I’ve argued since the March 2017 that there’s a simple problem with Snap (NYSE:SNAP) stock: expectations are too high. It’s easy to forget that Snap as a company is less than seven years old.
The company, and CEO Evan Spiegel, still are learning how to satisfy users and how to sell to advertisers. This remains an early- to mid-stage company and a successful one at that. Gaining 188 million daily active users in less than seven years is quite an accomplishment. Snap has had its share of stumbles to be sure, but most young high-growth companies do.
Yet SNAP stock, from the jump, has been priced as if it were something more. The obvious bull case was that Snapchat would become the next Facebook (NASDAQ:FB). Given the half-trillion-dollar market cap assigned to that company, even a minimal chance of that story playing out assigned significant value to SNAP stock.
But that story always seemed thin and seems thinner now. Facebook’s Instagram has essentially copied Snapchat and stunted its growth as a result. Snap posted a concerning decline in DAUs (daily active users) in Q2, which led SNAP stock lower. Snapchat looks locked into fourth place at best in social media, behind Facebook, Instagram and Twitter (NYSE:TWTR).
At the lows, there’s a case not to give up on SNAP just yet. But there’s a stronger case to leave the stock be and hope for either a lower price or better execution.
The Case for SNAP Stock
There’s two things Snap has going for it at the moment. It has enormous room for improvement, and time for that improvement to take place.
There are opportunities here to better monetize the existing user base. International monetization is limited. In Q2, according to the 10-Q, ARPU (average revenue per user, per quarter) was $2.21 in North America. It was $0.66 — 30% of the North American figure — in Europe and $0.96 in the rest of the world.
Those numbers are going to rise — particularly overseas — as advertisers become more comfortable with the platform and Snap improves and develops its own sales and marketing. Indeed, Twitter stock more than tripled in two years without much user growth as it improved its video strategy and made itself more attractive to advertisers.
As Larry Ramer pointed out this month, Snap is trying to provide better advertisements to its customers than Facebook or Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG). If that works, revenue growth will come even if user growth doesn’t.
Meanwhile, Snap has time. Adjusted EBITDA and cash flow both remain negative. But the company still has $1.5 billion in cash and securities. It just sold a 2.3% stake to Saudi Arabia’s Prince Alwaleed Bin Talal, bringing in another $250 million in cash. This is not a company that will go bankrupt any time soon, despite the losses.
The Case Against Snap Stock
The problem with the bull case remains the same: it’s not good enough from a valuation standpoint. Revenue will get better — it rose 44% in Q2 — but Snap is a long way from profitability. Snap won’t go bankrupt, but that doesn’t mean the business is worth $14 billion, the current valuation even backing out the cash on the books.
Indeed, even if Snap follows Twitter, I’m not sure the stock is all that cheap. Twitter is worth about $24 billion at the moment.
Assume Snap can get to a similar profile in five years — profitability, modest user growth, a clear niche in the social media ecosystem — and discount that valuation back at 10% to account for risk. SNAP stock in that model is worth $15 billion, or a little over $12 per share.
I do think Snap will probably be profitable at some point. But even that’s not guaranteed. The app redesign clearly has backfired. DAUs are now moving in the wrong direction. The hardware ambitions have never panned out. Bulls may stop asking whether Snap is the next Facebook. The more interesting question might be whether it’s the next Myspace.
The target demographic here generally has been teens and young adults. If they age out of the platform, and the next generation doesn’t follow, the user base can collapse. And the double-edged sword of the social media business model is that more users lead to more users, while less users lead to even fewer users.
As far as takeover potential goes, I’m skeptical. Facebook clearly isn’t a buyer. Google hasn’t shown much appetite for the space after its Google+ misadventure. I’d point out that Twitter tried to sell itself but couldn’t. Yahoo, now Altaba (NASDAQ:AABA), couldn’t find a buyer once its business started to decline, and finally sold to Verizon for $4.5 billion, a fraction of its peak valuation.
That’s a very possible outcome for Snap as well. And at a $14-billion valuation, with user growth stalling out, it’s not an outcome that is appropriately priced in.
As of this writing, Vince Martin has no positions in any securities mentioned.
