For better or worse, social media is a huge part of society. Billions of people interact with it daily, so advertisers spend heavily to better reach their intended audiences. Because of this, social media companies often make great potential investments.
Snapchat is a popular platform owned by Snap (NYSE:SNAP). Is this social media play worth an investment?
Bull Case: Snap has captured a key demographic and is optimizing revenue
Keithen Drury: Different than other social media companies, Snapchat is a communication platform. Rather than scrolling through feeds or advertisements, the primary use is sending pictures back and forth to friends. Snapchat popularized filter use, which is just one way it generates revenue. It also has programmed content with ads placed between segments, similar to television ads.
Snpachat is in its second growth phase: maximizing revenue. Third-quarter revenue grew 57% year over year to more than $1 billion. Year to date, it has increased 77% to $2.8 billion. Management is guiding for around $1.2 billion in the current quarter, making it possible for Snapchat to crack annual revenue of $4 billion. If Snap can maintain its phenomenal growth rate, gains for investors will likely follow.
The first growth phase was capturing users, something Snapchat has excelled at in its key markets. In these locations -- which include the U.S., U.K., Australia, France, and the Netherlands -- 90% of 13 to 24 year olds and 75% of 13 to 34 year olds use the app. Few companies have penetrated this lucrative advertisement demographic as well as Snapchat has. Due to this existing large audience, daily active users (DAUs) grew slower than revenue last quarter, up 23% to 306 million. However, Snapchat still has a ways to go to before it catches up with the industry leader, Meta Platforms.
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As the current customer cohort ages, Snapchat can capture a new generation while maintaining the previous one. By doing this, it should see continued DAU growth. With just 24% and 14% smartphone market penetration in North America and Europe respectively, Snapchat has had issues reaching older users, but this also means Snap still has a long way to go until it reaches peak adoption. And as Snap works to optimize revenue, the stock will continue to react sharply to quarterly earnings as the company is still unprofitable on a GAAP basis.
Bear Case: Snap is richly valued and faces tough competition
Keith Noonan: Even after plunging 34% since reporting third-quarter earnings, Snap still has an $80 billion market capitalization, and shares trade at 20 times this year's expected sales. That valuation is quite optimistic in light of challenges on the horizon.
Revenue was up 57% in the third quarter, but it also fell short of management's guidance and analysts' estimates. In that context, the company's top-line miss and $72 million net loss aren't concerning to me -- at least in the short term. Snap's core problems are its lack of control overs its own mobile platform and the strong competition in the advertising and mobile markets.
Snap primarily generates revenue from digital ads, and changes in the space are creating some headwinds for the company. Apple has already altered how user data is tracked and ads are targeted on its iOS mobile ecosystem, and Alphabet has also made changes to its Android operating system. Apple's ad-tracking changes were at the heart of the company's revenue shortfall last quarter, and it's possible that additional shifts could be on the way that destabilize the company's growth trajectory.
Apple's decision to change cookie tracking across its mobile platform has already helped the iPhone company quickly triple its share of advertising-driven app downloads, and platform owners have incentives to steer business through their own channels.
Snap has come up with some innovative and successful features in the social media space, but these features have often been quickly copied by competitors. While the company has a strong brand and impressive levels of engagement among millennial and Gen Z age demographics, the long-term trajectory for its services is still somewhat uncertain, and there's a risk that the many resource-rich competitors Snap is going up against will curb long-term growth.
Snap still has a large market opportunity to capture and monetize, but it will be a tough journey thanks to the stiff competition and its dependence on a few gatekeepers. Only those who can stomach large price swings should buy shares. With the stock down 40% from its all-time high, it makes sense for bulls to enter now. Snap has trounced the market over the last several years, but it's up to investors to determine if the company is positioned to continue this outperformance long term.