The social media landscape has changed dramatically over the past few years. TikTok, owned by Chinese tech company ByteDance, has grown into a behemoth. The video-sharing app is particularly popular with younger users, drawing them away from other platforms.
Surprisingly, TikTok's success hasn't impacted Snap's (SNAP 27.63%) ability to attract users to SnapChat. The company reported daily active users (DAUs) of 397 million in the second quarter, up 14% year over year, and users have tripled the amount of time using its TikTok-like Spotlight feature.
While Snap continues to be a popular and growing platform, the company has historically struggled to translate users into revenue and profit. That trend continued in Q2.
Deeply unprofitable
At the end of Q2, Snap had 50 million additional DAUs compared to the prior-year period. Despite this, revenue was down 4% year over year to $1.068 billion. Average revenue per user plunged 16% year over year to just $2.69, more than wiping out the positive impact of user growth.
While Snap is generating less revenue per user, it's spending more per user on infrastructure. The company is investing in artificial intelligence to boost the performance of its ad platform and provide a better experience for users, and the result is a sharp increase in infrastructure spending.
Snap shelled out $277 million, or $0.70 per DAU, in infrastructure spending during Q2. The company expects this per-user metric to rise to a range of $0.79 to $0.84 in Q3. Total infrastructure spending rose 38% year over year in Q2.
Snap has cut spending in other areas, so total costs actually declined slightly in Q2. But adjusted gross margin tumbled 7 percentage points year over year to 54%, and the company's operating loss worsened slightly to $404 million. Net income improved a bit to a loss of $377 million thanks to Snap's cash earning meaningful interest, but that's still an enormous loss. The cash-flow situation wasn't pretty, either. Snap reported a free-cash-flow loss of $118.9 million.
Snap is betting that by investing in AI, it can improve monetization and ultimately boost revenue and profit. One problem: That's what nearly every social media company is doing. Social media giant Meta is pouring billions into infrastructure spending as it uses AI to increase engagement and serve better ads, for example. Investing in AI looks to be table stakes, not a source of competitive advantage.
Stay away from Snap stock
Snap is valued at around $16 billion after a post-earnings plunge on Wednesday. That puts the price-to-sales (P/S) ratio at about 4. For a company that's suffering from slumping revenue and producing gigantic losses, that valuation is tough to justify.
Even if Snap's AI investments draw in more advertisers and boost per-user revenue, the hole Snap has dug itself into is so deep that anything short of a miracle won't turn the bottom line positive. It's possible that SnapChat, despite being popular among users, is just not a particularly good business.
SnapChat has been around for nearly 12 years. It has nearly 400 million DAUs. It produces an operating loss of about $1 per user each quarter. If the company hasn't figured out how to make SnapChat work as a business by now, I'm not sure it ever will.
