Pinterest: Q1 Mixed Bag, Our Optimism Remains – Seeking Alpha

Pinterest Takes Stock Public On New York Stock Exchange

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Premise – 1Q Report Presented a Mixed Bag, But Nothing Fundamentally Changed With The Bull Thesis

Pinterest (NYSE:PINS) reported 1Q earnings and gave 2Q forward commentary on Wednesday, April 27th. The numbers, as a monolith, were mixed, with some very nice upside surprises and some downside surprises. Our takeaway is that nothing much has changed fundamentally with the business and our perception of the thesis long-term. We’ve updated our valuation model and made slight tweaks to bear case and bull case estimates. Broadly however, we remain optimistic on the story long-term in spite of the mixed bag report.

1Q Headline Breakdown – Beating On Earnings, Revenue, Missing The Mark on Engagement

Let’s take a quick look at the numbers vis-a-vis consensus estimates.

  • EPS: $0.10 vs. $0.04 expected (+150% beat)
  • Revenue: $575m vs. $573m expected (+0.3% beat)
  • MAUs: 433m vs. 437.9m expected (-1.1% miss)
  • 2Q Rev. Guide: 11% vs. ~14% expected (~300bp miss)

These are sell-side numbers, and the buyside, which has been consistently underweight Pinterest for some time, likely had even lower expectations. So while the headline numbers are kind of meh, we think that institutional funds that track the stock were materially less optimistic than the sell-side.

We’ll go into the reasons for the beats and misses on the conference call breakdown, but the important thing to note for now is that Pinterest delivered a mixed bag.

Conference Call Notes – OpEx Ramp Delayed, Global Brand Awareness Campaign For 2H, Europe & CPG Weighing

Let’s look at some of our notes on Pinterest’s 1Q’22 earnings call.

Revenue was strong with 18% year-over-year growth to $575 million. This was due to strength from retail advertisers, our international business and our managed SMB advertisers, all of which offset the economic weakness we’re seeing in CPG and in Europe because of the war. – Ben Silbermann, CEO

As has been the case over the last few quarters, strength in Pinterest’s business has been driven by strong ad demand from retail partners who sign joint business partnerships. The international business is likely strong because of just how early it is in development of becoming anything material. Additionally, the business is seeing strength from managed SMBs. This could be, if we had to guess, an effect of incremental reductions in ad demand at Meta (NASDAQ:FB) for price-sensitive and ROI sensitive SMB DR advertisers.

We might be wrong on that, but most indications seemed to say that Meta struggled with measurement and targeting, especially in February, which maybe enabled some budget diversification, being a tailwind for a platform like Pinterest. The reason might have something to do with advertisers being more experimental with excess budgets as well as Pinterest’s insights being mostly 1P and on-platform versus Facebook/Instagram’s 3P/1P holistic approach.

Nonetheless, we think that Pinterest was one of the potential beneficiaries of Meta’s weakness.

With regards to weakness however, as most in internet pointed out, CPG and supply chain impacted verticals likely were uninterested in creating incremental demand until they have the supply to fulfill it. We expect this to be a recurring drag on the business in the quarters to come, but not a structural issue outright. So CPG remains weak, and on top of that you probably have advertiser demand and user headwinds in Europe as a result of the war. We’ve seen reports of potential deterioration in European consumer demand, which could be fueling that advertiser anxiety.

We also felt the impacts of lower traffic from search and time spent by people on competitive platforms. We’re doing a number of things to improve the Pinner experience and tackle engagement headwinds head on. In the near-term, we’re applying sophisticated machine learning to every aspects of our platform. As a result, we’ve seen marked improvements in the relevance of home feed recommendations, the quality of search results and engagement with notifications. All of these enhance the quality of our platform for Pinners, and are leading indicators of deeper user engagement. We also plan to launch a global brand awareness and comprehension marketing campaign starting in Q3. – Ben Silbermann, CEO

Pinterest felt the impacts of lower search traffic and time spend from competing platforms. This is a headwind that companies like Meta have been calling out and Pinterest is now calling out the same. This isn’t a top concern of ours, and is likely somewhat of a copout on engagement. Lower search traffic has been called out for multiple quarters and it doesn’t seem like anything is changing. Convenient scapegoat much? Short-term investments in improving recommendations and engagement quality are reassuring, but the continued y/y declines are concerning, nonetheless. Investments in ML are improving search quality and home feed relevance which deepens engagement long-term. That’s going to take time, talent, and investment.

