Snap Earnings: I’d Sit This One Out (NYSE:SNAP)

Snap Inc. (NYSE:SNAP) is about to release its third quarter earnings. On Thursday, it will give investors insights on user levels, revenue, earnings and more. Earlier this week, Netflix (NFLX) released its own earnings report, and beat expectations. NFLX rallied 13.8% after hours when the release came out.

For a little context, Snap, Netflix and Meta Platforms (META) have traded like a “basket” of stocks this year. They’ve been missing earnings by wider margins than their larger tech peers, as a result investors have been trading them based on one another’s releases. For example, after Netflix beat earnings expectations, Meta and Snap both rallied after hours: 1.5% for META and 2.92% for Snap.

Snap is the next of these companies in line to release earnings. The expectations are for $1.13 billion in revenue and $-0.01 in earnings per share (“EPS”). The stakes couldn’t possibly be higher. In 2022, the reactions to earnings releases have been extreme. Netflix has repeatedly moved by 10%, 20% or more after earnings, as have Snap and Meta. The after hours momentum in NFLX and SNAP shares after Netflix’s release was a sight to behold. Snap’s release could have a similar effect, not only on itself, but also on the third company in line: Meta Platforms.

The way in which Snap’s release could impact Meta is a topic in itself. Snap and Meta are both ad-tech companies so there is some actual information value in Snap’s release for Meta and even Alphabet (GOOG) shareholders. I do not believe that Netflix’s results are really material to the rest of the companies named here, but the markets seem to think that they are.

Regardless, the real point is how Snap’s release will impact Snap itself. SNAP shares have gotten quite cheap lately (I mean “cheap in dollars” not “cheap relative to fundamentals”), and a decent few people are bullish on the stock. If you look at recent SNAP coverage on Seeking Alpha, you will see that three of the last five articles (excluding this one) rate the stock a ‘buy,’ and one rates it a ‘hold.’ Overall, Wall Street, Seeking Alpha Quant and Seeking Alpha Contributors agree that the stock is a ‘hold.’

I happen to agree with this consensus. Snap stock is not as expensive as it used to be, but it’s still fairly expensive. Its earnings and cash flow multiples are very high, but the recent selloff took the sales and book value multiples to within the realm of sanity. Based on the previous two releases, you would think that Snap is heading for a post-earnings disaster, but that’s no guarantee. There could be a very large (short term) move upward if the release is good. It’s harder to be optimistic about the long term, though, so my opinion on it is overall neutral.

Competitive Position

We can start this analysis by looking at Snap’s competitive position. This section of the analysis is mostly unfavorable; Snap has many disadvantages relative to its competitors and only a few advantages.

To start with, it is one of several companies on the losing end of Apple’s app-tracking transparency (“ATT”) policy. ATT made it so that apps have to ask permission before they can track users on IOS devices. After ATT rolled out, only 25% of users opted in to tracking. So, ad-tech companies are now missing out on a lot of user data on IOS devices.

ATT had the effect of sending advertising money away from data-dependent ad platforms, and toward platforms that generate on-platform user intent signals.

Search based ad platforms like Alphabet and Amazon (AMZN) can target ads immediately without needing any prior data on the user. The reason is that they have search bars that people use to find things they want to buy: Google Search and Amazon.com‘s search feature. When a customer types ‘car’ into Google Search, Google immediately knows that they’re searching for cars, and can serve fairly targeted ads based on just that query. They can serve the most targeted ads (e.g. local car dealerships) when they have user data, but they can still show relatively targeted ads (e.g. car manufacturers) without it. The same goes for Amazon’s search bar: people enter what they want to buy right into it, some targeting is possible without data.

The social media companies do not have this advantage. They all have search functions, but people use them to find people or groups, not things. Snap’s own search tool is mainly used to find people you know. It is not widely used to find information about products and services. For this reason, Snap needs user data to show ads that are even a little bit relevant. With no user data, they are virtually incapable of showing relevant ads. In this sense, they are even more vulnerable to Apple’s privacy changes than Meta is. Facebook’s search bar is mostly geared toward finding people, but the app does have a popular e-commerce feature, so there is some product-based searching going on. Snap’s search feature is used almost exclusively to find people and groups, so not a ton of buying intent is generated on-platform.

