Properly valuing social media companies is usually difficult, if not impossible. The high earnings multiples observed for social media firms are often based on speculation and potential rather than evidence. That said, I think valuing social media companies relative to one another can be a fruitful endeavor. Here I examine Twitter (NYSE:TWTR) and Snap (NYSE:SNAP) vis-à-vis Facebook (NASDAQ:FB), using the past success of the latter to estimate what could be in store for the smaller rivals. Based on advertising revenue per time spent on the three sites, I conclude that Twitter does not look like a buy, while Snap could be undervalued.
Let's begin with the fact all of these social media concerns do not make money on content. Rather, their product is advertising space. They essentially sell their users to other companies, so in that respect social media companies are no different than traditional television broadcasters and print media. In 2017, digital ad spending will reach a projected $83 billion ($36 billion for social media alone). $26 billion went into Facebook's coffers last year, while Snap will garner an estimated $770 million in 2017. Twitter will rake in about $2.1 billion if current trends continue.
Now let's look at time spent on the various platforms ("user engagement" in industry jargon). The average Facebook user spends 50 minutes a day on the company's various products, while Snapchat takes 25 minutes from its users. Twitter brings up the rear with 17 minutes a day, at best. Dividing the ad revenue by total user hours spent on these three platforms a year gives us an estimate of how much advertisers are forking over for each hour. Facebook and Twitter both command $0.07 per hour, while Snapchat costs $0.02. By this metric, advertisers - the people who actually pay these companies - place at least the same value on a Twitter ad as they do on Facebook. Compared to its peers, Snapchat's ad prices look like a bargain.
This is the key factor that sets apart Snapchat from Twitter. If Snapchat can prove its viability as a platform for advertising, then revenue per user hour will surely increase. Indeed, revenue could easily triple if Snapchat matches Twitter and Facebook on this metric. Further, let's say that the market ends up valuing user hours at the same level as Facebook. Investors value Facebook at $1.10 for every hour spent on its sites, $0.50 for Snapchat, and just $0.32 per hour for Twitter. In that case, shares should be double the present value. So what about Twitter? I think that company's low valuation can be explained by its no-growth malaise. The user base has been stagnant, and even worse, time spent on the platform has steadily declined over the years. Facebook, however, has grown rapidly on both fronts, and Snapchat has also been on a tear.
I also think that CEO Evan Spiegel has a clear vision for where he wants to take the company, and he has proven adept at schmoozing with the advertising titans who feed the social media beast. Unlike Twitter Snapchat is mostly based on sharing images and videos, which is a medium that lends itself very well to advertising. Twitter, on the other hand, has wandered aimlessly with no clear plan for reversing its decline. Even though most people agree that the company's brand remains strong, nobody seems to know how to translate that into sales and profits. Passive consumption of Twitter content is thought to be much higher than the active user base, since tweets are widely quoted and shared on other media platforms.
As I said at the start, investors have to be willing to speculate at this point, so I definitely would not be jumping on the bandwagon just yet. Snapchat's platform does not offer the richness of data that Facebook and Google (NASDAQ:GOOG) (NASDAQ:GOOGL) provide, which is probably why the company is undervalued in terms of what advertisers are willing to pay. Investors should keep a close watch on what ad buyers are saying about Snap, which could portend a substantial rise in the price of the stock.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.