Social media company Snap Inc. (SNAP) is looking up compared to a few years ago when investor confidence was nearing zero, with an all-time low stock price of $4.99. Although the outlook isn’t dire, SNAP is in a state of flux once again.
The fiscal comeback combined with the recent Q3 results and guidance has resulted in a more mixed market sentiment. I am bearish due to reliance on a single product and stagnating growth in key regions.
Singular Product
The largest risk to SNAP is the singular product: Snapchat. A single product increases the risk substantially. The more mature company Meta (FB) has multiple social network products: Facebook, Whatsapp, and Instagram, in addition to non-social network assets.
SNAP’s underlying product in its most basic form is peer-to-peer messaging, which is not unique in 2022. So remember, when you see the user counts, many people are not interacting with revenue-producing content, only the peer-to-peer messaging. Monetizing has always been the most pertinent issue for SNAP, and this issue has not disappeared.
We’ve seen SNAP try to branch out with the Spectacles, which initially can not be considered anything more than a failure. SNAP has made progress on the spectacles due to the large investment into augmented reality (AR). At most, Spectacles can be seen as a value-added product but will not and cannot stand alone.
Making the reliance on a singular product even worse is the fact of relying on an app, which is dependent on the two major app stores. In October 2021, SNAP fell ~25% overnight as Apple (AAPL) implemented privacy changes. The privacy changes ultimately affect SNAP’s top line due to the reduced ability to target advertising.
Since the FB and Cambridge Analytica scandal in 2018, privacy has increasingly become more of a concern among users and lawmakers. Although FB is normally front and center of hearings, any privacy regulations will materially affect SNAP.
People are slowly becoming aware of the significant data collection that social media platforms collect, and it is unlikely this trend will reverse, causing more demand for regulations.
User Trends
SNAP’s users, to no one’s surprise, are young. The target age group is 13-34. SNAP is already skimming the maximum possible user count with 90% and 75% for 13 to 24-year-olds and 25 to 34-year-olds, respectively, in key regions. On the surface, that may seem great, but it’s extremely concerning for growth.
In North America, SNAP is only gaining one or two million DAU per quarter for years now, and only slightly higher growth for Europe. Almost all the growth is coming from the “rest of the world,” the lowest revenue region.
The only way to substantially increase revenue is to increase average revenue per user (ARPU). As SNAP describes: “North America is critical to growing revenue in the near and medium term, and we have a long runway ahead of us.”
The core problem with SNAP’s ARPU is the users who only use Snapchat as a messaging app, whose average revenue is insignificant. SNAP can’t just drop the low revenue users to reduce costs because social media requires high user counts.
The global trend of rising interest rates in 2022 will go against SNAP’s revenue. As interest rates rise, economic growth will slow, resulting in lower advertising expenditure.
Dilution
SNAP’s operating cash flow (OCF) of $71.5 million for Q3 seemingly shows a sign of relief, but I believe this is not the case. The issue is SNAP is relying on stock-based compensation, which many young and small companies do.
The problem is SNAP is priced well too high to be considered small anymore and has been publicly listed for just under five years. If stock-based compensation were to be included in OCF, it would be a gloom drop of ~$228 million.
Investors need to remember stock compensation can be treated similarly to issuing stock in the market and paying employees. If this were a one-off or temporary expense, it could be ignored, but it seems to be persistent.
Combined with the economic slowdown, a general fall or stagnation in equity markets isn’t unlikely. The recent tech slump is evidence of initial market movements which will devalue SNAP. If this does occur, SNAP will need to dilute even more to meet costs.
Manage has given the Q4 guidance of $1.165 billion to $1.205 billion, which has already disappointed some investors due to lower expected growth than previous quarters. If Q4 misses guidance, it will exacerbate SNAP’s dilution problems due to a most likely lower stock price.
Wall Street’s Take
Turning to Wall Street, SNAP stock earns a Strong Buy consensus rating based on 21 Buys and seven Hold ratings assigned during the past three months.
The average SNAP price target of $70.38 implies 96.8% upside potential.
Concluding
SNAP is going to face headwinds due to market conditions and demographics while still not being profitable after being public for nearly five years.
The risk of being reliant on a singular product is underestimated, as seen by the significant correction in October. I am a contrarian when it comes to SNAP, but to me, it is a Sell.
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