Snap Inc: Stock Price Euphoria Appears Unsustainable

Summary

Shares of Snap had a fantastic year, more than tripling in price to what is now per share.

Positive momentum has been driven by strong revenue growth. Snap may reach profitability in Q4.

Snap's still burning cash despite growth, and the stock is now trading at more than 16X revenue. We question Snap's ability to continue relying on the North American user base.

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Technology company Snap Inc. (SNAP), known for its camera based smartphone app, has been on a hot streak for much of the past year. While investors who bought the IPO are still in the red, the stock has roared back from lows of just over per share - to more than triple that at per share. The company has benefited from strong revenue growth, and an overall stock market that continues to march higher. The stock's price action has certainly made us look foolish since our previous coverage, but we remain concerned about long term investment prospects. The company continues to burn a lot of cash, despite its growth. Meanwhile, the company's revenue growth is highly concentrated in its existing North American user base. With the stock trading at high revenue multiples, we remain skeptical as to whether shares of Snap can sustain this momentum moving forward.

9183741-15790999703346498.png2019 was certainly the "year of Snap". After tumbling from IPO highs to just over per share at the end of 2018, Snap has rebounded with aggression. Since lows, the stock has almost tripled to per share. While investors who have held since the IPO still see red, investors who bought anywhere near the stock's lower range have made out extremely well thus far.

9183741-15791009583990848.pngsource: Ycharts

This momentum along with Snap's revenue growth and potential to post its first profit in Q4, could be a foundation for the stock to elevate beyond IPO prices in 2020. However, we see some red flags present that could undermine Snap's momentum.

The Company Continues To Burn Cash

This concern is a recurring theme from our previous coverage. The company continues to remain FCF negative, despite Y/Y revenue growth of 50% in the third quarter. We favor non-capital intensive business models, so it's great that CAPEX has been reduced so effectively in recent quarters. However, this puts more onus on operations to turn the business FCF positive. From a CAPEX standpoint, the business really can't get much leaner than it is now.

9183741-15791068120454876.pngsource: Snap Inc.

In the short term, Snap will get by. Since our previous coverage, the company sold billion in convertible notes to raise cash. This gives the company a hefty cash balance of 8 million, and another .5 billion in marketable securities. Our long term concerns stem around whether the business can sufficiently operate at a cash positive basis.

The company still generated more than 7 million in operating losses for Q3 2019 versus 3 million in Q3 2018. In other words, the company grew revenues Y/Y by 50%, but closed its operating losses by just 30%. At current run rates, this business still needs so much more growth in the years ahead. This doesn't even include Snap's recent 6 million purchase of AI Factory. We will likely hear more about this acquisition during the company's Q4 call to learn whether the company just wanted intellectual property, or if/how this new asset will impact Snap's cash appropriations.

Looking At How Sustainable Snap's Revenue Growth Is

Snap's Y/Y growth is certainly a positive development for the company. But knowing how much more the company needs moving forward, we aren't sold that Snap can sustain this needed growth in a sea of competition. The short video landscape is becoming increasingly competitive thanks to increased popularity from apps including Facebook (FB)/Instagram, and now Tik-Tok. Fellow contributor WY Capital recently outlined this in their analysis.

Furthermore, the company's North American user base - that is easily its most lucrative, has consistently been its slowest growing market from a volume standpoint. The North American user base has grown just a total of 6% over the past year.

9183741-15791112523666458.pngsource: Snap Inc.

The company's overall Y/Y user growth of 13% signals that most of that 50% revenue growth is simply due to extracting more out of its existing users. Non-volume growth is difficult to sustain over long periods of time. The company's highest jump in Y/Y revenue per user was in North America. But eventually there is only so much juice to squeeze. To truly sustain long term growth, the company will need to figure out how to better monetize its non-North American user bases, an area where Snap has shown progress - but remains well off of where it needs to be.

9183741-1579111764644469.pngsource: Snap Inc.

Compared to the .75 generated per user in North America, the remaining user bases generate just 27%-28% as much revenue per user. Further more, the North American market's 40% weight on global users means that either a decline in Snap's popularity, or a dip on revenue per user will be catastrophic to Snap's operating results because so much currently rides on it.

Shares Are Risky At Current Prices

This fragility in Snap's revenue growth is why shares are too risky at current pricing levels.

9183741-15791121122226706.pngsource: Ycharts

The stock was arguably oversold at the beginning of 2019, but the run on the stock has catapulted shares to approximately 16X revenues. This is an outrageously aggressive multiple, compared to just about any growing tech stock in the sector. This is especially difficult to justify given the company's revenue growth is not even being primarily driven by volume.

If we take the midpoint of Q4 guided revenues (0 million) and take FY2019 revenues at a 10X multiple (a still aggressive multiplier to reflect hypothetical bullish sentiment), the resulting share price of .88 per share still implies downside from current levels of 40%.

In other words, Snap has been priced at a level that is way too optimistic given the company's trailing operating results. While its perfectly reasonable to be optimistic about Snap's future, the current stock price falls well short of accounting for various risks that Snap must still work through. The company is still burning cash, faces aggressive competition, and has yet to counter its reliance on the North American user base. For these reasons, we see immense risk in Snap shares today.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Mar 07 2021 - Snap: The Game Has Changed, Buy The Dip, 0 Price Target

Dec 31 2020 - Snap: Path To 0 Billion Underway, Upgrading To Buy

Jan 20 2021 - Snap: Poised To Beat Earnings Again

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Apr 22 2020 - Snap: Proving The Bears Wrong, Again

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