Shares Slid Hard After Snap Warned Its Investors of a Slowdown

In this segment of the MarketFoolery podcast, host Mac Greer is joined by Motley Fool analysts Andy Cross and Aaron Bush to commiserate over the latest word from Snap Inc. (SNAP -2.72%) The company behind the social image and video sharing app Snapchat told the market that revenue growth is going to "decelerate substantially," and that is never going to please shareholders. The Fools review the recent numbers, consider the key problems the company faces, and offer an opinion on whether it has a Foolish investment thesis at any price.

A full transcript follows the video.

This video was recorded on May 2, 2018.

Mac Greer: Rough day for Snap. Shares down around 18% at the time of our taping after earnings. Snap is the parent company of the video messaging app Snapchat. Snapchat warned investors that revenue growth would "decelerate substantially." That doesn't sound good, Aaron. And you mix in the concerns over Snap's recent redesign, what is an investor to do about Snap?

Aaron Bush: Go to Facebook. [laughs] I mean, at this point, Facebook is running laps around Snap. Especially if Snap is going to be significantly decelerating their revenue growth.

Greer: And we should add that Facebook owns Instagram.

Bush: Yes, this is true. If you look at this quarter, Snap did gain a decent amount of users, but once again, and this is pretty crazy, its free cash flow was more negative than its revenue was positive, and that's a really tough spot to be in. So, when I look at Snap, I see two main problems. They have an advertising problem and a money-making problem. Which is just comically sad, because that's the two things they need to get right.

If you look at the advertising problem, the main place Snap could sell ads well is Stories. The redesign hasn't helped. They've proven far more seasonal than they should be for a company growing at this scale. Instagram's Stories is running circles around them. And if you go onto the platform, the ads feel pretty forced. So, I think there's still big questions there. Then, for the money-making problem, Snap is burning so much cash. It's a really big problem, and it'll take time to get out of. The best way to do it is through revenue growth, scaling over your marginal cost. But there are problems there.

And the other part is on the expense side. They laid off 100 people or so a month or so ago. I don't know if they'll do more of that, but they definitely will have to rein in expense control and dilution. They diluted shareholders 7% from this quarter from last quarter. So, that's the kind of trajectory we're on, so things are not looking very great.

Bush: That's a lot different than Apple buying back all its stock.

Greer: So, Aaron, I'm going to call you skeptical about Snap. [laughs]

Bush: Yeah, sure, why not?

Andy Cross: Aaron mentioned the advertising problem. That really comes from the user problem. Daily active users up 15% year over year and 2% sequentially. For a company with high growth expectations, when your revenue is growing 54% this past quarter, that's down from 200% this quarter last year, that's about what Facebook is doing. So, when you're competing against a company that's gigantically so much more impressive right now, especially when they say, "Listen, the rest of the year is not going to be good," and the entire first part of the conference call was really talking about the user experience and all the changes they've been trying to make, and how that has not worked -- investors do not like that, and they'll sell that stock down, as they have aggressively today.

Greer: OK, so, your growth is slowing rapidly. You have, as Aaron says, a money-making problem, and, oh, yeah, you're competing with Facebook. So, here's the question -- at some point, does this become a value play? Is that all baked in, and if they do anything positive, the stock starts going up? Or is this trying to catch a falling knife?

Cross: It's interesting, because Facebook, after its IPO -- it came out at about $38, ran up, and then they started running into all the problems, like, they don't have a mobile platform. The stock fell all the way back down into the low 20s.

Greer: Good time to buy! [laughs]

Cross: There were a lot of questions about, what's going on with Facebook, they missed the monetization opportunity. And that turned out to be a great problem to have. I just don't see that. Evan Spiegel and Robert Murphy are the co-founders, they own 35% of the company, that's a substantial amount of equity into a business. Because of the big competitive pressures that Snap is facing across the board, I'm just not as excited about that as I would have been for Facebook.

Bush: Yeah, I think right now, it's a falling knife. Maybe at some point it becomes a value play. I think what Snap has in its large user base, in its dedicated user base, the average user still spends about 30 minutes a day on Snap. That's still really impressive. Maybe one trick they might have up their sleeve is Tencent, which now owns, I forget the exact percentage, but they've been buying more of the company. And Tencent is the master of all social media companies, with WeChat, and figuring out how to get people engaged through different means. Maybe they could share some of their magic with Snap. But, I think that still might be a far-fetched hope.