inaccurate. Professional analysts tend to be too positive on stocks for a variety of reasons. However, it’s extremely noteworthy when a bunch of analysts all say to avoid a stock and put sour price targets on a company. Given Wall Street’s optimistic bias, a bunch of negative calls is a glaring red flag.
Following Snap’s underwhelming quarter, analysts rush to cut their outlooks. Oppenheimer cut the stock to “Market Perform,” citing issues with advertisers. Evercore cut the stock to “Underperform” with a $9 price target. Morgan Stanley topped even that, cutting its price target for SNAP stock down to $8, or around 25% more downside from today’s prices.
It’s Still Expensive
In my previous article, I warned about how ludicrously expensive SNAP stock was compared to other social media names. Even after a massive drop in the share price, SNAP stock is still the outlier on the price/sales ratio.
Investors are still paying 15x sales for SNAP stock, despite revenue growth coming in way light this quarter.
Facebook, Inc. (NASDAQ:FB), which is growing quickly and produces outlandish profits, sells at 12x sales. Twitter, which has reached a respectable level of profitability, is down at 9.5x sales. Spotify, which is unprofitable but has a much stronger market position than Snap, is way down at 6x sales.
It’s hard to look at these comparable companies and say that SNAP stock makes any sense at 15x. In fact, anything over 10x is quite hard to justify. That’d be trouble for SNAP stock, though, amounting to a share price under $8. And it’s quite realistic.
With the major slowdown in revenue growth, Snap no longer deserves any premium on that front. Revenues sequentially declined from $286 million in Q4 to $231 million this quarter. Even excluding the holiday quarter, this quarter topped Q3 2017’s revenues by just 10%, showing that Snap is no longer growing quickly at all.
Facebook Threat Looms
Even if all those problems weren’t enough, Snap still faces an existential problem. Its name is Facebook. Ever since Snap started picking up steam, Facebook has imitated many of Snap’s best features. Following the Snap IPO, Facebook’s Instagram in particular cloned much of Snap’s functionality seemingly in a move to crush the new rival.
With Facebook’s massive user base across platforms, it’s hard for a tiny company like Snap to compete. Let’s not mince words here. Facebook has $44 billion of cash sitting on its balance sheet. Snap has a market cap of just $13 billion. That should give a sense of the David-and-Goliath-style odds here of Snap beating out Facebook’s social media apps and advertising engine.
On top of that, Facebook’s Cambridge Analytica scandal will result in more regulation on the industry as a whole. In a perverse sort of way, this is likely to hurt Snap more than Facebook.
Snap has a tiny fraction of the online market, and as we saw this quarter, it has issues with some of its advertisers. Facebook, by contrast, is so huge that advertisers have to go there whether they like it or not. Very few major advertisers left the platform in the wake of the recent controversy.
SNAP Stock: Heading for Single Digits
Sure, SNAP stock could rally in the short term. It’s been sold heavily in recent weeks. Short sellers have been having a feast. They still make up 12% of the float, however, potentially setting the stage for a short squeeze.
In the bigger picture, though, there’s little to like here. Snap is seeing its losses actually widen. Revenue growth has stalled out. Management didn’t articulate a clear vision of how it’d improve these things on its conference call, leading analysts to downgrade the stock.
And at the end of the day, even if Snap were performing better, it still faces the prospect of a long and difficult battle against Facebook. Add it all up, and SNAP stock is still a clear avoid here.
At the time of this writing, the author owned FB stock and had no positions in the other aforementioned securities. You can reach him on Twitter at @irbezek.