The more important line from this is that Pinterest is launching a global brand awareness campaign. This is concerning in part because it leaves doubts in the minds of investors about Pinterest’s ability to generate organic top-of-funnel demand. Is the creator push going too slow? Is competition really that hot? If they’re ramping an awareness marketing campaign (boosting opex) to increase users, what does that say about long-term organic engagement trends? It’s not positive and if anything, could be a sign of relative desperation to juice engagement. This is also interesting considering that 1Q non-GAAP opex was +15% y/y and the 2Q commentary implies the same, but FY commentary implies 35-40% y/y. That acceleration is likely fueled by large incremental spend on that global brand awareness campaign.

But we’re committed to this strategy because we believe it will drive engagement over time and because we believe that native content in video, in particular, is fundamental to help the people get inspiration and shop in the future. – Ben Silbermann, CEO

Pinterest has often been critiqued for being too static-image-oriented as a platform. It seems that they’re understanding how fundamental video will be to the future of on-platform engagement, and are investing now to build out that ecosystem. Video is generally a more dynamic format for engagement and advertising anyway.

In 2021, I’m especially proud of our teams that laid the foundation for a native content ecosystem. It’s gaining traction. The number of video idea Pinners is up 15x year-over-year, and this content is resonating with more and more people as we continue to see that Pinners, who follow multiple creators, visit Pinterest more often compared to those who do not. – Ben Silbermann, CEO

It seems that the video push is already starting to pay dividends on the engagement side. Though it’s an easy comp, you’re seeing a 15x jump in Idea Pins engaged Pinners. Additionally, you’re seeing creator-engaged users spend more time on platform than non-creator engaged. Maybe these are early anecdotes that investment in creators and video are paying dividends in terms of increasing incremental engagement. It’s definitely too early to tell because video as a format and creators as a medium haven’t scaled globally, but early trends are relatively encouraging.

We also started beta testing Your Shop, which uses our unique ability to understand taste and preferences, to deliver an experience for each Pinner that’s personalized to them. This work is fundamental to our vision. So users can not only come to Pinterest with the expectation of being inspired but also know that they can turn those inspirations into a reality with purchases. – Ben Silbermann, CEO

This is interesting, as it is a new initiative that is expanding Pinterest’s involvement in deepening the shopper experience on platform. It’ll be interesting to see engagement with Your Shop when it leaves beta, but the idea of a personalized taste and preference experience for shoppers is compelling to say the least. Especially when you consider Pinterest’s trove of 1P insights on user interests, this feature just makes sense.

Beginning this quarter, we’re providing additional disclosure around our revenue, our monthly active users or MAUs, our average revenue per user or ARPU by presenting the U.S. and Canada, Europe and rest of world separately. – Todd Morgenfeld, CFO

This is an important shift in disclosures, and adds a layer of granularity to KPIs that we’ve been getting from Pinterest. Instead of getting two monolithic groups (US + international) like we’ve been getting in the past, now management is breaking it out into three distinct categories. This will help ARPU and user growth mapping, and is a +1 point for management integrity and transparency. It’s a good little step of providing more clarity on the business that we appreciate.

Revenue growth from Europe was 27% year-over-year. On a constant currency basis, revenue growth in Europe would have been approximately 34% year-over-year. – Todd Morgenfeld, CFO

So you want to talk about macro headwinds? How about a 700bp drag on European revenue growth as a result of FX headwinds? That’s some macro weight right there. Obviously this is a fluctuating situation as the Euro fluctuates with geopolitical and macroeconomic events, but the strength of the underlying business is being weighed by transitory factors. Keep this in mind when looking through the numbers.

And as we continued the distribution and placement of Idea Pins, we believe this negatively impacted our first quarter year-over-year revenue growth in the mid single-digits on a percentage basis similar to the prior two quarters. This impact was factored into our guidance for the first quarter. – Todd Morgenfeld, CFO

Ad inventory shifting to unmonetized Idea Pins inventory continues to have a mid-single digit weight on revenue growth, relatively consistent with the 2H’21 number. This has been consistently baked into management’s guide and will likely continue until the surface gets some monetization traction.

