Snap (NYSE:SNAP)
Snap (NYSE:SNAP) fell sharply after reporting first-quarter financials. Meta Platforms (META) shares rose on the announcement day (the business announced after the end of trade on Thursday) as the firm reported better-than-expected profits. While META reported healthy top-line revenue and free cash flow increases, SNAP revealed declining sales and virtually nonexistent adjusted EBITDA. As a result, we are in the unenviable situation of seeing SNAP stock drop significantly from my cost base while having little desire to increase my holdings. Although position sizing helped mitigate the impact on my portfolio, the truth remains. There is an underlying problem here that goes beyond macro.
Shares of SNAP
Following a precipitous drop following earnings, SNAP is trading near record lows.
It’s easy to forget that this stock was once a hot commodity in the technology industry. When I last wrote on SNAP in March, I pointed out the stock’s rising dangers while praising its low price. Since then, the stock price has dropped by around 25% as investors have lost faith in the company despite its seeming cheapness and the strength of its thesis.
Key Metrics for SNAP Stock
Revenue for SNAP was down 7% year over year in the most recent quarter. It sounds terrible once you remember that META only managed a 2.7% YOY increase. At the same time, SNAP was supposed to be a smaller but faster-growing rival.
The key reason for the downturn was a 19% drop in ARPU (average revenue per user). Management explained the decline on the conference call by pointing to improvements to increase click-through rates, such as hiding ads until clicked on. Investors may disagree with management’s assessment that these challenges are temporary setbacks. Still, they would be right to do so.
The 15% year-over-year increase in average daily active users was the only positive indicator for the quarter. At least, SNAP is still useful (for the time being).
SNAP’s gross margins dropped by 5% QoQ, mostly because of its rising infrastructure expenditures.
Adjusted EBITDA dropped to $1 million due to falling revenues and narrowing gross margins. Ironically, this outcome prompted the leadership to declare that the company was “making progress on our path to sustainable profitability.”
SNAP had $4.1 billion in cash and $3.7 billion in debt at the end of the third quarter.
The company has high hopes for a quickening of sales growth rates in the future. Management has been touting the debut of their augmented reality SaaS service, Shopping Suite, which would purportedly assist in enhancing sales and minimizing returns for retail clients, in addition to predicting that headwinds from their click-through conversion trends will abate.
$533 million in cash expenses were eliminated during the quarter, more than the $500 million targeted by management. Maybe that’s why adjusted EBITDA was still (barely) in the black after being up by $64 million in the two years previous.
While many tech firms today focus on short-term gains, much to the satisfaction of their investors, SNAP is taking a different tack. In contrast to META, which is also investing heavily in growth but has undertaken dramatic cost rationalization and is generating strong GAAP net margins, management has stated that they will continue to invest aggressively despite the company’s current lack of GAAP profits (or adjusted EBITDA, for that matter).
What Should Investors Do With Their SNAP Stock?
Recent SNAP prices are lower than historical averages. The drop in price makes it more affordable, but the market may be overestimating its potential.
Since the story has changed from secular grower to turnaround, the stock’s cheap valuation may be its only redeeming feature. Future growth for SNAP may remain in the low to mid-single digits. The fair value may be around 2.5x sales, signaling considerable downside, assuming 25% long-term net margins and a 1.5x price-to-earnings-growth ratio (‘PEG ratio’). The fair value increases to around 8.3x sales, signaling significant triple-digit potential if one accepts management’s projections of an acceleration in growth, climbing to about 22% in the near future.
How dangerous is it? The hazards of the macro environment and rivalry persist. SNAP may be more badly impacted by this than more established operators like META since the need for online advertising may increase if economic circumstances deteriorate. TikTok and META remain formidable rivals, and there’s always a chance that SNAP may become irrelevant in the future, possibly because it won’t be able to spend as aggressively as its rivals. Although the price of the shares seems low, there are only two possible outcomes given the company’s weak net cash position and absence of GAAP net income. Despite the stock’s high risk, we maintain our buy rating on SNAP stock.
Featured Image: Unsplash
