Description

Snap Inc. (SNAP) is a six year old self-described “camera” company which goes to market primarily through the Snapchat mobile application. Snapchat differentiates itself from other communications and social networking apps (like Facebook, Instagram, WhatsApp, Google Messenger, Weibo, Line, WeChat, et cetera) by having pictures and messages that auto-delete from the recipient of the message. The company offers users creative tools like Lenses (interactive animations overlaid on people’s faces) and Bitmojis (cartoon images around a user’s human traits) to improve engagement with the platform.

SNAP was co-founded by Evan Spiegel (you can learn more about his background from this puff piece in Vogue Italy from 2015 http://www.vogue.it/en/uomo-vogue/cover-story/2015/10/evan-spiegel#ad-image ) and Robert Murphy while they were at Stanford. Spiegel -- age 26 -- and Murphy -- age 28 -- control the company through super voting shares that give them control of roughly 89% of the votes. The publicly traded stock is non-voting. It is worth noting that neither Spiegel nor Murphy have any experience working for any other companies.

In order to provide adult supervision, SNAP hired 39 year old former J.P. Morgan equity research analyst Imran Khan as its “Chief Strategy Officer” to help the company create a story to pitch to the street. SNAP paid Khan 7.1mm shares of restricted stock (over $120 million at the $17/share IPO price) as an inducement to get him to join the company.

As of Q1 2017, Snapchat had 166 million daily active users who generate over 3 billion snaps (short videos and images) a day. The average Snapchat user opens the app 18 times a day for a total of around 30 minutes. 85% of SNAP’s U.S. daily active users are between the ages of 13 and 34 implying the company already has 50% of U.S. residents in that age range as users. (Its worth noting SNAP has been accused by a former employee of intentionally inflating its reported user numbers while it was a private company. http://www.businessinsider.com/snapchat-unseals-anthony-pompliano-lawsuit-over-user-growth-metrics-2017-4.) Snap usage is heavily skewed towards its younger users. Users 25 years and older visited Snapchat approximately 12 times for about 20 minutes a day in 2016 versus users younger than 25 who visited over 20 times for over 30 minutes a day.

SNAP generates revenue primarily through advertising. SNAP offers advertisers three main types of ad formats: 1) Snap Ads – traditional video ads inserted into the user experience, 2) Sponsored Geofilters – advertiser sponsored tools that can be incorporated into a user’s snaps, and 3) Sponsored Lenses – advertiser branded animations that can be overlaid on a person’s face or surroundings. Conceptually, SNAP grows revenue by either increasing its number of users, increasing the pricing it charges advertisers, or by increasing the number of ads it delivers to its users. SNAP also sells $130 “spectacles” – glasses with built in cameras to allow people to take pictures from their own perspective. Spectacles generated roughly $8 million in revenue in Q4 implying the company sold around 65k units.  

On March 2nd, SNAP priced its initial public offering of 200 million shares at $17/share, valuing the company at roughly $24 billion or 60x 2016 revenues. Interestingly, SNAP went public by selling nonvoting shares; investors have given complete control to the company’s 26 year old CEO and its 28 year old Chief Technology Officer. Spiegel was granted an additional 3% of the entire shares outstanding of the company for completing the IPO.

Snapchat’s products are not proprietary and the company faces direct competition from some of the largest Internet companies in the world. Facebook (FB) in particular has been aggressive in copying Snapchat’s functionality for its Instagram platform and more recently for Facebook. Just last month FB added the disappearing messages feature to Instagram. Instagram’s Stories feature – a blatant knock off of Snapchat’s Stories – has over 200 million daily active users, i.e. more than the entire snapchat user base. It’s worth noting that Facebook spent a significant amount of time at its F8 Developers’ conference in April talking about its camera effects platform -- ie its products meant to compete with SNAP.

In Asia, Naver (a large Korean internet company and an affiliate of Line) launched a Snapchat knock off product called Snow. Snow has been downloaded over 100 million times since it was launched in September 2015 and has 40 to 50 million users – more than the 36 million times Snapchat has been downloaded in Asia.

