3 Reasons Why Snap Stock Can Keep Heading Higher
It has been a rough year for most stocks but you don’t see Snap’s investors panicking. Snap’s shares increased by 27% following the release of the Q1 2020 report on April 21st. Snap’s DAUs were 229M in Q1 2020, which is a 20% y-on-year (YoY) increase.
Business Model
Snap (Snapchat) describes itself as a camera company because the smartphone camera is the centre point of all of their products and services from sending messages (Snaps) to Augmented Reality features. Snap generates a substantial part of its revenue through advertising, totalling 229M DAU. It also has a hardware business (spectacles).
Snap monetises its ad business in 4 ways:
1. Ads: Snap displays brand advertisements between your friend’s stories.While you kill time waiting for your friend’s message, they show you an ad. The biggest selling point for Snap is its user engagement rate. Users are actively looking at their screen. The mobile digital advertising market is growing exponentially and it is expected to make up more than 70% of the total digital advertising market in 2021, according to Statista.
2. Augmented Reality and Lenses: Snapchat’s AR features like Lenses and Bitmoji are gaining significant traction and driving engagement.
3. Discovery Section: The discovery section allows publishers to post on Snap to entice viewers to consume their content while they chat with and message their friends. This feature can help Snap to become a new version of TV for Gen Z and Millennials.
4. Geofilters: There are two types of Geofilter that you can create — personal ones or business ones for marketing. A national Geofilter can typically be seen by 50–60% of the daily Snap audience.
Snap’s hardware business, the spectacles, was introduced in 2016. Delivered from a dispenser machine, it comes with a 115° field of view and the retail price is between $129.99 and $149.99. It can also be used on other social media platforms. However, it is not bringing in much revenue at this point.
Analysis:
- The Global DAU increased to 39 Million, 20% of the YoY
Snapchat has emphasised that its user intensity is higher when in contrast to FB and Instagram. Instagram is more about sharing polished moments from the user’s daily lives while Snapchat encourages sharing as often as possible and sharing more ordinary moments. This creates more user engagement. On the other hand, Instagram users don’t post things often if the photo doesn’t meet a very high bar of quality.
If you compare Snapchat’s January to March Q1 2020, there is a 50% increase in DAU. This increase will show in Q2, so I expect to see more significant user growth in Q2 as a result.
2. It Has More Unrecognised Revenue Potential
Another critical metric that I have been following is the AR feature. This has increased Snapchat’s ARPU around the world. After Covid-19, consumers will be fearful of returning to confined spaces around other people to try make-up and beauty products, at least for the foreseeable future. As a result, they will develop new habits to navigate their purchasing decisions. For example, beauty testing and sampling historically have happened with physical products in stores. Due to the risk of Covid-19 transmission, beauty brands may be looking at investing in Augmented Reality to allow people to virtually sample the products and increase their e-commerce sales. Snapchat has introduced a “Shop Now” feature to its AR lenses. This is a straightforward way to measure ROI concerning Snapchat’s AR ad products. I foresee the augmented reality feature becoming more of a revenue driver for Snapchat with advertisers in particular.
According to Snap’s data, the average user plays around with the AR feature for three minutes at a time. This is a significant number that can be used to attract more advertisers. Three minutes of deep engagement is then added to the user sharing it with ten or more people who will likely do the same. This is pretty impressive. There have been more than 900 lenses created by community members on the platform. These lenses are AR apps, which the users use to make goofy games and quizzes.
3.Emotional Aspect of Snapchat
People are having fun with it and it makes them feel good about themselves. On the other hand, there is a resulting pressure on Instagram’s users. This is as they are intimidated about posting because they think that Instagram warrants perfection. If your post is not liked 50 times by your friends within an hour of posting, then it is almost not worth keeping neither the photo nor your friend! I think that Snapchat adds “ad value” to people’s happiness in a positive way. Snapchat is the ONLY platform to provide that. It is a win-win for both advertisers and users. Facebook has been trying to pivot its business to what Snapchat does since it began “building” (copying) Instagram stories. AR is a great way to scale up the ad business and I think that FB will pivot towards AR within a year.
4. Snap’s Discover is gaining popularity and its use has increased by over 35%
The feature provides a unique path for Gen Z and Millennial audiences who don’t use a traditional TV as often as the previous generations. To compete against TikTok, Snapchat has added a comparable feature called Cameos which allows the user to make short videos. All of these features together have the potential to keep the users engaged for longer.
5. Android problem is sorted
Snapchat has fixed their Android app. This has been a big problem for Snapchat. The business is all about network effects. If I am Android user and you send me a message from your iPhone, the message does not load quickly. As an Android user, I get frustrated and I am not incentivised to use the app. They have rebuilt their Android app and it re-launched in 2018. As a result, they have started to see more user growth. You can see daily active users of Snapchat 2014–2020 from Q1 2014 to Q1 2020 below.
Risks:
- High Operating Expense
Snapchat relies on its Cloud infrastructure partners Google and Amazon. It doesn’t own its servers. The hosting of the subscriber data in the Cloud is one of Snapchat’s largest operating expenses. The more users that Snapchat acquires, the more Cloud storage that it needs. This cost increases as it grows more ambitious and gains more users. This affects their path to profitability. In the end, this is going to limit Snapchat’s gross margin and its free cash flow.
Once they start building their own servers, the whole economic structure of the business will change.
2. Governance Issue
Evan Spiegel and Boby Murphy hold 97% of the voting rights, leaving the shareholders with little say. As a result, the cost of operating is not up for discussion. Based on Billy Gallagher’s book, How to Turn Down a Billion Dollars, Evan Spiegel’s leadership style is somewhat imperious and he does not allow other executives any input or control. In reality, this is a public company but it does not have a public company stock structure.
Financials:
Snap’s revenue for the quarter ending March 31st 2020 was $0.462B, which is a 44.33% increase year-over-year. The revenue for the twelve months ending March 31st 2020, was $1.858B, which is a 46.24% increase year-over-year.
Snap’s gross profit for the quarter ending March 31st 2020 was $0.209B, which is a 79.21% increase year-over-year. The gross profit for the twelve months ending March 31st 2020 was $0.912B, which is a 96.42% increase year-over-year.
Snap’s EPS for the quarter ending March 31st 2020 was $-0.21, which is an 8.7% decline year-over-year. Its EPS for the twelve months ending March 31st 2020 was $-0.73, which is an 18.89% decline year-over-year.
Snap is valued at $24.285B and the shares have closed up 4.16% at $17.49 today. It is still under its post-IPO pop to $27.09. This is up from a low of $4.99 in December 2018 when its users moved to Instagram Stories.
Summary:
- Snap is a growing company. They have managed to improve their ad/revenue per user drastically since 2016. This has grown at a rate of 33%, thus meaning that they are generating more money per user.
- It offers messaging, hardware, content, games and advertising in a unique ecosystem. Snapchat is doing a great job of growing their ecosystem outside of Snapchat. It will be interesting to see the role that Augmented Reality will play in Snapchat’s revenue growth after Covid-19.
- Since IPO, they have improved their gross margin drastically. This is a business that went for an IPO with a 0% gross margin. It reached 45% in 2019. Once they increase the gross margin to 80% and add another 150 million users, the balance sheet will look very impressive.
- A growing user base, combined with an increasing ARPU, has the potential to drive revenue growth and improve margins for years to come. If investors are willing to pay for Twitter, a company that still hasn’t converted its users to a profit since its IPO in 2013, why should investors not pay $25B for Snapchat? I think that Snapchat’s long-term potential remains severely misunderstood. This has been a great quarter for them.
