Shares of Snap (NYSE:SNAP) initially popped more than 10% in after-hours trade after the social media company reported better-than-expected first quarter numbers in late April. But, the rally didn’t last. By the time the conference call rolled around, Snap stock had given up most of its after-hours gains. The next day, SNAP stock fell into the red by more than 5%. A 10% gain turned into a 5% loss, all in the matter of less than 24 hours following its Q1 earnings report.
Why the big reversal? The numbers beat expectations, so you had an initial surge of buyer enthusiasm. But, they weren’t good enough to justify the huge year-to-date rally in the stock, so as investors took a closer look at those numbers and saw some red flags, the selling ensued.
Those red flags include a user base that’s stalled out, revenue growth that isn’t too impressive and is projected to slow, a demographic reach that’s too narrow to justify huge value add in the long run, and a P&L that’s still littered in red. Broadly speaking, that’s simply too many red flags for a stock that’s trading at over 10-times this year’s sales estimates.
Consequently, the big takeaway here is that the Q1 earnings report confirms that Snap stock is a tough buy above $10. Because of this, the current SNAP sell-off will likely persist until the shares normalize to more reasonable valuation levels.
Q1 Earnings Confirm Growth Concerns
To be sure, Snap did beat on all the important metrics. Revenues topped expectations. The company added more users than expected. Net loss per share was narrower than expected. Average revenue per user, or ARPU, came in above expectations.
But, that doesn’t mean much. Snap beat sell-side estimates, sure, but the sell-side consensus price target on Snap stock is below $10. Thus, Snap topped estimates from analysts who believe the stock’s forward 12-month price target is 15% below the current market value. As such, in order to get a pop in Snap stock, the company needed to smash sell-side estimates, and they didn’t do that.
Instead, the beats were narrow, and the trends confirmed that Snap still has a few major growth problems to deal with. Namely:
- The user base is stalled out. Snap added 4 million users in the quarter, but the user base is still smaller than it was a year ago, and appears to be stagnating in the 190 million to 200 million range.
- Revenue growth is slowing. Sales rose 39% in the quarter. That’s down from 54% growth in the year ago quarter. Next quarter, revenue growth is projected to slow to under 33%. By comparison, the much-bigger Facebook (NASDAQ:FB) is growing at roughly the same rate (30% revenue growth last quarter).
- Narrow reach implies medium-term value cap. Snap is touting its ability to reach 75% of Americans between the ages of 13-34, but that simultaneously implies exceptionally limited reach outside of that demographic, and the big spenders in the U.S. economy are outside of that demographic.
- The company is still running huge losses. Although gross margins are improving and opex rates are falling, Snap is still running huge losses amid slowing revenue growth, and that’s not a great combo since the company needs huge revenue growth to drive sufficient opex leverage to produce profits.
Overall, then, Snap’s quarter wasn’t great. Sure, the company beat depressed sell-side estimates. But, the report didn’t assuage going concerns related to stalled out user growth, slowing revenue growth, and profitability.
Snap Stock Is A Tough Buy North Of $10
According to my numbers, Snap stock is simply overvalued above $10 at this point in time.
Snap’s user base currently hovers around 190 million. It has hovered around that number for several quarters now, importantly ever since the widespread launch of Instagram Stories and WhatsApp Status. It increasingly appears that competitive dynamics have put a lid on Snap’s user base. Ultimately, this user base likely won’t get much bigger than 200 million users in the long run.
Quarterly ARPU was $1.68 last quarter. That’s fairly low. At Facebook, ARPU exceeded $10 last quarter, but that number is skewed because it includes Instagram revenue in the numerator but not Instagram users in the denominator. Still, over at Twitter (NYSE:TWTR), quarterly ARPU was around $6 last quarter, and that number appears close to maxing out as it was up just 6% year-over-year.
The bull thesis is for Snap’s ARPU to hit and exceed $6 in the long run. But, that won’t happen. Snap’s cohort of under-34-year-old’s spend — on average — is 25% less than the average American. So, from an expenditures viewpoint, each user on Snap is arguably 25% less valuable than each user on social media platform with normal demographics, like Twitter. At scale, then, Snap’s ARPU likely won’t ever hit $6 given its focus on a low-income, low-spend group. Instead, it will probably max out around $5.
Assuming so, and that gross margins scale towards 80% while the opex rate falls towards 30%, then I think Snap can reasonably do about $0.70 in earnings per share by fiscal 2025. Based on a digital ad average 25 forward multiple, that implies a reasonable 2024 price target for Snap stock of $17.50. Discounted back by 10% per year, that equates to a fiscal 2019 price target of just under $11.
Considering we are just one quarter into fiscal 2019, Snap stock is a tough buy above $10.
Bottom Line on SNAP Stock
Heading into the first quarter print, Snap stock was slightly overvalued and due for a pullback. Now, that pullback is happening. It will continue for the foreseeable future, because shares remain richly valued and the fundamentals remain challenged. Fundamental support will kick in around $10. Until then, I’m not interested in buying the dip and adopting my own take on the trending Snapchat #WCW hashtag: We Can Wait.
As of this writing, Luke Lango was long FB.
