Snap Stock Is A Compelling Buy For Long-Term Investors (NYSE:SNAP) – Seeking Alpha

Snapchat Parent Snap Begins Trading On New York Stock Exchange

Drew Angerer/Getty Images News

Introduction

Snap Stock 5 Year Price Action

Snapchat 5Y Price Action (TradingView)

Snap (NYSE:SNAP) has fallen 71% from its highs in September 2021. With a high expected growth rate on the topline of 33% the next 4 years, this stock warrants a closer look to determine whether current share prices do really offer investors an asymmetric opportunity to initiate a position. This article covers Snapchat’s growth story as well as the possibility for the company to be the leader in the AR software and hardware segment, which although if true, would be years away.

Business Model

Just like most other social media companies out there, Snap primarily makes its revenues from advertisements. Close to 99% of the overall topline was attributable to ads for the fiscal year ending 2021, and the other 1% to ‘snap spectacles and other sources’. In terms of monthly active users (MAUs), Snap is still nominally far behind its larger peers, with over 530M MAUs while Facebook (FB) has more than 5X that at 2.9BN and TikTok with over 1BN MAUs. However, it would be premature to assume that just because Snap has a smaller daily active user (DAU) and MAU base, it would be an inferior opportunity relative to the rest of the industry.

Snapchat Q1'22 average daily active users

Snapchat Q1’22 IP (IR)

Looking past the nominal value and focusing on growth rates, Snap’s DAUs have been steadily increasing over the years. In its most recent FQ1’22, Snap’s DAUs increased 18% YoY, primarily driven by growth in the RoW segment. On a QoQ basis, growth has slowed to 4.1% when compared to the growth observed from Q4’20 to Q1’21 of 5.7%. Snap has also been seeing strong growth in India (RoW segment) especially after TikTok was banned in June 2020, in what can be considered to be a catalyst that drove further adoption as consumers turned to counterparty sources of entertainment.

Snap revenue by geography

Snapchat Q1’22 IP (IR)

On a high level, revenues grew 38% yoy for Q1’22, driven by an increase in user count as well as ARPUs. What’s particularly impressive is the fact that the growth on a YoY basis is despite the fact that for the last month within Q1’22 (March), Snap halted all advertising in Russia, Belarus and Ukraine.

In terms of its geographical concentration, revenues are primarily generated from its legacy North American market just like it is with Facebook. North America accounts for 71% of the entire topline, followed by a roughly even split between the European and RoW markets, that both account for 15% each. On a nominal basis, North America brings in close to 5x the amount of revenues generated in Europe and the RoW, also because ARPUs there are significantly higher, 4X that of Europe’s ARPUs and 8X that of the RoW. On a yoy basis, Snap increased its North American revenues by 37%, which lagged the 43% growth observed in Europe and 38% in the RoW segment. This is as expected purely due to the law of numbers and the fact that Snap is looking to grow its revenues outside of its key market more. Although a QoQ drop was observed in Q1’22, this is normal due to the typical seasonality in ads businesses where Q4 tends to bring in the highest revenues as a function of aggressive spend by merchants during the holidays.

Key Metrics

When it comes to Snapchat, the average user spends 30 minutes on the app on a daily basis. With about 1/5th of the DAUs that it has compared to Facebook, this 30 minute spend is surprisingly only 3 minutes less than the time users spend on Facebook itself. Furthermore, given the increased competition from rivals such as TikTok, current engagement times are still about 10% higher than the time reported in 2021.

Social Media Engagement Stats

Social Media Engagement Stats (Pew Research Center)

Relative to peers, Snapchat’s engagement statistics also fares rather well. 59% of Snapchat users are reported to use the app on a daily basis, which is exactly in line with the 59% of Instagram’s user base that open the app once a day. This daily active usage also trumps the use of YouTube and Twitter (TWTR) and is primarily because of their predominant user base – the younger population. According to the Pew Research Centre, these figures are even higher amongst those aged between 18-29, of which 71% of them use the app on a daily basis.

AR – The Future

In contrast to VR which creates an artificial environment through a bulky enclosed-like hardware, AR makes use of the surrounding environment by overlaying new information and objects over it. Through recent acquisitions, it appears that Snap is trying to enhance their advertisement experience for merchants with the inclusion of AR features, and this is in line with the broader interest of retail companies who have already started launching marketing campaigns with the use of such a technology. Furthermore, 63% of Snap’s DAUs use AR filters which are some of the best in the industry. Going forward, this can be extrapolated to the consumption field where more consumers may start to prefer using an AR filter to virtually try out products before purchasing them online.

Global AR Active Users

Global AR Active Users (Statista)

Global AR Glasses Sales

Global AR Glasses Sales (Statista)

In terms of the TAM, the AR sector has been growing as a whole, meaning that there is also a substantial macro tailwind for Snap.

Snap also acquired NextMind early this year, a Paris based neurotech start-up. It is developing a brain-computer interface BCI technology (BCI) that will give us the ability to control the tech device with just our minds. According to SiliconRepublic:

Since 2017, NextMind has been developing non-invasive brain-computer interface technology for hands-free interaction with devices such as computers and augmented and virtual reality headsets. Its first product, released two years ago, is a headband developer kit used to monitor neural activity and enable users to ‘push’ virtual buttons or select and manipulate virtual objects by focusing on them.”