However, sequentially, our non-GAAP OpEx declined 1% due to pushing off creator-related spend, slower hiring than we anticipated, particularly in the bay area and a few other favorable items. – Todd Morgenfeld, CFO

As we noted in the headline numbers digest, EPS beat pretty massively. Here’s your reason. Costs came in light, only up 15% y/y on a non-GAAP basis, and was actually down sequentially vs. the guide of ~10% sequential growth. They’re blaming a competitive hiring environment for talent slowing new hires across the company (especially in NorCal), and delaying creator investments. We’d expect creator investments to ramp into 2H, so you’re going to get cost acceleration from that eventually. We think labor market shortages and competition for talent will be a continuing factor giving laborers the leverage until you start to see broader market strength wane. So that might be a more structural factor that takes spend down short-term. Personally, we’d rather they not grow headcount vigorously and overpay for competing talent and see easing pressure on operating margins, especially in an FCF/EPS centric market environment like today’s.

As Ben mentioned, we’re looking at ways to drive more sustainable user acquisition and retention. For example, we’re making Pinterest more browsable without immediately requiring users to sign up when they land on the site. While this had a modest negative impact on global new user signups initially, we believe that removing barriers for longer browsing sessions can drive more activations over time. We also believe our investments in the core Pinner experience on home feed, search and shopping can make Pinterest feel more personal and relevant in the near to medium term. And that our investments in creator-led native content and short form videos can bend the curve on engagement in the long run. – Todd Morgenfeld, CFO

Here’s management’s short, medium, and long-term strategic direction on improving engagement trends. Short-term they’re trying to make the platform more sticky and more frictionless by enabling greater web browsing on platform before asking for a signup. This change was initially a headwind as less people signed up upon being prompted, but Pinterest has noticed this strategy work to increase long-term signups in international markets. We’ll see if it pans out domestically.

Additionally, over the medium term, the team continues to build out recommendation and personalization on platform to keep engagement more entrenched and to increase time spend/session frequency.

Long-term the push is still connecting users with creators and bending the engagement curve towards video to really entrench the experience.

With respect to our Q1 engagement trends, it’s worth noting that our global mobile app MAUs, which account for the significant majority of our impressions and revenue grew in the mid single digits year-over-year. Mobile app MAUs in the U.S. and Canada were also relatively resilient, declining around 6% year-over-year versus down 31% year-over-year for web-based MAUs. Sequentially, U.S. and Canada mobile app MAUs were flat. Our younger Gen Z users were also a source of strength growing mid single digits year-over-year. Finally, shopping engagement remained relatively resilient with the number of Pinners engaging and shopping surfaces is growing year-over-year. – Todd Morgenfeld, CFO

Revenue generating users (i.e. the global app users) grew mid single digits against a 1Q’21 comp. Think about that. Against the peak comp for Pinterest, the most valuable users they have are growing mid single digits. That’s important when you hear the argument about declining engagement. The group that matters the most is growing in spite of lapping incredibly difficult comps.

Domestic mobile MAUs still generate the most impressions and revenue for the company and they were down 6% y/y. Not a positive, but again, you’re going against a Covid juiced comp and a company that in that one-year time frame did very little on the product innovation side. The product tide is likely turning and you could see that y/y accelerate.

Additionally, you can see the drop-off in engagement has been driven it seems primarily due to waning web traffic. You can blame this on SEO changes, the Covid lockdowns easing worldwide, and the fact that most of this engagement is likely more ephemeral and less entrenched than mobile. As management has discussed before, these web users are generally top of funnel users, so while the user acquisition engine has been weaker y/y, mobile is still in a position of relative strength.

Sequentially, you have flat engagement in US+C mobile MAUs, a positive signaling that maybe engagement is nearing a bottom. Additionally, you’re seeing strength being driven by Gen-Z growth and shopping growth, two of the most important things to watch with this story.

