Snap (NYSE:SNAP) shares have been one of the best performers of 2019. Among stocks with a market capitalization over $10 billion, only Asian digital entertainment provider Sea Limited (NYSE:SE) has outperformed the 115% rise in the SNAP stock price. Snap stock (or Snapchat stock, as it’s sometimes to referred to) had gone pretty much straight down following its 2017 IPO, but clearly investor attitudes have changed.
As I wrote earlier this year, there are some reasons for optimism. Revenue is growing, monetization is improving, and losses are narrowing. Both fourth quarter and first quarter earnings came in above expectations. Viewed from a certain angle, Snap Inc seems to be back on track.
I’m still skeptical that’s the case, however. The numbers are getting better – but they’re hardly good. And there are still clear reasons to wonder whether Snap can generate real profits of any kind, at any point. The gains still look like they’ve gone too far — and will fade quickly if Snap stumbles again.
SNAP Stock and Profitability
Snap isn’t profitable or anywhere close. The company posted an adjusted EBITDA loss of some $575 million in 2018. In Q1, the loss narrowed by $94 million but still came in at $123 million. Q2 guidance suggests less in the way of improvement, with a loss of $125 million-$150 million against $169 million the year before.
On its own, the absence of profitability isn’t fatal to the bull case for Snap stock. The company still has $1.2 billion in cash and investments on the balance sheet. It’s highly unlikely that Snap goes kaput. The current losses are coming in part from investments aimed at driving future growth. Just because Snap profits are negative doesn’t mean the Snap stock price should be at zero … or anywhere close.
But the current valuation — nearly $15 billion even net of cash — suggests that profits will come at some point, and likely big profits. Yet the stumbling blocks on that path remain.
Monetization and the SNAP Stock Price
Snap revenues are a function of two factors: the size of its user base and its ability to monetize those users. On the latter aspect, Snap has room for growth, notably outside of North America. In Q1, for instance, Snap generated $2.81 per user in North America, a figure some 34% year-over-year.
However, ARPU (average revenue per user) was just 77 cents in Europe, and 97 cents in the rest of the world. Those overseas markets have more room for improvement: ARPU rose 47% in Europe and 68% elsewhere.
Improving user monetization is the primary catalyst to Snap’s growth and its eventual profitability. Facebook (NASDAQ:FB), for instance, generated more than$39 per average daily user in North America in its first quarter. Even if Snap can get to a third of that level, its North America revenue would rise more than 300%. That kind of move would put Snapchat in line with Twitter (NYSE:TWTR), who generated over $13 per U.S. daily user in Q1.
That said, it’s a long — and uncertain — road to get there. Snapchat has a more mobile-heavy interface, which hurts advertising space. Monetization improvement already is slowing. More broadly, Snapchat isn’t Facebook and it may not even be Twitter. At least for now, it remains a much more niche business.
And the underlying problem here — and the key reason why SNAP stock largely has struggled since its IPO — is that its niche isn’t growing. Daily active user growth remains minimal: Snapchat’s DAU base has risen less than 2% in the last five quarters.
Still, the base is solid: roughly 50% higher than that of Twitter. But even Twitter has managed to post growth of late. And as Snap itself noted in its Q1 report, the company reaches 90% of all 13-24 year-olds, and 75% of those between the ages of 13 and 34.
There’s not much room left for Snapchat to grow in those age ranges. Efforts to expand to older consumers largely have failed. And so Snapchat’s growth requires monetization improvement but at this point, that simply doesn’t seem like enough.
How Snapchat Stock Moves Higher
Is monetization enough to get Snap profitable? It’s hardly guaranteed. The company in Q1 still lost, on the EBITDA line, almost 40 cents on every dollar of revenue. Add back the $160 million-plus in share-based compensation and the figure gets well north of 80 cents on the dollar.
This is a sharply, sharply unprofitable company. If revenue doubles, Snap likely still isn’t generating even cash flow to offset the dilution to shareholders from employee stock options. If it triples, Snap maybe posts consistent non-GAAP profits.
We’re probably at least five years from that point … if Snap gets there at all. And if the company has to do all the heavy lifting by itself — doing the tougher work of convincing advertisers to spend, rather than getting more users to join the network — it’s going to cost quite a bit of money in the process. It’s not just Facebook and Twitter that it’s competing against, but Alphabet (NASDAQ:GOOGL) and now Amazon (NASDAQ:AMZN) with its own advertising platform.
It’s worth noting that this core problem — a lack of user growth — isn’t new. It’s why SNAP stock tumbled to $5 in December. Investors didn’t trust the company’s growth prospects. Execution is better, and ARPU is growing, so some optimism makes some sense.
But a clean double looks like too much and so does a $15 billion valuation. Snap Inc still has a lot of work left to do just to get profits in the range of breakeven. It seems unlikely investors will stay patient the entire time.
As of this writing, Vince Martin has no positions in any securities mentioned.