Moreover, the BCI they are developing requires us to use it as a headband and no surgery or implants are needed. If this endeavour succeeds, it will be pivotal in making the AR/VR experience more immersive and desirable, but as previously cautioned, it is perhaps still too early to tell.

Financials

Snapchat Model

Snapchat Model (Panther Investment Research)

Revenues have grown at a 59% CAGR for the past 5 years. Moreover, analysts expect revenue to grow 33% over the next 4 years ending FY25. Furthermore, given that revenues are primarily driven from advertising and that is then driven by user count and APRUs, the inherent ‘discrepancy’ between Facebook’s North American ARPU of $214 and Snap’s North America ARPU of $31 (sum of FQ1-4) shows there is still a long potential runway of growth for Snapchat relative to Meta. No doubt this surface level comparison is premature given that Facebook dominates the monetization of their core product (users) like no other, the point being that Snapchat’s ARPU potential can still see significant growth overtime if they successfully incorporate AR into advertising.

Moving on, EBITDA has been negative over the past couple of years but has been growing. In fact, analysts estimate that EBITDA will turn positive in 2022, and EBITDA is expected to grow at a CAGR of 73% for the next 4 years ending FY25.

Snapchat Model

Snapchat Model (Panther Investment Research)

FCF has always been negative, but similar to EBITDA, the gap has been closing driven by higher CFO relating to the company’s core operations alongside moderate CAPEX growth. FCF also turned positive just last year, albeit slightly skewed due to the high SBC artificially inflating the CFO nominal numbers. As per estimates, analysts also expect future CAGR growth of 100% for the next 4 years, which would be a remarkable pivot if projection numbers do materialise.

Valuation

Snap Stock valuation

Snapchat Model (Panther Investment Research)

Snap is currently trading at an EV/Sales multiple of 9X. Its average historical multiple over the past 5 years stood at 20X. For reference, Meta is currently trading at an EV/Sales multiple of 4.3x with an average historical of 9X.

  • Comparing Snap and Meta’s revenue growth rates, we can see that Snap future revenue growth rates are similar to Meta’s 5 year historical growth rates.
  • Comparing Snap and Meta’s EBTIDA growth rates, we can also see that Snap’s future EBITDA growth rate of 73% is almost double what Meta’s EBITDA growth rate was in the past 5 years of 30%, and a similar trend can be observed when comparing between their FCF growth rates.

Although not an apples to apples comparison given that Meta has significantly higher margins (gross, operating, net), is the market leader, and Snapchat isn’t even profitable on a GAAP basis, together with the fact that Snapchat is a much smaller business and hence their future growth rates are much higher growing off a lower base, it does seem warranted that Snap should trade at a multiple somewhat similar to Meta’s historical multiple, but at a slight discount (0.5)X. As such I have chosen a base relative valuation (RV) multiple of 8.5X.

For the worst case scenario, I assume that Snap’s future revenue, EBITDA, and FCF growth rates have all been overstated, and will in fact be closer to Twitter’s numbers now. In this case, I believe Snap will trade at a lower multiple of 6X. And lastly, for the bull case, I assume Snap marginally exceeds future estimates, and would thus warrant the 9X that Facebook earned.

Snap Stock Price Target

Snapchat Model (Panther Investment Research)

Using the current $22 stock price and estimated 2025 sales of $13.75B, with an 80% weighting for the normal case and 10% each for the 2 extremes, together with an end-day 10% margin of safety, the stock presents a 75% upside from current day levels with a TP of $39 ending 2025.

Risks

There are multiple risks associated with investing in Snap.

  1. There is competition from other social media companies in the AR space. TikTok is launching its AR effects tool to all creators and developers. This directly competes with Snap’s competence in AR. Moreover, TikTok has 3X the amount of MAU’s that Snap has. That being said, Snap is shielded from geopolitical risks unlike TikTok that is under ByteDance, a company in China. Should geopolitical tensions rise, it may be highly likely that users boycott / be banned from TikTok. In such a case, Snap’s investment thesis is all the more compelling.
  2. Another risk is that Snap’s investments in AR will only culminate in a marginal improvement in the topline while they incur high capex to develop their hardware (AR glasses). This will not bode well for free cash flows especially if progress and adoption turns out to be slower than initially anticipated. However, I am of the opinion that AR is the future of marketing and companies like Snap investing in themselves today to reposition their dominance will see substantial growth opportunities down the road.

Conclusion

In conclusion, Snap has consistently been growing its user base and revenues over the past couple of years. Their financials are starting to incrementally improve with EBITDA and FCF turning positive in FY21. Moreover, based on RV to its peers and historicals, Snap offers an upside of 75% in 4 years. An investment into Snapchat today is also a bet on the growing AR market, with the integration of AR into their core business of advertising together with acquisitions to further develop their AR glasses suite.

Although unprofitable on GAAP bottom line basis and hence representative of the typical ‘tech’ company that investors have abandoned as the Fed steps up its interest rate hikes and quantitative tightening with the bond market pricing in a 2.75% rate for the December meeting, the company’s balance sheet is still rather strong with manageable debt.

As such, with a compelling proposition, Snap is an investment that can and should be considered in the current market environment and investors may want to look to adding exposure when prices do hit $22.

Leave a Reply

Your email address will not be published.