Snap Inc. (SNAP -3.00%) may be losing heaps of money, but the company behind the popular Snapchat app is growing fast. Second-quarter revenue soared 153% year over year to $181.7 million, while revenue through the first half of the year surged 200% to $331.3 million. This triple-digit growth makes the $18 billion market capitalization more palatable.
Unfortunately for investors, Snap's explosive growth isn't long for this world. Year-over-year comparisons have been as easy as they get thus far, an effect of Snap's relatively recent effort to ramp up revenue. The comparisons only get harder from here on out.
Image source: Snap.
The coming growth slowdown
It wasn't until the middle of 2016 that Snap really began focusing on revenue. The company launched its advertising application programming interface (API) in June of that year, allowing third parties to sell ads on Snapchat for the first time. Leaked internal documents revealed the company's goal for 2017 revenue was $500 million to $1 billion, a massive increase from less than $60 million in revenue in 2015.
Snap is on pace to hit that target this year, thanks to the rapid rate of growth since its revenue push began.
Chart by author: Data source: Snap Inc.
But Snap will begin lapping its pre-IPO efforts to boost revenue starting in the third quarter of this year, meaning that the year-over-year growth numbers are going to start looking less impressive. Analysts are expecting third-quarter revenue of $242.6 million and fourth-quarter revenue of $314.6 million, representing year-over-year growth of about 90% in each case.
That level of revenue growth is nothing to sneeze at, but this assumes that Snap is able to match the average analyst estimate. Snap has reported quarterly results twice so far as a publicly traded company, and it has fallen short of expectations both times. Repeat performances during the second half will drive the company's growth rate deep into the double-digits.
Snap's revenue is driven by the number of daily active users and the amount of revenue generated on average by each of those users. During the second quarter of 2017, the number of daily active users increased by just 21% year over year. With the user base in danger of stagnating a la Twitter, Snap will need to rely on boosting its revenue per user to keep its growth rate up. Average revenue per user more than doubled year over year during the second quarter, leading to the big revenue increase.
Chart by author. Data source: Snap Inc.
But average revenue per user has been erratic in recent quarters. It decreased on a sequential basis for the first time during the first quarter of 2017, then rebounded during the second quarter. Unless Snap can pull a rabbit out of a hat during the second half and increase its average revenue per user dramatically, year-over-year growth in this metric is going to slow way down.
Hard to justify
Snap is valued at roughly $18 billion, or about 20 times the average analyst estimate for 2017 revenue. It has no price-to-earnings ratio because there are no profits. Snap is on pace to post an eye-popping loss this year, with a net loss of $443 million in the second quarter alone.
As revenue growth slows, it will become more difficult to justify this nosebleed valuation. If Snap follows a similar path as Twitter, which saw its rapid revenue growth stagnate and then reverse as both its user base and average revenue per user topped out, it's hard to imagine Snap stock doing anything other than tumbling.
