Abstract>>> SNAP's revenue is growing (up 69% year-over-year), its profit margins are improving, and it is constantly innovating.
Snap (SNAP), a camera-focused video app, has been stagnant from its initial public offering (IPO) in 2017 until the end of 2019. Until 2020, the company's stock price hovered around $20 a share, tracking a flat user base as they faced increasing competition from rivals like Facebook.
However, with the advent of the pandemic, lockdowns accelerated user growth, jumping from 229 million MAU to 319 million MAU in two years, equivalent to a 39% increase. The stock price has skyrocketed under this growth, rising 432% as of October 2021.
Snap MAU (Statista)
Thanks to Apple's new privacy policy, the company released a poor earnings report in the third quarter of 2021, with revenue below analysts' expectations. Snap also provided poor guidance for the fourth quarter of 2021, causing the stock to fall further and is currently down 59% from its highs. SNAP continued to innovate, increasing revenue and profits, but the stock price went in the opposite direction. Let's take a closer look at Snap's innovations and the company's valuation.
Snap share price (Y chart)
Innovators
Snap was founded on September 16, 2011 by Evan Spiegel and Bobby Murphy, who renamed "Picaboo" Snapchat and "Picaboo" Snap. The company pioneered the "Camera Spotlight" social media app, which was then known as "The Next Facebook." Previously, apps like Facebook were very focused on news feeds, and yes, pictures/videos were uploaded, but didn't focus on real-time.
The vanishing elements of Snap images/photos make the content very appealing to people. Spiegel says he uses "real-life conversions" as a model because if something disappears after 24 hours, people don't feel embarrassed when uploading it. This was a genius move at the time, as the lack of social pressure increased engagement and frequency of posting compared to other social media apps, such as Instagram, which was acquired by Facebook in 2012.
Snap Innovation (Investor Relations)
"Innovation" is a word that is often thrown out, but in Snap's case, it makes sense. Snap has always been an incredible innovator. Their augmented reality filter was groundbreaking at the time. These not only increase user engagement, but also provide brands with the opportunity to create custom geofilters, which opens up a new approach to advertising. Back in 2014, Snap even launched "Snapcash," a currency trading feature.
Snap AR (Investor Presentation)
Snap's innovation was quickly suppressed as larger competitors like Facebook took "inspiration" from the concept of "stories" that disappeared 24 hours later and integrated the feature into their Facebook and Instagram apps.
As an avid snap user years ago, the author remembers seeing the same feature on Instagram one day and thought it would take too long to upload content across multiple platforms, so he decided to delete the Snap app. The author believes that many people do the same. The feature was rolled out globally between 2016 and 2018, the flat user growth section of Chart 1.
Snap still has a big appeal to gen Z and millennial audiences over 50% of 29-year-olds. However, TikTok stole the limelight in this space, with more than 1 billion MAU and 43% of viewers aged 18 to 24. Luckily for Snap, they took "inspiration" from TikTok and introduced a new spotlight feature that is very similar to TikTok and Instagram reel features.
Snap feature (investor presentation)
This trend suggests that all of these major social media apps are converging into a hodgepodge of "innovative" features of other apps. The challenge for Snap is that while most are original, they are smaller players with 319 million MAU, compared to 2.9 billion and 1 billion for Facebook and TikTok, respectively.
But a key feature of Snap is that it focuses on "close friends," unlike Facebook, where many people will have thousands of "friends," unlike Instagram, where people might follow a range of influencers. Snap doesn't use the number of friends as a social currency like other platforms.
There are several key reasons why this is strong. First, interacting with friends promises to gain higher engagement. Second, multiple studies have shown that close friends influence purchasing decisions more than influencers or companies, as shown in the chart below. This is very powerful for potential advertisers and spreaders, as the chart below shows that 70% of 18- to 29-year-olds are influenced by close friends when making purchase decisions.
Buying Impact (Marketing Chart)
Snap's challenge now is to find a way to monetize these close friends effectively. Maybe Snap can introduce a feature called "Close Friend Referral," which is a sub-program where you can all earn points if you buy a product that your friend uses.
Snap is still leading the pack when it comes to augmented reality footage, with "try-on" and "wrist tracking" features that could revolutionize the way users shop online.
SNAP also boasts massive, fully augmented reality experiences that are highly advanced compared to rival platforms.
AR Lens (Investor Presentation)
The company has also completed a series of acquisitions as it aims to remain innovative and up-to-date compared to its competitors.
Strategic Mergers & Acquisitions (Snap)
Growing finance
Snap's revenue has grown fivefold since 2017, from $825 million to $4.1 billion in 2021. Recently, the company's revenue has been growing rapidly, with an annual growth rate of 64%.
Snap income (created by the author)
Gross profit also jumped from $1.3 billion to $2.3 billion, up 76% year-over-year. Gross margin has risen from 40% in 2019 to 57% year-to-date.
Margins Snap (created by the author)
Snap is still losing -$702 million, but if we subtract $1.5 billion in R&D spending, they will be solidly profitable. In 2021, their free cash flow is positive at $293 million. On its balance sheet, Snap has $3.692 billion in cash and cash equivalents, but surprisingly, its debt levels are as high as $2.2 billion and won't mature until 2025.
Fair valuation
To assess snap's value, the authors incorporated the latest financial data into a discounted cash flow model. To be more accurate, the authors have capitalized R&D expenses. For revenue growth, the authors estimate it at 40 percent next year, then conservatively estimate it at 20 percent over the next 2 to 5 years. Both figures are significantly lower than the previous growth rate of more than 60 percent.
Snap Financials (created by the author of Motivation 2 Invest)
For operating profit, I predict that they will increase to 35% in the next 5 years, which is optimistic, but not impossible, because this is still far below Facebook's operating profit .
Snap Stock Valuation (created by author Ben at Motivation 2 Invest)
With these factors in mind, the authors got a fair value of $33 per share, which is the trading price of the stock today.
In terms of relative valuation, Snap has the highest EV/EBITDA multiple (forward) of 59 times, while Twitter has 23 times, Pinterest has 17 times, and Meta has the lowest EV/EBITDA multiple, at just 8 times. However, the expected growth rate is also the highest (50%+) compared to other players.
EV to EBITDA (created by the author)
The price-to-sales ratio shows a similar story, with Snap's price-to-sales ratio of only 12 and Meta only having 5.
Price-to-sales ratio (created by the author)
risk
Governance issues: It's important to note that Snap's Class A shares don't have voting rights. While this may not be a problem for the average retail investor, many institutional investors don't like this lack of governance because Snap's two founders have 99.5 percent of the voting power.
Social Media Wars: Stiff competition from rivals like Facebook and disruptors like TikTok isn't good news for Snap. TikTok recently announced that it will launch an AR filter tool called "Effect House" that competes directly with Snap's products. Now while Snap is still a leader in augmented reality, that's not good news. The authors' prediction that major social media apps will aggregate the same functionality seems to be coming to fruition.
Previously, Yahoo Finance reported that global TikTok revenue just exceeded Twitter and Snap combined. It can be observed that the speed at which the social media landscape is changing is still crazy.
Macroeconomic issues: Growth stocks tend to underperform in an environment of high inflation and rising interest rates because their valuations are based on cash flows that are more inclined toward the future. The 10-year Treasury rate, a commonly used discount rate, has jumped to 2.7% from 0.59% in 2020 some time ago.
epilogue
Snap is a great company that is a true innovator in social media and augmentation in the real world. Their users, revenues, and profits have all grown dramatically over the past few years, but the social media landscape is always changing, with fierce competition from competitors threatening future growth. The company's current valuation is reasonable, but it is not cheap relative to competitors.