Is It Too Late to Buy Snap Stock?

Snap's (SNAP 27.63%) stock price plunged 19% during after-hours trading on July 25 after the social media company posted its second-quarter earnings report. Its revenue fell 4% year over year to $1.07 billion, which marked its second consecutive quarter of declining revenue, but it still beat analysts' estimates by $10 million. Its adjusted loss of $0.02 per share stayed flat from a year ago and cleared the consensus forecast by two cents.

Snap cleared Wall Street's low bar, but it certainly didn't impress the bulls and its stock price remains nearly 90% below its all-time high from September 2021. Let's see if it's too late to buy Snap as a turnaround play. 

Image source: Getty Images.

Snap's declining ARPU offsets its rising DAUs again

Snap's number of daily active users (DAUs) grew 14% year over year to 397 million in the second quarter, but that represented its slowest DAU growth since the third quarter of 2019. Its North American DAUs rose only 2% to 101 million, but its European DAUs increased 9% to 94 million while its Rest of World DAUs grew 25% to 202 million.

Snap's overseas growth reduces its average revenue per user (ARPU) because it generates higher ad revenue from its North American users. That's why its ARPU declined for the fifth consecutive quarter with a 16% year-over-year drop. Its North American ARPU fell 14% to $6.83, and its European ARPU dipped 2% to $1.93, but its Rest of World ARPU grew 3% to $0.98.

As the following table illustrates, Snap's shriveling ARPU has been offsetting its stable (albeit decelerating) growth in DAUs and causing its revenue to decline year over year in the first half of 2023:

Data source: Snap. YOY = Year over year.

Snap's slowing DAU growth was likely caused by fierce competition from ByteDance's TikTok and Meta Platforms' Instagram Reels, which both target Snapchat's core audience of younger users. Its declining ARPU can be attributed to a mix of those competitive headwinds, the broader slowdown of the advertising market in this challenging macro environment, and Apple's privacy-oriented changes on iOS -- which made it more difficult to craft targeted ads from third-party data.

Snap is trying to grow its ARPU again by rebooting its ads and expanding its subscription-based platform, Snapchat+, which exceeded 4 million subscribers in the fourth quarter. But even with the help of those subscribers -- who pay $3.99 per month for exclusive icons, pins, backgrounds, filters, and friend-tracking features -- its total ARPU is still declining.

It's also been expanding its short video platform, Spotlight, which grew its number of monthly active users (MAUs) by 51% year over year to more than 400 million in the second quarter, to widen its moat against TikTok and Reels. In addition, more than 150 million people have already used its new artificial intelligence-powered chatbot, My AI, to send more than 10 billion messages. Unfortunately, neither of those features is generating meaningful revenue yet.

That's why Snap expects its revenue to slip by 0% to 5% year over year in the third quarter. It said its business "remains in a period of rapid transition" as it tries to improve its advertising platform, but it has "limited" visibility of the near-term ad market. 

Its margins are still being squeezed

As its revenue growth cooled off, Snap cut costs, abandoned some of its plans to build a "superapp" through integrated games and original videos, and laid off nearly a fifth of its full-time workforce over the past year. But it's also been ramping up its investments in new Snapchat+, Spotlight, and AI-powered features. Its operating and adjusted EBITDA margins suggest that the balancing act isn't working out too well:

Data source: Snap. EBITDA = earnings before interest, taxes, depreciation, and amortization.

Snap posted an adjusted EBITDA loss of $38.5 million in the second quarter, and it's bracing for another adjusted EBITDA loss of $50 million to $100 million in the third quarter -- which implies its adjusted EBITDA margin will drop to a midpoint of negative 6.8%.

It attributed that compression to higher infrastructure spending for its new machine learning, AI, and advertising features -- which caused its headcount to rise 2% sequentially in the second quarter after a three-quarter streak of reductions. It anticipates another "modest" increase in its headcount in the third quarter.

Is it too late to buy Snap's stock?

Analysts expect Snap's revenue and adjusted EPS to decline 12% and 59%, respectively, for the full year. Based on those estimates, it still doesn't look like a screaming bargain at 4 times this year's sales -- especially when Meta, which faces milder declines this year, trades at less than 7 times this year's sales. Unless Snap proves it can end its dismal cycle of slowing growth and rising costs, I believe it's still too late to bet on this social media underdog's long-shot turnaround.