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Snap’s Revenue Warning Had Really Poor Timing

SNAP stock - Snap’s Revenue Warning Had Really Poor Timing

Source: dennizn / Shutterstock.com

  • The first anniversary of Snap’s (SNAP) acquisition of augmented reality startup Wave Optics was on May 21.
  • Snap paid $542 million in cash and SNAP stock for the company.
  • Wave Optics’ shareholders could have gotten most of the payment in stock. Snap’s May 23 revenue warning most likely scuttled that.

On May 21, 2021, Snap (NYSE:SNAP) announced that it would acquire augmented reality (AR) startup Wave Optics for $542 million in cash and SNAP stock. At the time, Snap shares were trading around $54. They are down massively since.

Snap CEO Evan Spiegel spoiled the one-year anniversary of its Wave Optics acquisition when the company filed an 8-K on May 23, stating that it would report Q2 2022 sales and earnings below the low-end of its April 21 guidance.

In the last five trading days, Snap is down around 40%. The news is devastating to anyone holding SNAP stock, especially for any former Wave Optics shareholders still holding Snap.

Here’s why.

SNAP Snap Inc.  $13.29

The SNAP Stock Portion of Deal Now Highly Doubtful

Of the $510.4 million in actual consideration — $31.4 million as compensation for future employment services of Wave Optics’ staff — $252 million was for upfront stock ($53.62 a share). Snap also paid out $13.7 million in upfront cash. It’s Snap’s choice how the remaining $238.4 million is paid out. It can be in cash, stock, or a combination of both by May 2023.

SNAP stock has lost 75% of its value over the past year. At current prices, one would expect that the company would almost certainly choose the cash component for the second payment.

That’s unfortunate for Wave Optics’ former shareholders, some of whom are likely still holding SNAP stock at highly discounted levels thanks to a slowdown in Snap’s business.

SNAP Takes a Hit

I don’t think there’s any doubt that the markets will continue to suffer. We’ve got a global economy facing high inflation, a brutal war, Covid-19 and supply chain issues that have cut margins, making it impossible for investors to get excited about stocks.

Snap can’t do anything about investor uneasiness.

What it can do is continue delivering growth. Monday’s announcement puts that in jeopardy.

I thought its first-quarter results weren’t too bad, even though it missed analyst estimates. Its daily active users (DAUs) increased 18% year-over-year to 332 million, beating its projection of 329 million at the midpoint of its guidance. Sequentially, it grew DAUs by 4.1%. Sequential growth is always good.

However, investors weren’t all that impressed by its results. Its 18% DAU growth rate was 200 basis points less than its growth in Q4 2021 and 400 basis points less than Q1 2021.

In addition, during its April conference call, CEO Evan Spiegel said that the first quarter’s ad environment was challenging and unlikely to get better in the second quarter. He was right. Apple’s (NASDAQ:AAPL) iOS privacy changes haven’t helped.

The company’s underlying financials aren’t all that bad from where I sit. But, of course, Spiegel’s latest comments suggest things could get worse before they get better.

The SNAP Stock Financials Aren’t That Bad

As the company pointed out in its Q1 2022 press release, it was the third consecutive quarter with positive free cash flow (FCF). As a result, its trailing 12 months (TTM) FCF was $203.3 million, 314% higher than a year earlier. It now has two consecutive quarters with positive TTM FCF. 

Sure, the non-GAAP loss of $39.3 million compared to a $2.6 million profit a year ago doesn’t look so hot, but as long as it’s generating more cash than it needs to keep the lights on and the business running, it’s been heading in the right direction.

Furthermore, since Q4 2020, it’s grown its TTM sales by 76%, from $2.5 billion to $4.4 billion in Q1 2022. In Q4 2020, its North American TTM revenue accounted for 71% overall. North America accounted for 72% of its TTM sales in the first quarter. If Snap could ever figure out how to accelerate its growth outside North America, the profit potential is significant. 

Lastly, the company’s TTM adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) over the past six quarters have increased by 1,412%, from $45.2 million in Q4 2020 to $682.9 million in Q1 2022. That’s five consecutive quarters with increasing adjusted EBITDA.

These numbers I’ve mentioned will take a step back in the second quarter, which is unfortunate for former Wave Optics shareholders.

What Will Snap Do?

Wave Optics likely wouldn’t have agreed to the deal’s structure if they thought Snap’s long-term trajectory was poor.

As TechCrunch’s Ingrid Lunden pointed out when the deal was announced a year ago in May, it was “Snap’s biggest acquisition to date in terms of valuation.” Wave Optics had to give up something in return to get the premium valuation. That something was the second payment’s variable structure.

Imagine if Snap’s stock had gone up 75% over the past year instead of down. The company could have fulfilled the $238.4 million payment by issuing 2.54 million shares instead of 17.94 million it would have to issue at current prices.

Fortunately, Snap’s still got another year to see if it can’t get its share price back to where it was when the deal was struck. If it doesn’t, it’s got more than $5 billion in cash and marketable securities on its balance sheet to complete the terms of the acquisition.

It’s a challenging goal in today’s bearish environment. I hope the Wave Optics shareholders who got Snap stock in the first payment have already sold. If not, it’s a lesson learned about why taking cash is the only way to go when selling a business.

On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia.

Article printed from InvestorPlace Media, https://investorplace.com/2022/05/snaps-revenue-warning-is-really-poor-timing-for-snap-stock/.

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