Summary
Snap Inc is facing challenges including slowing daily active user (DAU) growth in North America, declining average revenue per user (ARPU), and sluggish strategic investments.
These issues, along with a significant pullback in ad spending across the market, have led to a bearish short-term outlook for the stock.
Despite these challenges, SNAP has potential growth opportunities including international expansion, ARPU growth, and strategic initiatives including augmented reality, virtual shopping, and Snapchat+.
I view the current valuation as expensive, with a weighted average price target that implies a 25% discount to today’s price.
The company needs to carefully execute its growth strategies and find alternative methods of monetization from its existing user base to become attractive in the long run.
Justin Sullivan
Thesis
Snap Inc. $Snap Inc(SNAP)$ represents a strong AdTech business that has been facing various public and economic headwinds that have put and will continue to put, short- to medium-term pricing pressure on the stock.
However, I believe that SNAP's potential to scale ARPU, continue to grow DAUs and expand geographically all represent significant upside for the stock, along with exciting future levers for growth in augmented reality, shopping, and hardware could provide the business the much-needed growth it has been seeking.
My weighted average NTM price target for the stock is $9, implying a 25% discount to the share price at the time this analysis was written. My analysis will cover the growth levers at play: ARPU decline, DAU growth, international expansion, strategic product positioning, and user demographic trends.
ARPU Metric Analysis
The analysis I conducted and share below highlights quarterly ARPU for SNAP since 2019. SNAP has experienced YoY total ARPU decline over the last four consecutive quarters, with the lone bright spot of ARPU Rest of World growing 5% YoY in 1Q23. Additionally, in the first quarter of this year, SNAP had the steepest YoY ARPU decline in company history of 18% in North America, 12% in Europe, and 19% across the entire company. The decline in ARPU has been largely driven by drops in ARPU across all regions, but primarily from North America and Europe, the two largest-revenue-contributing regions to SNAP across the platform.
Author's representation
In addition to the regional decline in revenue per user across all geographies, SNAP has exhibited a much faster decline in LTM ARPU growth (12% decline) relative to peers, which have had flat ARPU growth on average as highlighted in the analysis below. However, over the next twelve months, SNAP is projected to regain some of its lost footing amongst the competitive landscape, with an expectation to grow ARPU 5% versus a 2% decline from the peer set. I believe that the anticipation of an improved advertising base and slowing DAU growth should allow the company to drive more revenue growth per user over time.
Author's representation
It should also be noted that SNAP is positioned in the bottom half of the ARPU range of the competitive set, in terms of pure dollars per average user, which I see as an opportunity for SNAP to find further ways to monetize in the future. More on that later.
DAU & MAU Analysis
SNAP is one of the only AdTech companies to publish strictly DAU metrics, instead of MAUs -what many other competitors report. This seemingly minute difference in the way the company reports its metrics represents to me a key piece of information related to how the company views itself, its users, and its monetization strategy: the plan is, and always has been, to monetize a highly sticky, active, and engaged user base.
The company has been able to grow DAUs across all regions in 16 consecutive quarters, highlighting a key growth area for the business. However, DAUs began to decline QoQ in North America for the first time since 1Q19, signaling to me that SNAP is in the process of reaching market saturation in its most profitable region.
Author's representation
The graphic above demonstrates SNAP's accelerated LTM DAU growth (17% versus an average of 8%) and NTM DAU growth (16% versus an average of 5%) relative to peers. I believe the strong growth in users will prove to be a key area to monitor as the company saturates more international markets as the company has nearly done in North America already (4% growth). The chart also depicts SNAP in the top-half of the comp set in terms of strict MAU numbers, with 750 million reported MAUs compared with 703 MAUs on average for the competitive set.
International Expansion
Even though SNAP has struggled to grow its user base and ARPU in North America, where the company is based, I believe there remains upside related to international growth. The company has successfully been able to increase market penetration, ARPU, and DAUs in key international markets, namely in India, France, Pakistan, and Saudi Arabia, as evidenced by the 5% ARPU and 27% DAU growth in Rest of World in 1Q23. SNAP still has a long way to go in terms of driving further international ARPU and DAU growth while diversifying revenues away from its core North American market.
