Snap (NYSE:SNAP) investors had second thoughts about the messaging app's second-quarter earnings results. Shareholders initially sent Snap stock soaring after hours on the news that it beat revenue estimates and narrowed losses more than expected, but the next day they reversed course and shares closed down 7%.

The reason for the about-face was the realization that Snap lost three million subscribers during the second quarter. Although Snap's daily users rose 9% year over year, daily users declined sequentially for the first time in the company's history, falling almost 2% compared to the first quarter. 

Two women taking a selfie

There wasn't a lot to smile about with Snap's second-quarter earnings report. Image source: Snap.

Snap blamed the decline on CEO Evan Spiegel's disastrous app redesign, which walled off celebrities and commercial accounts from friends and family and changed the sorting of its Stories feed from populating in order of most recent post to placing posts by profiles interacted with most at the top of the feed. With Snapchat's reputation as a realtime platform, users were outraged at the changes made to Stories.   

Yet the trend of declining growth has been building since well before Snap went public.

Chart of Snap's daily active user growth

Data source: Snap quarterly SEC filings. Chart by author.

Pinning their hopes on ads

Despite the drop in users, Snap's quarterly revenues rose 44% driven by changes to its advertising platform. Snap generated nearly 75% of ad revenue from programmatic ad buys in the most recent quarter, up from 18% last year. As a result, revenue per user has risen 34% year over year and 16% quarter over quarter.

While the decline in users may be partly responsible for this rise, it also suggests that there's more demand among advertisers to get onto the platform. Despite lower engagement, advertisers are clamoring to appear on Snap because of its high rates of penetration with teens and young adults.

Earlier this year, Piper Jaffray found that 45% of 16-year-olds listed Snapchat as their preferred social media platform, up from 39% a year ago. Likewise, eMarketer's research suggests that Snapchat's penetration rate among 18- to 24-year-olds is nearly 95%. If Snap can reengage its users, Snap should have the ability to attract additional advertisers and further boost revenues.

Antisocial media

Snapchat isn't the only platform witnessing declining user rates. Facebook reported its U.S. user numbers were flat in the second quarter, and Twitter recently warned growth for the year would slow as it purged suspicious accounts from its platform.

That doesn't bode well for Snap. It is possible that social media has hit a peak after which future growth will be more difficult and the chances for contraction increase. Broad saturation and a steady diet of bad news surrounding platforms may deter further growth.

Snap may finally have found the formula to grow its ad business only to find that member growth has hit a wall. In short, advertisers might like the platform now more than users do, and when Snap stops discounting its ad rates to attract them advertisers might not like it as much either.

Key takeaway

Snap posted a loss of $357 million in the second quarter, which was 20% less than a year ago, but still a substantial loss with improvement resulting mostly as a result of recording significantly lower stock-based compensation expenses. It's not really because it is a better-run business.

It also offered its first-ever guidance for the coming quarter, forecasting revenues of $265 million to $290 million,  representing a deceleration in its growth rate, which could also suggest additional sequential declines in users in the quarters ahead.

Although Snap may have finally figured out a way to make money, time is a commodity in short supply for the company. If it cannot reverse its recent user declines, it may be too little, too late for Snapchat.  

 

Rich Duprey has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Facebook and Twitter. The Motley Fool has a disclosure policy.