Are you considering a stake in shares of Snapchat parent Snap (SNAP -0.41%) following February's post-earnings pullback? It's not a terrible strategy. Good stocks are great buys when they're on sale. Now down by one-third of February's peak, Snap stock is clearly on sale.
Before using Snap's setback as a long-term buying opportunity, however, four matters need to be addressed first.
About Snap
You know the company -- or more specifically, its app. Snapchat is a social media platform best known for allowing users to embellish and share pictures (and videos) with friends and followers. As of the final quarter of last year, 414 million people were using the app every single day.
The quarter in question was OK. Its user base grew, but the top line of $1.38 billion for the three-month stretch ending in December fell short of estimates by barely growing at all. Although per-share earnings of $0.08 topped estimates of $0.06, that's still down from the profit of $0.14-per-share earnings in the comparable quarter a year earlier. Sales guidance for the first fiscal quarter was also lackluster, while the recent announcement of roughly 500 layoffs (about 10% of its workforce) further rattled investors.
These are all just symptoms, though. The underlying problems are what must be addressed for the symptoms to abate. Four big challenges are the core of what's ailing Snap right now.
1. Snapchat needs more of the most fruitful users
Snapchat may have grown its daily users to 414 million in Q4, tacking on another 8 million from Q3's headcount. But, it didn't grow this number evenly. Most of this growth came from outside North America and Europe. In fact, the app actually lost a small portion of its domestic user base during the final quarter of last year.
So what? Does it really matter where these users live?
Actually, it does. See, North America's users boast the biggest average revenue per user (ARPU) of $8.96 per quarter, up just a bit from the year-ago comparison. The "rest of the world" ARPU is a much smaller $1.03 per quarter, down from Q4-2022's figure of $1.10. Europe's fourth-quarter ARPU edged up 5% to $2.49 per quarter, but Snapchat only added 1 million (net) daily users in Europe during the final three months of 2023.
Data source: Snap's Q4-2023 earnings slide deck.
In other words, Snapchat isn't growing where it matters the most.
2. Spending must be effective, but it must also be done
Kudos to Snap for being disciplined enough to not recklessly spend in the name of growth. Last year's total operating costs and expenses were essentially in line with 2022's.
It's arguable, however, that right now, the right move may actually be spending a bit more to get some growth -- any growth -- going. Last year's revenue was also flat versus 2022's tally.
The company's still culling costs, too. The layoffs now underway will likely lead to an earnings before interest, taxes, depreciation, and amortization (EBITDA) loss of between $55 million and negative $95 million for the quarter ending in March -- a maneuver that's expected to help boost the bottom line beginning in the second quarter.
Even so, management doesn't appear completely confident that these job cuts and other initiatives will actually produce meaningful, sustained top- and bottom-line growth. As CFO Derek Andersen commented during February's Q4's earnings call: "From here after restructuring on the opex [operational expenditures] side and getting to a good size on our overall fixed cost cash cost structure ... it's about being disciplined from here, which we expect to be able to do. And the changes we made give us room to invest to support our growth as if we -- if and when we accelerate revenue."
That's hopeful, but hardly inspirational.
Connect the dots: It's not clear when or even if the company will ever work its way out of the red, as Snap is struggling to find a spending plan that's effective as well as sustainable.
3. Snap still doesn't seem to know how Snapchat is best monetized
All great companies are able to adapt. Not all companies making adaptations, however, are necessarily great. If a company is still tinkering with its core product more than a decade after it was launched, maybe that product was never really all that marketable.
That's arguably where Snap is right now.
Although Snapchat debuted in 2011, the kind of advertisements it's historically been used for are now undergoing major changes. Chief among these changes is a shift from simple brand awareness advertising to direct-response ads.
Perhaps worse, as Snap continues to make this change, revenue growth appears to be slowing down. The first quarter's sales-growth guidance of between 11% and 15% looks and feels impressive because the comparison is to an abnormally weak Q1 of 2023.
SNAP Revenue (Quarterly) data by YCharts
It's a red flag simply because now 13 years into its existence, one would think the company might have already followed Facebook's and X's lead by making such a change.
4. Snapchat lacks the scale and reach of other web advertising platforms
Last but not least, while no $19 billion company doing nearly $5 billion worth of business per year can be considered "small," in comparison to other web-advertising platforms like Meta Platforms' Facebook or Alphabet's Google, Snapchat is tiny. Facebook reports over 2.1 billion daily users, for perspective.
It's not necessarily the end of the world; smaller companies can do just fine despite their size. It's clear that Snap isn't doing as well as similar names, though.
As LightShed Partners analyst Rich Greenfield bluntly asked during February's conference call:
[Is] Snap's smaller scale relative to Meta ... just sort of a fundamental long-term issue? Because I think people are looking at Meta growing 30% at a tremendous underlying scale ... is there a dramatic acceleration that you see possible throughout the whole year as you lean into DR [direct response] and the ML [machine learning] investments pay off? Or are you just sort of fundamentally disadvantaged?
It's not just Meta's Facebook outpacing Snapchat, either. Amazon's ad business grew 27% during the fourth quarter. YouTube's advertising revenue improved 15.5% year over year, while Google's search ad sales were up nearly 13% in Q4 of last year. It's possible that prospective advertisers are looking for a platform with greater reach and deeper engagement.
Never say never, but certainly not right now
The good news is that none of these challenges are insurmountable. Snap may well fix these four things in the foreseeable future. The bad news is, all of these challenges will be difficult to tackle.
Snapchat is now 12 years old, and it's still trying to figure out how to turn an actual profit. This isn't the kind of company that you'll want to take a significant risk on just yet. Indeed, most investors won't want to take a shot on Snap at all until most of these matters are addressed.