International markets, namely Europe (11% DAU growth) and Rest of world (31%), represent the key growth areas for SNAP from a DAU perspective. In my opinion, a key focus area for the company moving forward will be how quickly it can grow its international user base while also driving ARPU (which we have already seen as starting to decline). Should the company begin to reverse the growing DAU trend in the coming quarters, I believe the business will have to find other growth levers outside of DAU and ARPU expansion.
The chart above shows the current breakdown of the geographic revenue dispersion for SNAP, along with forward-looking projections of DAU and revenue growth that were built on proprietary models.
Author's representation
From a pure revenue perspective, SNAP currently derives about 64% of its revenue from 26% of its DAU base in North America, highlighting the earnings power of the highly saturated US market. In my opinion, the real future growth is expected to come from Europe (16% of revenue and 25% of DAUs) and the Rest of World (20% of revenue and 50% of DAUs). I believe the full upside for SNAP can be had if the company can drive ARPU in these growing international markets which are currently consisting of nearly 74%, or three-quarters, of all DAUs on the platform.
Strategic Initiatives and Product Positioning
Over the last 3 years alone, SNAP has invested a minimum of $1 billion in strategic M&A acquisitions for at least 10 businesses. The transactions highlight the growth priorities for the business as well as where the company wants to position itself in the future. A deeper analysis and breakdown of the transactions I conducted illuminates how small of a revenue contributor the investments in new products are, in my view, expected to be. These investments I conservatively estimate to generate approximately $20 million (based on an estimate for how much the largest acquisition of WaveOptics was generated in ARR pre-acquisition), or less than 1% of total sales.
The bulk of SNAP's recent investments has been in hardware for augmented reality (AR) lenses, cameras, and technologies, software for online and virtual shopping, and infrastructure for open-source databases and technologies. The bet SNAP is making, in my view, is on AR as a tool for users to search for products, buy products online, and receive advertising in the form of AR lenses. I believe that while the strategy has legs, the investments in the technologies themselves and the changing user behaviors will not be had for at least 12 to 24 months. As such, pricing in the growth for the M&A & business line strategy shifts proves to be too nominal at this stage of the company's valuation but is worth monitoring closely as a potential growth lever as the company continues to search for ways to monetize outside of traditional mobile ads.
Author's representation
In the chart above, I assume that organic revenue is growing at 8% over the next twelve months, that the most recent acquisition of WaveOptics was generating $20 million ARR, and that SNAP can double WaveOptics / M&A revenue in the first 12 months. With these assumptions, which are on the more aggressive side, it becomes clear to me that these investments in alternative product lines may contribute up to 5% of sales growth over the next 12 months and less than 1% of total sales. The potential for these investments to pay off will therefore, in my opinion, likely require more time to truly scale and provide investors with an attractive ROI.
The investments that SNAP has been making in the future of shopping in my view can be seen as a distraction. The corporate signaling and bulk of air-time on more recent earnings calls signal to me that the business is aware of and attempting to pivot and expand outside of its core advertising business. The potential for distraction I believe extends beyond just that of management's time, effort, and resources, but also that of investors. As seen in the past with the wildly public failure of Spectacles, perhaps this next foray into physical products will be better than the first.
Business Model Shift
SNAP launched Snapchat+ (plus), the company's first-ever subscription service in June 2022 that costs $3.99 per month to give users exclusive features including pinning friends as a BFF, badges, My AI chatbot, background generation thru text, image generation based on conversations, story rewatch counts, Snapchat web. This new product, in my opinion, has the potential to grow over the next 12 to 24 months into a highly profitable business line for the company.
According to TechCrunch, as of April 2023, Snapchat+ has more than 3 million users, surpassing 2 million in February 2023 and 1 million in August 2022. This equates to $12 million in recurring revenue or 1% of current total sales. While this figure is immaterial today, I believe the subscription service could grow into something more meaningful, sticky, and profitable over the long-term - if not this service, then similar business model shifts, paid tier offering, or other services to monetize the current sticky user base of 383 million DAUs.
User Demographic Trends
It is no secret that the majority of users on SNAP are of the Gen Z and Millennial cohorts. According to SNAP's S-1, 58% of users are Gen Z and 27% are Millennials, combining 75% of all users on the platform. As a result, this demographic has a lot of competition for their time on mobile: iMessage, Instagram, TikTok, YouTube, WhatsApp - the list goes on. As the highly competitive market continues to heat up, advertisers on each program are forced to decide which platforms are best to spend their scarce ad resources on. While many companies do not publicly disclose what the ROI on each platform is, or how much time is spent per day or month per platform, the ARPU amongst competitors is telling. I compiled a list of competitors by LTM ARPU and LTM ARPU growth using publicly available financial information.
