Should You Buy Snap at a 30% Discount to Its IPO Price?

Snap (SNAP 2.24%), owner of the Snapchat platform, recently posted second quarter 2018 numbers that topped analyst estimates. Company revenue rose 44% year over year to $262.3 million, beating consensus expectations by $11 million, and its non-GAAP net loss narrowed from $195.5 million to $176.6 million, or $0.14 per share, topping expectations by three cents.

Snap's stock initially rallied on those headline numbers, but quickly reversed course after a closer look exposed some other, more troubling figures. Let's review Snap's report to see if the stock -- which remains nearly 30% below its March 2017 IPO price -- has a chance to recover.

Image source: Getty Images.

First the bad news...

The sorest spot in Snap's report was its sequential drop in daily active users (DAUs). The organization's DAUs rose 8% against the prior-year quarter to 188 million but fell 2% from the first quarter. That represents Snap's first-ever sequential decline in DAUs, and indicates that its growth is grinding to a halt.

Source: Snap quarterly reports.

Snap blames the deceleration on its redesign of Snapchat half-a-year ago, which frustrated many core users. The new app merged Snapchats and Stories into a non-chronological order, the "Send" page made it tougher to find friends, and re-watching Stories took longer and required more steps than it had in previous versions.

Snap tried to fix some of those issues, but the user revolt -- which was amplified by celebrities like Kylie Jenner turning against the platform -- clearly dented its user growth. That exodus likely helped Facebook's (META 2.98%) Instagram Stories surpass 400 million DAUs in late June. Instagram has also copied nearly all of Snapchat's defining features -- including ephemeral messages, stories, and filters -- over the past few years.

Meanwhile, Snap's growth strategy remains unfocused. During the quarter it released a new version of Spectacles, added Group Video Chats, launched a new Lens Explorer feature for finding user-made lenses, introduced new developer kits for creating Snapchat content, and launched new Snappable augmented reality games.

None of these efforts should significantly boost its user growth, though, and the better ideas remain vulnerable to copycats. Facebook, for example, has already cloned Snapchat's Snappables with its own AR games for Messenger.

Now some good news...

On the bright side, Snap's average revenue per user (ARPU) rose 34% year-over-year and 16% sequentially to $1.40 during the quarter. For comparison, its ARPU improved 34% year over year in the first quarter but tumbled 21% sequentially due to the company's shift toward programmatic ads and some seasonal headwinds.

The second-quarter ARPU growth was buoyed by Snap's strong ad revenue, which rose 48% against the prior year and 14% sequentially to $260 million. During the company's earnings conference call CFO Tim Stone stated that growth was "driven by traction in our global online sales business, which includes SMBs [small and medium-sized businesses] and sales partners, and strong growth in international countries."

Image source: Snap.

Snap's ad prices fell 52% in the second quarter against the comparable quarter and 9% sequentially, but those declines were easily offset by a 191% comparable and 26% sequential jump in total impressions. In other words, Snap's ads got cheaper, but it sold a lot more of them across its platform.

Snap's switch to automated, algorithm-powered programmatic ads helped drive that growth. Seventy-five percent of Snap's ad revenues came from programmatic ads during the quarter, compared to just 18% in the prior-year quarter.

In addition to narrowing its non-GAAP loss in the last three months, Snap also cut its GAAP net loss from $443.1 million to $353.3 million, and narrowed its adjusted EBITDA loss from $194 million to $169 million. The company reduced stock-based compensation expenses by 36% to $156 million (partly through several rounds of layoffs), as its cash and equivalents rose from $334 million at the end of 2017 to $393 million. In other words, Snap's financial discipline is improving as the company matures.

Snap expects to generate 27%-39% year-over-year sales growth in the current quarter, which, if achieved, will match analyst expectations. This strongly indicates that Snap can continue growing its business even as its DAU growth stalls out.

Do the risks outweigh the rewards?

Snap has improved certain aspects of its business, but it's still a deeply unprofitable company that remains in Facebook's crosshairs. Moreover, the stock still trades at 13 times this year's sales -- a lofty valuation that can't be justified by its decelerating growth in revenue and users. I'd steer clear of Snap, and stick with bigger social media players like Facebook.