Snapchat has seen significant deceleration in user growth starting in the second half of 2016 -- ie right after the launch of Instagram Stories. On a sequential quarter basis SNAP’s global daily active users in second quarter of 2016 grew at 17%, the third quarter at 7%, and the fourth quarter at 3%. Sequential user growth accelerated to 5% in Q1 2017 likely due to the normal seasonality for app downloads (people get new phones for Christmas and download new apps in January.) We don’t think it is any surprise that SNAP’s user growth slowed significantly after the early August 2016 launch of Instagram’s stories feature. It is also worth noting that as SNOW has gained scale, SNAP’s user growth in Asia (its reported Rest of World segment) has stalled.

Source: Company Reports

Comscore data suggests that SNAP continues to see deceleration in usage through April continuing a pronounced trend since the start of the year.

Source: Goldman Sachs

SNAP has blamed its deceleration in user growth trends on product issues with its Android App. Snapchat was developed mostly on iOS and the company until recently spent relatively little time on optimizing the Android experience. This culminated with Spiegel issuing a mea culpa in October 2016 to the company’s Android users after the App slowed down to an almost unusable speed. ( https://www.reddit.com/r/Android/comments/567m32/can_we_talk_about_snapchat_quality_on_android/ ) Poor Android App performance hasn’t been Snapchat’s only product quality issue. When the company launched Memories and Bitmoji in August 2016, Bitmoji crashed.

Unlike Facebook, SNAP knows relatively little about its users and does not have remotely similar advertising targeting tools. This relative lack of information limits the targeting capability of advertisements that SNAP can deliver and likely means that SNAP will never achieve advertising rates comparable to Facebook. With the information it knows about its users across all of its different platforms, Facebook’s Instagram is almost guaranteed to always be a more effective advertising platform than Snapchat can ever be.  

In mid-March online advertising trade publication eMarketer cut its 2017 advertising revenue estimate for Snapchat to $770 million from prior estimates of $800 million. (http://www.reuters.com/article/us-snap-advertising-idUSKBN16L1JC )  Wall Street analysts estimate the company will generate over $1 billion in advertising revenue in 2017.

Last week, industry publication Digiday reported that SNAP is offering discount coupons and bonuses for advertizers in order to front load advertising spending into Q2 (https://digiday.com/marketing/snapchat-wooing-ad-buyers-discount-coupons-bonuses/ ). SNAP obviously wants to print a large Q2 revenue “beat” in order to minimize the impact on its share price from its IPO lock up expirations at the end of July.

“The platform is incentivizing brands and media buyers, offering bonuses, discount coupons and media credits for ad buys carried out in the second quarter of 2017, said multiple agency executives whom Digiday interviewed. The nature of the incentives, and their value, vary from one media agency to another. Agency execs reported the offers started last week and multiple buyers said the offers extend to mid-June, which happens to be when Snap’s second quarter starts to wrap up.

One media buyer, who wished to remain anonymous, said Snapchat was offering new application programming interface partners a 10 percent bonus media coupon; another said it was providing discounts on ads bought on its self-serve platform. A third agency executive said Snapchat was offering its holding company a 10 percent “reservation” discount, giving a 10 percent credit for any API buy completed through Snapchat. Snapchat declined to comment for this story.

“I can confirm that there are some bonuses and added-value incentives,” said a media buyer at a holding company media agency who wished to remain anonymous. “The value of the discount varies from client to client, but the bottom line is that they’ve been very aggressive in offering incentives to get brands moving on their products.”

……

But in Snapchat’s case, it’s a move clearly driven aimed at getting more advertisers on board the platform during the second quarter, so the company would be able to show “better revenue and scale” of advertisers in its next earnings report, said Brian Cristiano, CEO at Bold Worldwide. There are still doubts among ad buyers about Snapchat’s ad options, not to mention its slowing user growth that’s led some to say it’s the “next Twitter.” That is not meant as a compliment.”