While we typically don’t provide MAU guidance, for the last three quarters, we’ve shared a quarter to date snapshot of MAUs in our earnings. As of April 25, U.S. and Canada MAUs were at 94 million and global MAUs were 432.9 million. – Todd Morgenfeld, CFO

Management says engagement is basically flat both in the new US+C segment and globally. So, while yes, Pinterest reported a slight sequential bounce in 1Q relative to the holiday quarter, it looks like through April that bounce was at least flattening out.

As you think about MAUs for Q2, I’d like to provide you with some additional context. Q2 has historically been our seasonally weakest quarter for MAUs, given that people tend to be outside more, travel more and engage in our core use cases less often. As a reminder, at the end of the quarter we calculate MAUs based on a 30 day look back from the last month of each quarter. Since June is one of our weaker months for engagement in the U.S., a snapshot of MAUs on April 25 may not predict June MAUs. – Todd Morgenfeld, CFO

We would take this as a hint that Pinterest could see a sequential decline in MAUs. Why? Because the headline number is a 30 day look back from June, and if June is seasonally weak, and the quarter is already starting flat, you’re either going to see (a.) a big jump in May traffic or (b.) flat May traffic and a pullback in June. So far, through May, our checks are lukewarm, nothing incredible for m/m engagement.

We think a big reason the stock caught a post-earnings bid was because investors saw the headline user number up q/q. If that fades in 2Q, which is currently our base case, the stock might get doghoused again. We essentially think that this is management’s hint at a likely q/q decline in 2Q engagement trends.

On the revenue side, we expect Q2 revenue to grow around 11% on a percentage basis year-over-year. Please note that our Q2 revenue guide takes into account a few considerations. First, it’s worth noting that we had a particularly strong Q2 last year with revenue growing 125% after a week Q2 of 2020. Second, the macroenvironment remains challenging, including supply chain issues and inflation exacerbated by the conflict in Europe. It’s unclear how long these conditions will persist. Third, we continue to monitor the impact of higher CPAs. – Todd Morgenfeld, CFO

Revenue is guided +11% after 1Q came in +18% y/y. That’s a pretty major decel, even if it is the bottom for growth rates as comps ease into 2H. Your first catalyst for the deceleration is the 125% growth comp from 2Q’21. The macro environment, especially in CPG is challenging to say the least. So you have comps, macro, and higher CPAs. The comps are toughest in 2Q, which could enable acceleration against easy comps in 2H. On the macro side, inflation is structural and it doesn’t seem the RUS-UKR conflict will be easing any time soon. So you’ve got a weak macro environment. And then, you have higher price per action, which management delves into more later.

In general, we believe that higher pricing has multiple drivers, including industry-wide dynamics and recent trends in our user base.

In Q1, we observed that higher pricing lowered budget utilization for a subset of our U.S. small and medium sized advertisers – small and medium sized advertisers that are more price sensitive. – Todd Morgenfeld, CFO

Essentially, price per action (i.e. app install, signup, purchase etc.) is growing because the number of impressions isn’t holding up as well (because of declining engagement) and broadly high demand for digital ad inventory. This has led to more price sensitive advertisers being more cautious with budget utilization, a dynamic that makes sense when you’re not a global brand that can kind of ‘look the other way’ on the technicals of ad performance.

Finally, our investment in building a native content ecosystem will likely remain a mid single digit headwind to revenue. However, we believe that this effort will both be engagement and revenue accretive over time. – Todd Morgenfeld, CFO

Management continues to point out that investing in the native content ecosystem is a mid single digit revenue growth headwind as it has been for the last few quarters.

We expect the second quarter non-GAAP operating expenses to grow at 10% quarter-over-quarter as we push some of the spend from Q1 into Q2 and beyond. We plan to continue to scale our investments and our native content ecosystem, the core Pinner experience and headcount across research and development and sales and marketing, but timing could be lumpy quarter-to-quarter. We also plan to push our Q2 brand marketing campaign to start towards the end of Q3 and into Q4 this year. For the full year, we plan to invest in our growth initiatives. Layering in some of the benefits and under spend for Q1 and recognizing that this is a competitive hiring environment, we are expecting non-GAAP operating expenses to grow in the range of 35% to 40% year-over-year. – Todd Morgenfeld, CFO

This 10% q/q comment translates to 15% non-GAAP y/y cost growth in both 1Q and 2Q. Key investments are going to be made in 2H surrounding investments in headcount, brand marketing, and their creator push. It seems that slower than expected cost growth was fueled by the competitive labor market in Silicon Valley slowing headcount growth and delays on brand marketing and creator expansion. So that headline earnings beat was likely driven by delayed cost growth. Additionally, keep in mind that the prior guide for full-year cost growth was ~40% y/y and now it’s in range of 35-40%. This reflects a broader trend in tech earnings as companies slow cost growth to reflect slower revenue growth.

