Justin Sullivan
Background
Snap (NYSE:SNAP) has provided another weak quarterly result. The major disappointment was the slowdown in revenue growth to a single-digit number. Given the low growth rate, the company’s shares can no longer be called “growth” shares. Even despite the 30% drop in share price, the company’s shares do not look attractive, since the company’s business still has several problems and there are risks of further deterioration of company fundamentals. Let’s move on to the analysis of reporting results in order to determine what disappointed investors so much in the company’s reporting.
Revenue analysis and DAU dynamic
Quarterly revenue grew by only 6% YoY to $1.1 billion, which was 1% worse than consensus expected. Excluding the impact of the US dollar strengthening, the growth was +8% YoY. The company received 28% of its revenue outside the USA in 3Q.
The number of daily active users (DAU) increased by 13 million QoQ (+4%) and by 54 million YoY (+18%) to 360 million (0.5% better than expected) in 3Q. The company has already reached 75% of the addressable audience aged 13-34 in 20 countries, which may make it difficult to further increase users. However, so far the company has still grown steadily by 13-15 million per quarter. But this growth was mainly due to the “Rest of the world” segment this quarter (+13 million QoQ), which in the future may put pressure on the overall ARPU (average revenue per user), since ARPU in the “Rest of the World” is significantly lower than in the USA ($0.31 per month versus $2.72).
It is also worrisome that the number of ad impressions increased by only 8% YoY. That suggests that the amount of time spent on Snapchat has decreased YoY.
ARPU Dynamics
The reduction of the advertising market due to the problems in the global economy continues to put pressure on ARPU. It decreased by 10% YoY and turned out to be worse than consensus expected by 1%. The company notes a slowdown in demand for brand advertising, which has already led to a decrease in eCPM YoY by 3%. For direct-response advertising, the management did not give specific figures. However, taking into account the general drop in ARPU, the fall may be more than it was in the case of brand advertising. The change in Apple’s (AAPL) IDFA policy still has a negative effect on Snap’s business. The reduction of the advertising market and the emergence of new options for placing advertising budgets for advertisers (Netflix (NFLX) and Disney (DIS) will launch ad-supported plans for their streaming services by the end of the year) may lead to an even greater decrease in demand for advertising placements in Snap.
Geographical breakdown
In terms of geographical breakdown, the best results were in the “Rest of the World” segment. The number of DAU in the US region was 100 million (+4% YoY, within the expectation). ARPU in the region grew by 1% (0.5% worse than expected). The worst figures were in Europe, where the 10% growth of DAU (0.7% better than expected) was almost completely offset by a decrease in ARPU by 9% YoY (1.6% worse than expected). The “Rest of the World” segment DAU growth result turned out to be better than consensus expected by 2%. Nevertheless, the decrease in ARPU was also significant (a drop of 14% YoY).
Marginality
The overall level of marginality does not inspire optimism. However, a positive trend is observed in infrastructure spending. Gross margin was 61%, + 1 percentage point YoY. The main part of the improvement came from a reduction in infrastructure costs by 1 DAU (due to the more efficient use of the cloud infrastructure) that improved by 12% YoY and reached $0.58 per DAU. The SBC-adjusted EBITDA was (-$57) million (-5% margin), while the consensus expected a positive value of $23.2 million (2% margin), and a year earlier it was +$152 million (14% margin). It is noteworthy that, without adjusting for SBC, the EBITDA margin was (-35%). Such a high amount of SBC (the main part of the premium goes through the RSU) creates a threat of shareholder capital dilution. To prevent the dilution, the company spent $500 million (3.1% of shares were repurchased at an average price of $9.75) in Q3 to buy back shares. Also, it announced a new $500 million buyback program that will allow to buy back 4% of outstanding shares at the current price. Due to the positive change in working capital, the company managed to show a positive cash flow of $18 million (margin of 2%), while the FCF loss of $105 million (-9% margin) was expected, and a year earlier there was a loss of $122 million (-11% margin).
The 4th quarter forecast
Another disappointment of the reporting was the lack of a formal forecast for Q4 revenue. Management provided only a forecast for DAU, which implies 375 million DAU at the end of Q4 (that implies an increase of 18% YoY and 4% QoQ). The forecast for MAU turned out to be 5 million better than consensus expected. The management did not provide a formal revenue forecast. Consensus expected 1.37 billion (+7% YoY). The management plans to complete a staff optimization program during the 4th quarter, which assumes a 20% reduction in staff. In the 3rd quarter, the number of staff has already been optimized by 11%.
Comps valuation and final thoughts
Snap’s (forward EV/S 2.66x) shares are trading below the peer (PINS (4.29x)), MTCH (4.88x)) multiple level. However, this difference can be explained by the fact that the margin of competitors is higher. Snap has long been perceived by investors as a growth stock. Now, that growth has slowed to a single-digit rate, so Snap has finally lost the status of a growth stock. At the same time, unlike competitors (PINS, MTCH, META), it doesn’t have a relatively high EBITDA and FCF margin.
Based on the results of reporting and analysis of the advertising market dynamics, I do not see any significant drivers for Snap’s stock growth in the coming quarters. At the same time, the risks of continuing deterioration of the fundamentals remain. On the one hand, a 30% drop in stocks looks excessive. But on the other hand, I don’t see any fundamental reasons for growth now. A technical rebound is possible, but in order to increase the investment (non-speculative) attractiveness of the company, it is necessary to show an improvement in the fundamentals. As a result, I maintain my neutral view on the company’s shares.
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