Beyond these strategic aspects of Snap’s competitive position, I was able to find these data points about its market share:

• Snap’s revenue is not adequate to place it in lists of “biggest ad platforms by market share.” It is generally part of the ‘other’ category that follows Google, Meta, Amazon and Microsoft (MSFT).

• Based on Statista’s estimate of the online advertising market size ($521 billion), Snap has a 0.86% share of the ad tech market (calculated as 4.5 divided by 521).

• Snap’s daily active users have been declining relative to Instagram’s since 2017.

• Snap’s ad revenue grew at 13% last quarter.

Basically, these don’t look great. Snap is a bit player in its industry. It does have relatively fast revenue growth for its space, but that’s about it. The loss of engagement to Instagram is a particularly striking red flag.

Snapchat Financials

Having looked at Snap’s competitive position, we can now turn to its financials. In its most recent quarter, Snap delivered:

• $1.11 billion in revenue, up 13%.

• A $400 million operating loss, worsened by 108%.

• A $422 million net loss, worsened by 178%.

• ($147 million) in free cash flow, worsened by 27%.

It was a pretty bad showing across the board. When we look at management’s statements, we can see that non-cash costs were a big part of the damage. For example, share count increased 3% due to stock based compensation. Still, free cash flow declined along with earnings, so it wasn’t just non-cash charges. Snap’s expenses really spiralled out of control last quarter.

On a brighter note, Snap’s balance sheet looks fairly solid. As of the most recent quarter, it boasted:

• $6 billion in current assets.

• $1 billion in current liabilities.

• $3.4 billion in total equity.

• $4.2 billion in total debt.

• $3.7 billion in long term debt.

So we get a total debt to equity ratio of 1.23, a long-term debt to equity ratio of 1.08, and a current ratio of 6. These measures suggest “OK” solvency and excellent liquidity. You generally want a debt/equity ratio at or below 1, and a current ratio above 1. Snap’s current ratio is therefore extremely good, its D/E ratio slightly high but not extremely so.

Valuation

Finally, we can get to Snap’s valuation. This part of the picture is mixed. At Yesterday’s closing price, Snap traded at:

• 145 times forward earnings.

• 65 times operating cash flows.

• 3.76 times sales.

• 5 times book value.

The earnings and cash flow multiples are still sky-high, but the sales and book multiples are not THAT high, at least not by the standards of big tech stocks. For reference, Meta Platforms, which some consider a deep value stock, has a p/sales ratio of 3. I don’t mean to say that Snap stock is cheap-it isn’t. But this does look like a situation where a stock could become cheap given adequate cost cutting. Snap has a 61% gross margin, if it trimmed enough fat it might be able to achieve positive net income in the upcoming quarter, and get the forward earnings multiple down. As of today, there are no signs of that happening, but Thursday’s release might change the situation.

The Risk to Shorts

So far in this article, I’ve outlined what appears to be a bearish case on Snap. The company is not currently profitable, its growth is slowing, and it got slapped by Apple’s privacy policies. An open and shut case, right?

On a long term basis, I think that it is an open and shut case. I have a hard time picturing anything that could turn Snap into a thriving company. However, you need to consider time frames. There is significant potential for SNAP shares to rise after earnings because expectations are so low already. Snap already delivered two brutal quarters this year, many people think we’re in a recession, and the media is telling people that tech earnings will be bad. So much bad news is baked into this stock already that the expectations are low. Even a slight beat could get the stock moving upward.

For this reason, I definitely don’t think anybody should be shorting SNAP stock. There’s significant potential for somebody doing that to get burned by an “OK” earnings release. To me, SNAP is not a stock to buy OR sell, but one to stay away from. The business is in rough shape, but the potential for a short term rally can’t be written off.