And entering Q1, we started to lower baseline than we would have absent the algorithm updates in November 2021, when we had few resurrections from research in February and March that we typically see. – Ben Silbermann, CEO

A little added color on seasonal tailwinds in 1Q that Pinterest didn’t see this time around because the normal February-March desktop user ‘resurrection’ occurs. This is due to intentional on-site changes and Google’s (NASDAQ:GOOG) (NASDAQ:GOOGL) continued changes in their SEO algorithm that Pinterest is continuing to adjust to.

For example, when you visit Pinterest now compared to a few months ago, the experience is a lot more open, meaning you can explore the whole service, you can explore different pins without prompting you to sign up, and we allow you to dismiss that prompt. Todd mentioned that that caused some modest declines in MAUs in the short-term, but we think it’s the right long-term strategy. It’s one that we’ve been testing internationally and results in higher activation rates and more sign-ups over the medium to long term. So we’re proactively investing in better relevance. – Ben Silbermann

One of the key changes being made on-site at Pinterest is enabling greater on-site exploration prior to prompting the user to create an account. This lets top-of-funnel engagement feel more organic before prompting a user to create a new account. This was a short-term headwind to user growth, but management said that it has been something the company is doing internationally and its leading to improved retention and more long-term signups. These are the little technical, product level changes that management is making to boost engagement. You love to see management teams make these little changes to the product to add more value over the long term.

And in search, we began to introduce new features such as structured search for things like recipes that will expand it in new verticals. And what we’re seeing from those is an increase in search query volume and a resulting increase in engagement. – Ben Silbermann, CEO

When we talk about Pinterest being an inspiration engine, this is what we mean. Giving the full-funnel inspiration experience across creators, search, and organic content recommendation is key to driving engagement. And right now, it looks like the technical investments in recommendation are starting to pay off in terms of improving search volume, something that probably bodes well for business long-term.

And just for – just to kind of reset from Feb 1 to March 31st, the U.S. declined from 86.6 million monthly active users to 85.2 million, and global MAUs declined from 436.8 million to 433.3 million. – Todd Morgenfeld, CFO

These figures help us quantify how much damage the aforementioned headwinds did to engagement as the quarter progressed. With RUS-UKR, continued SEO churn, and changing signup philosophy, we can see that as the quarter progressed, engagement clearly took a hit. Keep this in mind for modeling.

Globally, the decline was due to lower engagement in Russia, Ukraine, and other countries in Europe. And we think based on our estimates that, that was about a 5 million global MAU impacts. So had it not been for those events, we think our global MAUs would have been modestly up from the Feb 1 MAU number that we shared. – Todd Morgenfeld, CFO

Here we get a number for how big an impact the RUS-UKR issue had on engagement. They’re saying about a ~5m MAU headwind in Europe broadly resulting from the conflict, and that engagement would’ve likely been greater than the 436.9m MAU number they shared on Feb 1. This just gives us some perspective on how much downside engagement saw from the conflict, and where numbers would have been if the conflict didn’t happen.

We’ve known for a long time that Pinners have a lot of commercial intent and they bring that intent to Pinterest. And what we’ve seen is that as we remove barriers to people executing that intent by linking them to products, by ensuring those products are in stock, that the prices are accurate, their purchasing behavior increases. And so our core strategy has been around increasing that inventory, making the matching more efficient and then eventually streamlining that conversion event at the end. – Ben Silbermann, CEO

This is quite interesting, as it best outlines what Pinterest’s philosophy on native checkout might look like. Creating a streamlined process from inspiration to purchase is needed to make the process as organic as possible, and it seems that’s something they’re working on. Just look at their latest initiative Your Shop. These things are still in beta, in the works, but it’s good to see that management hasn’t abandoned native shopping.

