Shares of social media platform and digital ad company Snap (NYSE:SNAP) have fallen off a cliff in the wake of the novel coronavirus pandemic going global. And with good reason. With the economy coming to a screeching halt, ad budgets will get whacked over the next few months, and especially Snap ad budgets given the platform has broad exposure to brand and discretionary advertising (i.e., advertising on trendy brand products that consumers aren’t interested in buying right now).
It makes sense, then, that SNAP stock is down about 40% from its early February highs.
At the same time, it makes sense why long-term investors would want to buy this big dip in SNAP.
The bull thesis here is pretty simple and compelling, and it breaks down into the five following parts:
- Consumer discretionary spend — and advertising — will rebound once the virus fades, likely by summer. Current modeling projects that the coronavirus pandemic will peak in mid-April, and be largely contained by May or June, paving the path for an economic and digital ad market rebound in Q3.
- Snap will see record high engagement and robust user growth in the second quarter. Snap has already reported record high engagement figures for March, and those record high engagement figures will only go higher in April.
- Once the digital ad market rebounds, Snap will turn record high engagement into record high sales. Ad dollars follow engagement, always, so once the ad market rebounds in the back-half of the year, Snap will turn record high second-quarter engagement into record high second half sales.
- All financial trends are moving in the right direction for Snap right now. Snap’s user base is growing. Average revenue per user is rising. Gross margins are rising. Expense rates are falling. Operating margins are expanding. Net losses are narrowing, and will soon turn into net profits.
- SNAP stock has significant upside potential into the end of the year. My modeling suggests that SNAP could finish the year around $17.
All in all, then, I think now may be the time to get bullish on the stock. I like SNAP at $10 and lower, all else equal. Here’s a deeper look at why.
Digital Advertising Trends Will Rebound
Current coronavirus pandemic modeling, based on the epidemic’s spread in various different regions, suggests that social distancing will work to essentially halt spread of the virus by May or June.
If true, today’s social distancing measures will be removed by summer 2020, at which point tremendous fiscal and monetary stimulus will turn pent-up consumer demand into robust consumer discretionary spend. Robust consumer discretionary spend will translate into a strong recovery in digital advertising trends.
Such strong digital advertising trends should persist into the back-half of 2020 as the economy gradually normalizes.
Record High Engagement in Q2
Snap recently reported that, not surprisingly, the platform saw record high engagement in March as consumers across the globe were told to stay at home.
This record high engagement will only go higher in April, as “stay at home” orders across the globe remain in place, and as consumers become increasingly bored and turn to exploring digital platforms for entertainment. This will lead to new users signing up for Snap, inactive users turning into active users, and active users increasing time spent on the app.
Net net, Snap’s user and engagement growth trajectories should meaningfully accelerate in the second quarter.
Record High Sales in 2H20
Meaningful user and engagement growth in the second quarter will coincide with a drop-off in sales growth, mostly because advertisers won’t spend that much in April or May as the virus keeps the economy at a standstill.
But, ad dollars always follow engagement. So, once ad spending trends do rebound in the third and fourth quarters, Snap is well-positioned to see a huge influx of ad dollars chasing the platform’s record high engagement.
In this sense, Snap’s record high engagement today paves the path for record high sales tomorrow.
Strong Financial Trends
Before the pandemic, all of Snap’s important financial trends were moving in the right direction.
In the fourth quarter of 2019, the user base added 8 million new daily actives. Average revenue per user rose more than 20% year-over-year. Revenues rose more than 40% year-over-year. Gross margins improved by 460 basis points sequentially. The opex rate dropped 13 percentage points sequentially. Adjusted earnings before interest, taxes, depreciation and amortization turned positive.
These financial trends may take a sidestep in the second quarter at the peak of the coronavirus pandemic. But, once the virus fades away and economic activity normalizes, all these favorable financial trends should resume.
Huge Upside Potential
From where the stock sits today, my modeling suggests that shares have huge upside potential over the next 8 months.
I’ve reduced my fiscal 2020 and 2021 estimates on Snap to account for coronavirus pandemic disruption. Still, into 2025, I see the company growing users at a roughly 5% annual clip, average revenue per user at a 15% annual clip, and revenues at a 20%-plus clip. Gross margins appear to be on a glide path toward 80% by then. Expense rates should continue to move lower, as the company has proven its ability to grow while exercising strict cost control.
Net net, I’ve revised my 2025 earnings-per-share estimate lower on Snap, from $1.50 a few weeks ago, to $1.25 today. Still, based on a 20-times exit multiple and 10% annual discount rate, that equates to a 2020 price target for SNAP stock of $17.
Bottom Line on SNAP Stock
The near-term coronavirus headwinds impacting the digital ad market will pass. Once they do, Snap will turn today’s record high engagement, into tomorrow’s record high sales. I expect this pivot to take place sometime in the summer, and for it to push SNAP stock toward $17 by the end of the year.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he was long SNAP.