Author's representation
The graphic above highlights SNAP's significant decrease in ARPU of 12% relative to its peer set, most of whom stayed flat over the last twelve months. in my view, SNAP's ability to attract users outside of the current Gen Z and Millennial user base, grow the current generational base, or find ways to have them spend more active minutes per day are the levers that the company needs to solve before growth continues to flatten and decelerate. Lastly, I think that as the current user base matures, the next generation is ushered in, and other competitors provide more and more products and services, the competition for ad dollars will only get worse before it gets better.
Valuation
In my opinion, the current valuation of the stock is expensive today. I believe there is a lot to like about SNAP over a longer-term time horizon 12 to 24 months from today. The growth I believe will depend on international expansion, ARPU re-growth, and strategic initiatives that are exciting. Over the short term, SNAP is currently facing headwinds in the form of ad and marketing pullback across the spectrum, market saturation in its core and most profitable North American market, and increased competition in a flighty user demographic.
Below is a peer comparison table of SNAP against its competitors. In the analysis, I compared SNAP's LTM DAU growth, LTM ARPU, LTM ARPU Growth, and EV/NTM Sales metrics against the comp set. I used EV/NTM Revenue because the company and some of its competitors or not yet profitable, eliminating and distorting valuation methods including EV/EBITDA.
Author's representation
When compared to the comp set, SNAP has the second-highest LTM DAU growth rate (17%, behind only YALA of 19%), a bullish sign of the company's growth relative to peers. However, as previously discussed, much of this growth is from less profitable international markets rather than its core North American market, which is growing at 4%, below the median 7% of the comp set. In addition, SNAP is well below comp set average in terms of LTM ARPU on a hard dollar basis ($3 against a median of $10) and LTM ARPU growth (a 12% decline against a median of a 1% decline). This shows me that the company is lagging in terms of pricing power relative to its competitors and is more impacted by a lack of customer stickiness than its peers.
As such, I see a 35% downside from today's share price, which I view as currently inflated likely fueled by an uptick in options trading, stock market activity, and bullish tech sector sentiment. Additionally, I think in the short term, revenue growth from ARPU deceleration, DAU growth saturation in key, profitable markets, and bets on future products and services will likely take time to develop and bear economic and investment fruits from.
Author's representation
This weighted average price model is based on ARPU and MAU & DAU growth models as previously described. Additionally, and perhaps more importantly, I used changing multiples, which have been volatile recently, in each of the three cases. At a blended rate, the short-term downside relative to current valuation is worth considering.
Risks
Despite short-term view and recent pricing pressure on SNAP, there are several catalysts that I believe may alter my price target and change my view from bearish to bullish. The catalysts revolve around monetization strategies of existing users in DAU-saturated markets, strategic initiative execution in AR and virtual shopping, and business model expansion.
First, I believe that how the company handles DAU market saturation in key, profitable North American and, soon, European markets, coupled with SNAP's ARPU growth plan will prove to determine how the core business will function in the short to medium term. We have seen how ad buying and ARPU fluctuate in a matter of days, mostly due to automatic bidding, higher ad volumes, and increased demand for customer eyeballs.
Second, in my view AR and virtual shopping on the platform over the next several months may move how the Street views the stock, and, if executed correctly, may warrant enough consideration than is currently being shown in this analysis.
Last, in my opinion, business model expansion and product line rollouts, including Snapchat+, could prove to be highly sticky and profitable if SNAP can continue to attract users to the subscription and offer other services, products, and features as a means to find alternative methods of monetization from the existing user base.
Conclusion
The recent headwinds SNAP is facing - slowing DAU growth in North America, declining ARPU, and sluggish strategic investments - in tandem with a significant pullback in ad spending across the market, in my view has caused significant stress on the value of the stock, causing my short-term outlook to be more bearish on the stock.
However, I see a path for SNAP to generate long-term shareholder value over the long-term with proper monetization, strategic initiative execution, and business model & geographic expansion in the short- and medium-term.
Source: Seeking Alpha
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