Snap (SNAP 2.24%), the parent company of Snapchat, is a battleground stock for investors. The bulls admire its resilience with Gen Z users, its ability to lock in users with new features (like AR lenses, games, and original videos), and its narrowing losses.
The bears claim that Snap will struggle against Facebook's (META 2.98%) Instagram, which has cloned many of Snapchat's popular features; that it could run out of cash before achieving profitability; and that its valuation is still too high.
Image source: Getty Images.
The bears seemed to be right throughout most of 2018, as Snap's growth in daily active users (DAUs) hit a brick wall. However, Snap's DAU growth turned positive again this year, its losses narrowed, and its ecosystem expanded. Those improvements brought back the bulls, and Snap's stock rebounded sharply.
On Tuesday, Snap posted its third-quarter earnings, and the numbers clearly favored the bulls again. Its revenue rose 50% annually to $446 million, beating estimates by $10 million and marking its strongest growth in five quarters.
Its net loss narrowed from $325 million to $227 million, and its adjusted EBITDA loss narrowed from $138 million to $42 million. That all translated to a non-GAAP loss of $0.04 per share, which beat expectations by a penny. But does that earnings beat indicate that it's finally safe to buy Snap's stock?
Flourishing in Instagram's shadow
Snap ended the third quarter with 210 million DAUs, which marked a 3% growth from the second quarter and 13% growth from a year earlier. This marks Snapchat's third straight quarter of DAU growth and allays some fears about competition from Instagram and ByteDance's TikTok.
|
DAU growth |
Q3 2018 |
Q4 2018 |
Q1 2019 |
Q2 2019 |
Q3 2019 |
|---|---|---|---|---|---|
|
Sequential |
(1%) |
0% |
2% |
7% |
3% |
|
Annual |
5% |
0% |
(1%) |
8% |
13% |
Source: Snap quarterly reports.
The company expects that growth to continue with 214 million to 215 million DAUs in the fourth quarter, which would represent a 2% growth from the third quarter and 15%-16% growth from a year earlier.
Pivoting toward higher-growth overseas markets
Snapchat's DAUs rose both sequentially and annually across all three of its global markets -- North America, Europe, and Rest of World:
|
Region |
DAUs (Q3 2019) |
Sequential growth |
Annual growth |
|---|---|---|---|
|
North America |
84 million |
1% |
6% |
|
Europe |
65 million |
2% |
9% |
|
Rest of World |
61 million |
9% |
28% |
Source: Snap quarterly reports.
Like Facebook, Snap is relying more heavily on its stronger growth in emerging markets to offset its slower growth in North America and Europe. However, investors should note that Snap generates significantly higher average revenue per user (ARPU) in North America than the other two markets:
|
Region |
ARPU (Q3 2019) |
Sequential growth |
Annual growth |
|---|---|---|---|
|
North America |
$3.75 |
19% |
43% |
|
Europe |
$1.05 |
11% |
24% |
|
Rest of World |
$1.01 |
(16%) |
21% |
|
Total |
$2.12 |
11% |
33% |
Source: Snap quarterly reports.
Widening its moat with Discover
However, Snap's total ARPU growth remains solid as new features like new AR lenses, video games, and original videos on its Discover tab lock in its users and attract more content providers and developers.
Image source: Getty Images.
The total daily time spent watching Discover content grew 40% annually during the third quarter, and the platform reached a monthly audience of over 10 million viewers with over 100 channels. Roughly 80% of its U.S. users now watch Discover content.
Those videos are also a key growth engine in overseas markets, where it added over 50 channels during the quarter. As a result, the time international users spent watching premium Discover content surged over 55% annually.
Discover's robust growth is in stark contrast to Instagram's counterpart IGTV, which failed to gain momentum due to its lack of original content, clumsy navigation features, and a lack of cohesion with Instagram's core platform. Therefore, Discover should be considered Snapchat's best long-term defense against Instagram.
A solid outlook with narrowing losses
Snap expects its fourth-quarter revenue to rise 38%-44% annually, compared to a consensus forecast for 42% growth. It expects its adjusted EBITDA to come in between break-even and $20 million, compared to a loss of $50 million a year ago.
Those improvements indicate that its free cash flow, which improved from negative $159 million to negative $84 million between the third quarters of 2018 and 2019, should continue to improve in the fourth quarter and allay some concerns about its cash burn rate.
Snap won't achieve GAAP profitability anytime soon (due to the stock-based compensation expenses, which gobbled up 36% of its revenue during the quarter), but its core business is improving as it executes tighter financial discipline and a more focused expansion of its ecosystem.
A good speculative play
Snap still isn't cheap at 11 times this year's sales and 8 times next year's sales. However, those valuations look more sustainable than its post-IPO valuation of over 30 times sales. Snap still trades below its IPO share price of $17, so investors with an appetite for more risk should consider nibbling on this growth stock as its metrics improve.
