Snap's (SNAP 2.09%) stock popped nearly 9% on Aug. 31 after the company announced that it would lay off about 1,200 employees, or approximately 20% of its workforce, as it grapples with a severe slowdown. 

Snap will discontinue its investments in its Snap Originals videos, its Minis mini-programs, its video games, and its Pixy selfie drone. It will also shut down its location-based social networking app Zenly, which it acquired in 2017, and its music creation app Voisey, which it bought in 2020.

In an internal memo, CEO Evan Spiegel said Snap's revenue had only risen about 8% year over year so far in the third quarter, which was "well below" its own expectations and would represent its slowest growth rate as a public company. Spiegel said Snap "must now face the consequences" of that slowdown and "adapt to the market environment."

A person takes a selfie.

Image source: Getty Images.

Spiegel said Snap's restructuring would focus its future on just "three strategic priorities: community growth, revenue growth, and augmented reality." Everything else would likely be cut. Two of Snap's top executives -- its chief business officer Jeremi Gorman and its vice-president for ad sales Peter Naylor -- also abruptly left the company and joined Netflix in that seismic shuffle.

That's a lot of information for Snap's investors to process, so let's take a breath and review its prior problems, its aggressive turnaround plans, and the potential challenges to see if its stock can recover over the next 12 months.

What happened to Snap?

During Snap's investor day presentation last February, the company impressed the bulls by saying it could grow its annual revenue by more than 50% over the next few years. But since then, Snap's year-over-year growth in daily active users (DAUs), average revenue per user (ARPU), and total revenue have all significantly decelerated.

Period

Q2 2021

Q3 2021

Q4 2021

Q1 2022

Q2 2022

DAU growth (all figures YOY)

23%

23%

20%

18%

18%

ARPU growth (decline)

76%

28%

18%

17%

(4%)

Revenue growth 

116%

57%

42%

38%

13%

Data source: Snap. YOY = year over year.

Snap's growth ground to a halt for three main reasons. First, it vastly underestimated the impact of Apple's privacy changes on iOS, which enabled its users to opt out of data-tracking features and ads.

Second, Snapchat likely lost a lot of its younger users to ByteDance's TikTok, even after it launched a similar Spotlight short-video feature in late 2020. TikTok also overtook Snapchat as the top social media platform for U.S. teens for the first time this spring, according to Piper Sandler's latest Taking Stock with Teens survey.

And third, the entire ad sector cooled off as inflation, rising interest rates, and other macroeconomic headwinds rattled the broader economy.

But despite facing all those bright red flags, Snap refused to officially abandon its long-term target of achieving more than 50% annual revenue growth. Analysts had expected Snap's revenue to rise 11% to $4.58 billion this year, but they could significantly reduce those estimates in light of its recent update.

Slowing growth and lots of red ink

Snap's net loss narrowed from $945 million in 2020 to $488 million in 2021. But in the first half of 2022, its net loss widened year over year from $439 million to $782 million. Analysts had expected Snap to post a net loss of $1.34 billion for the full year, but its forthcoming layoffs and restructuring efforts might reduce that red ink.

The layoffs make sense because free cash flow -- which had turned positive in 2021 -- turned negative again in the first half of 2022. The company was still sitting on $2.3 billion in cash and equivalents along with $2.6 billion in marketable securities at the end of the second quarter, but its elevated debt-to-equity ratio of 1.6 doesn't give it much room to raise fresh cash.

Nonetheless, Snap's decision to stop investing in new original videos, games, and mini programs altogether douses the hope that it can turn Snapchat into an all-in-one "super app" like Tencent's WeChat in China. That reversal might also reduce the stickiness of its ecosystem, throttle its DAU and ARPU growth, and erode its defenses against other social media platforms.

Snap plans to keep supporting the creation of new augmented-reality lenses, but Meta's (META 2.48%) Facebook and Instagram, TikTok, and other social media platforms have also started rolling out similar features over the past year.

Where will Snap's stock be in 12 months?

The stock has already plunged about 85% over the past 12 months, and it's now trading far below its IPO price. But it still doesn't seem like a screaming bargain yet at 4 times this year's sales. It's merely reasonably valued relative to its peers: Meta trades at 4 times this year's sales, and Pinterest trades at 5.5 times this year's sales.

Therefore, I don't expect Snap's stock to make any meaningful gains over the next 12 months. Its desperate cost-cutting and the elimination of its ecosystem-expanding projects indicate it's bracing for a brutal slowdown that could easily last for more than a year. So investors should stay away and stick with more-promising tech stocks instead.