The reality is that advertisers currently have no clue what their return on investment is for advertising on Snapchat as advertising on the platform is less than 2 years old. If those returns turn out to be materially less than other mediums, SNAP will experience a similar collapse in advertizing pricing that Twitter has seen over the last 2 years. With only about 15% of the U.S. population as users, SNAP remains a niche advertising medium vs. competitors like Facebook and Google. SNAP lacks the tracking and reporting capabilities of  Facebook or Google which also likely dampens enthusiasm from advertisers to spend on the platform. In the studies that have been done to date, 70% of users skip SNAP ads entirely.

Earlier this month, SNAP reported its first quarter as a publicly traded company. SNAP missed sell side estimates on all metrics reporting revenues of $149.6MM vs. estimates of $158.3MM, EBITDA of -$188.2MM vs. estimates of -$180.7MM, and global daily active users of 166MM versus estimates of 167.3MM. For a much hyped company that went public in early March to miss on all of the relevant metrics in its first reported quarter is quite stunning. Given the company’s pronounced deceleration in user growth trends its quite plausible that SNAP chose to go public in March because it was running out of money and likely wouldn’t have another opportunity to go public at a valuation anywhere close to its recent private funding rounds. Very few Internet companies have been able to reaccelerate user growth after it stalls.

SNAP currently has an enterprise value of around $27 billion. This equates to roughly 67x 2016 revenues and 27x 2017 estimated revenues.

SNAP has no track record of coming close to achieving profitability. Despite growing revenues form $59 million to $404 million in 2016, operating loss rose to $520 million from $380 million. Even in Wall Street’s rosiest scenarios, SNAP will struggle to be breakeven before 2020. The company is likely to lose about $1 billion over the next 2 years. Even in bullish models like Morgan Stanley’s SNAP will burn through its existing cash balances before achieving positive EBITDA. The company will need to raise additional equity just to stay afloat.

SNAP has already committed to spend over the next five years $2 billion with Google Cloud and over $1 billion with Amazon Web Services. For a company that only generated $404 million in revenues in 2016 to commit itself to spend over $600 million a year on cloud expenses alone for the next five years strikes us as very aggressive. With such large fixed payments, if SNAP’s revenue growth fails to materialize the company could spiral into bankruptcy in the next few years.

Source: Company Reports

SNAP’s valuation is heavily dependent on the size of its user base and we believe the market will react negatively to the company’s likely continued slow growth in users. Just like Twitter, SNAP’s valuation will implode when user growth stalls out.

In addition, on July 29th, SNAP’s IPO lockup expires and over 1 billion shares held by insiders become available for sale. With SNAP’s venture capital backers having massive gains on their investments at current share prices, we would not at all be shocked if they decided to sell aggressively once the lockup expires.

With a commoditized product, an unclear pathway to profitability, and slowing user and revenue growth, we think SNAP shares have significant downside over the next 12 months. At a very generous multiple of 10x 2017 revenues of around $1 billion, SNAP would trade around $7/share or down roughly 70% from current trading prices.

Other Random Tidbits

In August 2014, the company loaned $5 million to each of Mr. Murphy and Mr. Spiegel. These loans were repaid in September 2016.

In February 2016, the company loaned $15 million to Mr. Spiegel. This loan was repaid in September 2016.

On his hiring in January 2015, the company loaned $1.8 million to Mr. Khan. This loan was repaid in August 2016.

SNAP doesn’t have a corporate headquarters. Instead the company houses its employees across many office buildings throughout Venice, CA.

Because the company’s publicly traded stock is non voting, holders of the publicly traded stock are exempt from their obligations to file under sections 13(d), 13(g) and 16 of the Exchange Act. The company is not required to file a proxy statement.

Catalyst

IPO lockup expires on July 29th when over 1.1 billion shares will be freed from the lockup.

Continued deceleration in user growth.