The Underdog Keeps Barking
If you were to search news on $Snap roughly six months after it’s IPO, you would see headlines like the one I got at the top of my results today: Snapchat is in the middle of an Identity Crisis.
Snapchat is beleaguered in an arena of misapplied comparisons. Alongside the article above, you’ll find a headline advising that Snap cannot keep up with its brothers, Facebook (Instagram) and Twitter. These narratives: faux comparisons, celebrity criticism and vogue valuation methods, have pummeled Snapchat’s pricing into near penny stock territory from its IPO of nearly $30 per share.
What follows is not an endorsement, I want to give a fair take on a company that has (until very recently) been completely written off after only two years of trading.
The Narrative
“Snapchat lost as many as 3 million daily active users in 2018. Meanwhile, Instagram has grown so fast over the past two years that its Stories feature alone is much bigger than Snapchat, with more than 500 million daily active users.”
Since the days of MySpace the daily active user (DAU) measure is used to indicate profitability as it logically connects shareholders to the expectation of advertising revenues. If you were to take a look at the Snap narrative you would presume this is the only measure used to understand Snap’s future potential and current hardship. This despite the fact that Facebook’s own metrics concerning users are coming under recent scrutiny:
Facebook had previously reported that about 3 percent to 4 percent of its active users were fake. According to the new figures, the accounts taken down each quarter were equivalent to 25 percent to 35 percent of its active users (though those accounts were not counted in Facebook’s active-user tallies because they had been removed).
More curious was how Facebook’s estimate of active fake accounts barely budged even as the number of accounts it took down each quarter fluctuated widely. For instance, Facebook said it had caught 583 million fake accounts in the first quarter of 2018 and 800 million the next quarter. Yet between those two quarters, it told investors that its active fake accounts had increased by roughly one million.
The New York Times article linked above is excellent, but it’s also not as damning as Aaron Greenspan’s analysis. His personal bias is disclosed in the report. If you’re an advertiser spending money for ads on Facebook these are very serious concerns, are you sure you’re paying the right price for your ads? With all this said, is DAU still a relevant measure when the company that seizes the greatest benefit from it is also suspected of corrupting their numbers? The market will be re-evaluating this as the situation evolves.
Something to consider outside of the realm of DAU forecasting and valuation: There are several features about Snap that have made it stand out to users, features that haven’t been stolen (?), borrowed (?), adopted (?).
In fact even with respondents giving near equal rates of use (~83% of teenage respondents use both Instagram and Snapchat) on a monthly basis. Snap has outpaced Instagram consistently on being the favorite:
The following is my personal thesis on the qualitative feature of favorite introduced above.
Why is Snap the favorite, and why can’t analysts figure out why? After asking that question, I wonder if they are users? Are teenagers just into ghosts placed on yellow backgrounds? Maybe they really like the augmented reality lenses? – Can’t be that, Instagram has successfully pilfered that novelty along with many other features. What is it that Facebook/Instagram can’t mimic?
Simply, Snapchat gives the user the privilege and perception of privacy. The privilege is having your own private conduit to review activity from friends (or influencers) or have them review yours. In this exchange your friends cannot see your user statistics, they have no idea if you are popular, unpopular, how many retweets or likes you get. It’s devoid of the social signaling competition that is found on nearly every other social media platform. Furthermore, the constant social competition, envy, and curation of content that comes with its own baggage:
“What happens many times when they log on is that you kind of activate a lot of social comparison,” said Oscar Ybarra, PhD, a professor of psychology at the University of Michigan. “People don’t necessarily have to be super aware that this is occurring, but it does. You log on, you’re generally dealing with very curated content on the other side.”
He notes that even if individuals are aware of the “curated” nature of many online platforms, “they nevertheless feel like, ‘How am I stacking up?’ or ‘How is my life stacking up?’ compared to what these people are presenting. I think that what happens is that the more you use the platforms, the more social comparisons tend to induce, and that relates to these decrements in how people are feeling.”
It shouldn’t be hard to imagine why a teenager, already beset with the stresses of social hierarchies, sport and scholastic achievement, would find favoritism in an application that carries very little curation or reward for signaling any of it.
Besides the invaluable feature of separating oneself from the pages of our friends and acquaintances, users can also separate themselves from the review of those closest to them. I would say this could be more of a trope than fact, but avoiding grandmas comment on your latest flex post (sic), could be appealing to some users. Bear in mind everyone complains about the idiosyncrasies of certain family members until they can’t – call your grandparents kids. (Public Service Announcement)
The perception of privacy is another matter, which unlike the privilege mentioned above, is important to both adults and teenagers. Even if the perception is wrong when it comes to illegal activity.