Thesis – Picture Remains Bright On a Long Enough Time Horizon

In bear markets, investors tend to go underweight long-term thinking, and overweight short-term thinking. Pinterest, over the short-term, certainly has challenges. When you look at the macro picture, it’s certainly starting to look gloomy. When you look at company specific factors like continued user volatility and CPG partner weakness, we can understand the concern.

However, taking a long-term view is going to be rewarding here. At time of writing, Pinterest’s EV is ~$12B. You think that if Microsoft (NASDAQ:MSFT) and PayPal (NASDAQ:PYPL) were willing to buy at a multiple of that a few months back that there’s no interest now? $12B EV for a platform with 430m high purchase intent users? There’s definitely an M&A value prop, maybe even a spot for an activist or PE firm to get involved.

On a standalone basis, we still find reasons to be bullish. If you believe in digital advertising’s secular story and Pinterest carving out its niche in it with dynamic and targeted advertisements to a unique audience, the story hasn’t changed much. The work they’re doing is to enhance the core experience and entrench engagement while also providing advertisers the necessary tools to optimize their ads. The long-term value is still there.

In essence, we think they can carve out a meaningful business within the digital ad space regardless of any potential M&A. That said, M&A is certainly a possibility that investors should keep in the back of their minds.

Valuation

’22E Base Case KPI
MAUs (in m) 441.0
ARPU (in $) 6.86
Revenue (in $b) $3.025
Gross Margin (in %) 78.99
GAAP OpEx (in $b) $2.174
FCF (in $m) $599.761
Tgt. P/S Mult. 7.12x
Mkt. Cap (in $b) $21.552
Shares Outstanding (in m) 656.899
Price Target $32.81
+Upside/-Downside +43.21%
Rating Buy

Our valuation implies +17% FY revenue growth, with slight y/y compression in gross margins and mid 20s GAAP OpEx growth (mid 30s non-GAAP). Our target P/S multiple is more of an implied output multiple that we get from running our DCF. That DCF carries ’31E sales of ~$9.948B and FCF of ~$2.192B with an 11% discount rate, 3% terminal growth rate, and a 17x exit FCF multiple. So that P/S multiple is just a reflection of our DCF valuation against our ’22 sales estimate.

’22E Bear Case KPI
MAUs (in m) 436.0
ARPU (in $) 6.82
Revenue (in $b) $2.972
Gross Margin (in %) 78.74
GAAP OpEx (in $b) $2.202
FCF (in $m) $524.936
Tgt. P/S Mult. 3.5x
Mkt. Cap (in $b) $10.402
Shares Outstanding (in m) 656.899
Price Target $15.83
+Upside/-Downside -30.91%

Our bear case assumes user numbers bottom in 2Q with a much more modest 2H recovery than modeled in our base case. Additionally, we assume a much more lumpy back half recovery as economic conditions worsen broadly. Coupled with a much lower target multiple for a lower growth rate and our higher expectations for OpEx, and you get a -30% bear case scenario for the stock. This is as bearish as it gets for us.

’22E Bull Case KPI
MAUs (in m) 448.0
ARPU (in $) 6.82
Revenue (in $b) $3.091
Gross Margin (in %) 79.25
GAAP OpEx (in $b) $2.165
FCF (in $m) $667.06
Tgt. P/S Mult. 12x
Mkt. Cap (in $b) $37.092
Shares Outstanding (in m) 656.899
Price Target $56.46
+Upside/-Downside +146.44%

Our bull case for the stock assumes a reaccelerating in engagement growth and a vicious 2H re-acceleration in revenue growth. This assumes supply chain conditions normalize to a degree and inflation cools without material economic damage. Think of this as the ‘soft landing’ scenario that the Fed talks about all the time. Our target multiple reflects a renewed appreciation for Pinterest and growth tech broadly as a subset of equities as we see revenue growth reaccelerate. We think the multiple reflects that.

Conclusion – In Spite of The Challenges, We Remain Bulls

We reduced our target on the stock to reflect some of the recent headwinds, but our fundamental long-term optimism remains. We’re keeping the stock at Buy.

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