Snapchat Is Quietly Building an Impressive Video Business

Imagine a company that reaches a people other companies struggle to engage, and which enjoys an expanding demographic reach, a fast-growing video presence, and an app that users open 30 times a day on average. Many investors think of social media company Snapchat as the crazy picture sharing-app that young people use -- but that misunderstanding could spell opportunity for savvy investors.

The disappearing default

On Snapchat's Q2 2020 conference call, Chief Business Officer Jeremi Gorman said the service reaches 90% of 13- to 24-year-olds, and 75% of 13- to 34-year-olds, in the United States. Users are attracted to the service because its default setting makes shared items disappear shortly after their recipients view them.

Source: Sprout Social. Chart by author.

A service like Twitter allows posts to be dug up from long ago, making Snapchat potentially seem like a safer option. However, the positive for users of this disappearing default could be considered a negative for advertisers.

A few years ago, Facebook blamed earnings challenges partially on Stories' (24-hour posts) lower monetization. This issue seems to be replicating itself with Facebook's WhatsApp messaging business. Fool.com contributor Adam Levy noted early this year that marketers' ability to target ads on WhatsApp might be limited by the fact that the service is more private than other platforms.

Image source: Getty Images.

Snapchat realized that it needed to diversify beyond temporary sharing, so it launched Discover in 2015. Discover is a different twist on sharing video stories, where editors and artists decide what the feed includes, instead of letting an algorithm automatically assemble the list based on a video's popularity. As interest in Discover has grown, the company redesigned the app to include video as a prominent option. Recently the app was updated to make shows, and specifically Snap Originals, easier to find.

The strategy seems to be working. Snapchat's average revenue per user jumped from just $0.32 in Q1 2016 to $2.02 in Q1 2020. During this same period, daily active users have nearly doubled from 122 million to 229 million. Over the last few quarters, Snapchat has also devoted a section of its earnings release to discuss the increasing engagement, and developments, behind its nascent video service.

Watching for better profits

Snapchat videos face significant competition from both social media and more traditional offerings. In the streaming video space, we can't overlook the dominant position that Netflix enjoys. During the initial pandemic lockdowns, Netflix users watched an average of 3.2 hours of video on the service per day. In addition, Netflix accounts for 8% of the cumulative time watching videos online worldwide. One thing that sets Snapchat apart is that the median age of Netflix users is 35 to 44, whereas Snapchat appeals to a younger demographic.

To demonstrate the appeal of Snapchat's video business, the company announced that "more than half of the U.S. Generation Z population are watching Snap Originals." User engagement for Snapchat and Twitter reveals startling differences.

Sources: Statista and Business of Apps.

Beyond these significant differences, approximately 80% of tweets in the U.S. are generated by the top 10% of users. By comparison, more than 60% of active Snapchatters create new content daily. In short, Snapchat users seem more engaged with video and far more active.

Snapchat is leaning into its users' appetite for video by investing heavily in its Discover business. Two years after introducing Discover, the company added video channels from names like Entertainment Weekly, The New York Times, and others. In the fourth quarter of 2019, Snapchat added 78 new international Discover channels. In the company's most recent quarter, an additional 180 new channels were added. 

Though the company's average user skews younger, in the over-35 age group, engagement grew by more than 40% year over year.  Meanwhile, younger users seem to be increasingly turning away from traditional media, and toward Snapchat and other social sources, for news and entertainment. Evan Spiegel, CEO of Snapchat, said that, "More than half of the entire U.S. Gen Z population (was) watching COVID-related news created by our partners." In addition, according to eMarketer, "the average U.S. adult spends 29 more minutes with mobile content compared to TV." If this evidence bears out, this secular trend toward mobile entertainment could be a long-term growth driver for Snapchat. 

One of these things is not like the other...

With similar user bases between Snapchat and Twitter, investors may believe the two companies are interchangeable options. However, if we look at how each company performed between Q2 2019 and Q2 2020, there are some glaring differences.

Data sources: Snapchat and Twitter. Chart by author.

Investors should note that Snapchat's cash flow was negative, but also remember that the company is investing in growing its user base and the service's appeal. Investors looking for positive free cash flow can clearly see that the company is moving in the right direction toward this ultimate goal.

Analysts expect Snapchat to keep outperforming Twitter over the long haul: 

Source: Yahoo Finance.  

Snapchat's disappearing posts help users feel comfortable engaging with the service, and Discover video provides Snapchat a way to attract a broader user base. The company's improving cash flow each quarter over the last 12 months, plus significant projected EPS growth, suggests that its cash flow should continue to trend upward. Investors should consider snapping up the shares of this growth stock before the market fully realizes that Snapchat isn't just for kids anymore.