At this point in our experience with social media we all know of several posts that should never been made public. When they remain, and the awkward disagreeable comments start rolling in it’s usually a great time for the OP (original poster) to reflect on their decisions in life thus far. Snapchat doesn’t have this very public problem. You can send near anything, so long as the receiving end doesn’t screenshot it, which you would be notified of, you are assured that the communication will only be for that other party. This is what gives each user, the perception of privacy. There are many problems with this perception from a criminal activity standpoint. Despite reams of breaking news articles highlighting illegal activity communicated over Snap, users still carry the perception of privacy untarnished. Notwithstanding this contradiction and the scores of arrested would-be criminals, the perception of privacy is a lucrative feature that has yet to be fully copied by competitors.
These are qualitative arguments for the future strength of Snap as a company. Users love it. Features cannot be easily copied (excellent moat). But what about the money?
Show me the Money
Does Snap make money? Negative, it doesn’t make any money. So why would anyone invest in it? Never mind that Facebook spent a year below their IPO and nearly six years without profitability, two years is just too long for a company in the growth phase of their existence to still be losing money (don’t tell Tesla).
Snap’s DAU fell and stalled in 2018, and with it the stock went too, dumping roughly 23.6% at the beginning of May and continuing a slow decline with stalled user growth and bad press releases. For sometime I had been watching this stock due to the value propositions I stated above. I did not believe that this shedding of value was true price discovery.
An event last year that personally piqued my suspicion was the drop the stock made after Kylie Jenner lamented a design change on the Snap application. As a novice investor I didn’t realize that Kylie Jenner was the foremost commentator on social media application product and development, I didn’t realize that social media users everywhere (teenage, adult, and the elderly) conduct their use of a product based on her review and dispensed critique. While I didn’t realize this in my infinite ignorance, other smarter investors did, and they pulled out of Snap and into a safer equity,… like Facebook. I would love to comment on this more but I’ll wait for Snap to turn a profit before going further. And this could be soon, compared to other equities in the markets their books are not so dire. Latest 10-K:
User Metrics
• Daily Active Users, or DAUs, decreased to 186 million in Q4 2018, compared to 187 million Q4 2017.• Average revenue per user, or ARPU, increased 37% to $2.09 in Q4 2018, compared to $1.53 in Q4 2017.
Financial Results
• Cash used in operating activities was $689.9 million in 2018, compared to $734.7 million in 2017.• Free Cash Flow was $(810.1) million in 2018, compared to $(819.2) million in 2017.
• Common shares outstanding plus shares underlying stock-based awards, including restricted stock units, restricted stock awards, and outstanding stock options, totaled 1,507 million at December 31, 2018, compared with 1,453 million one year ago.
• Capital expenditures were $120.2 million in 2018, compared to $84.5 million in 2017.
• Cash, cash equivalents, and marketable securities were $1.3 billion as of December 31, 2018.
• Revenue increased 43% to $1.2 billion in 2018, compared to $824.9 million in 2017.
• Total costs and expenses excluding stock-based compensation expense increased 14% to $1.9 billion in 2018, compared to $1.7 billion in 2017.
• Operating loss decreased 64% to $1.3 billion in 2018, compared to $3.5 billion in 2017. • Net loss decreased 64% to $1.3 billion in 2018, compared to $3.4 billion in 2017.
• Diluted net loss per share decreased 67% to $(0.97) in 2018, compared to $(2.95) in 2017.
• Adjusted EBITDA loss decreased 20% to $(575.6) million in 2018, compared to $(720.1) million in 2017.
Could that decrease in DAU be the death knell?
It doesn’t appear to hurt business. In fact, the redesign that pummeled the stock price appears to have resulted in considerably more revenue per user. They still haven’t made a profit and they are aware – late last year a memo from Snap CEO Spiegel declared:
As a team of owners, it’s incumbent upon us to complete our transition from a startup to a sustainable business as soon as possible. Our 2019 stretch output goal will be an acceleration in revenue growth and full year free cash flow and profitability. With profitability comes increased autonomy and freedom to operate our business in the long term best interest of our community without the pressure of needing to raise additional capital.
I encourage readers to go to their books directly, they are elucidating. For analysts, much of what’s shown entwines with the theme the CEO voices above. There is a direction and they are proceeding along it:
Concluding Remarks
Depending on how 2019 goes, they could see profitability for the year. The field they are in is an early one, so they could at any point go the way of MySpace if they do not continue trying to understand and implement unique features for their users. Once upon a time they wanted to develop a payment feature as part of the app. While this attempt failed miserably it could be something they could revisit once profitability gives them the latitude to attempt the experiment again. Partnering with an intrepid payment processor willing to utilize their user network could keep their overhead slim and their operations nimble by having the other entity attend to risk factors associated with taking and dispatching payments – but now I’m just thinking out loud.
This is not an endorsement or investment advice. If you invest in a stock I recommend or have a positive opinion on, then you did not conduct your due diligence well enough and you deserve to be parted from your money. Just as I am when I am wrong. That said, I wanted to post this article last year when Snap was far more hated. Now that there are a handful of observers that are positive on Snap I will have to be content with joining the small chorus of marginal bullish voices instead of being a soloist.