Oh Snap! Snap Is Probably Overvalued

As someone approaching mid-life, understanding the kids of today isn’t always straightforward. The younger generation’s love of social media is a case in point. In my mind, understanding the utility of Snapchat, the multimedia instant messaging app and service developed by Snap Inc. (NYSE:SNAP), is even more challenging. This may be a cognitive bias on my part, but researching the stock in an unbiased as possible a manner leads me to the conclusion that the stock is overvalued.

The Snapchat application, or app, is popular because pictures and messages are normally only available for a short period of time after which they are automatically deleted and become inaccessible to their recipients.

Parent company Snap calls itself a camera company available the world over. Its key product is Snapchat, the smartphone camera app has various functions including camera, communications, Snap Map, stories and Spotlight which enable users to communicate via videos and pictures. Another product is called Spectacles, an eyewear product that syncs with Snapchat and takes photos and video from the user’s point of view. Snap makes revenue mainly from advertising, where advertisers target Snap’s younger audience.

Snap was founded in 2010 and is expected to produce over $4 billion in revenue for 2022. Its IPO was in 2017 and the stock has a market capitalization of about $15 billion.

Snapchat has garnered a large and relatively loyal group of active users since its launch. There are on average about 363 million daily active users (abbreviated as DAUs from here on) on the app each day. Over 250 million DAUs play with the augmented reality features daily. There are over 6 billion Augmented Reality Lens plays each day and more than 250,000 Lens users have used the Lens studio to produce content. More than 75% of people aged between 13 and 34 in more than 20 countries currently have Snapchat on their smartphones.

The bull argument for the stock is that its penetration of users per number of smartphones in use is only 25% in North America and just 7% in the rest of the world, which on the face of it provides a massive growth opportunity. The Snapchat app is currently is available in 40 different languages.

Augmented investment reality?

Snap reported disappointing Q3 results in October, with revenue up only 6% but still reporting a net loss of $359 million. This included a $175 million restructuring charge, which at this stage of a company’s life, seems to me to be a red flag. Adjusted EBITDA was $72 million, but it added back a huge number for stock compensation which was $343 million. Although plenty of analysts and corporates exclude stock compensation when modelling financial results, Warren Buffett famously said, “If compensation isn’t an expense, what is it? And, if real and recurring expenses don’t belong in the calculation of earnings, where in the world do they belong?”

So when looking through Snap’s adjustments it is difficult to come to a conclusion that sees meaningful non-adjusted, or GAAP profits for Snap any time soon.

Snap’s balance sheet has cash and investments of $4.4 billion but the stock has a low Altman Z-score of about 1. Also, Snap’s convertible bonds are so out of the money that this financing should be considered debt, not equity. To Snap’s credit, however, the interest rate on the convertibles is low.

DAUs were 363 million in Q3, up 57 million or 19% year-on-year. DAU numbers have increased sequentially and year-on-year in each of the major regions: North America, Europe and Rest of the World. Total amount of time spent on Spotlight was up 55% compared to the previous Q3. The problem is Snap is finding it difficult to monetize this large and growing user base. Average revenue per user is down to $3.11 in Q3 from $3.49 a year ago.

The Street doesn’t see positive GAAP earnings per share estimates for many years. Even looking at adjusted earnings per share and adjusted EBITDA, Snap is selling at more than 60x earnings and over 100x EBITDA.

For a growth tech stock you might want to use price-to-revenue and one Wall Street analyst has a price target of $11 based on 4x 2023 revenues. I don’t buy it.

Conclusion

I will usually give the benefit of doubt to a company that is innovative and has market share with a potential huge growth opportunity ahead of it. The thing is I just can’t see that Snapchat is more than a fad. There seems to be increasing competition, and difficulties in monetization of the user base.

Changes in management in two key operating roles and the large restructuring are red flags for me. Then, although I obviously don’t use it myself, it seems that TikTok is the cool app the kids are on today. This must be eating at the market share of social media platforms, especially from Snapchat.

If Snapchat was so great, Meta, Alphabet, Microsoft or Twitter would probably have acquired it already.

I might be a dinosaur and totally wrong, but my analysis tells me to sell Snap if you own it, and to avoid it if you don’t.