Did Rihanna End Snap?

Summary

• Snap and Rihanna had a tete-a-tete over an ad making light of domestic violence.
• Racy ads likely connotes Snap's desperate need to amplify user engagement to grow revenue.
• The Rihanna tete-a-tete may not crush Snap, but consistent operating losses and cash burn could.
• Sell Snap.

Pop stars Chris Brown and Rihanna. Source: stylecaster

A few weeks ago, pop star Rihanna and Snapchat (NYSE:SNAP) made major headlines. Snapchat ran an advertisement for a game called "Would you rather." The game poses tough questions to its participants. The choices the Snapchat ad gave were "Slap Rihanna" or "Punch Chris Brown." Brown pleaded guilty in 2009 to assaulting Rihanna during an argument when they were dating.

Rihanna criticized Snapchat on social media for animating something that would intentionally bring shame to domestic violence victims, and making "a joke of it."

Snapchat removed the ad from its platform and also admitted the advertisement was approved in error:

"The advert was reviewed and approved in error, as it violates our advertising guidelines. We immediately removed the ad last weekend, once we became aware. We are sorry that this happened."

Snap's share price fell by over 5% after Rihanna's criticism went public, wiping out over $800 million of its market value. The criticism has been a public relations nightmare for the company. Rihanna has millions of fans, and I would wager that many of them are avid users of social media, including Snapchat. Secondly, amid the "Me Too" movement women are fighting back against violence and harassment. This is the wrong time to make light of it. That said, the Rihanna tete-a-tete is just one of many of Snapchat's problems.

Snapchat Is Hemorrhaging Cash

When I first heard about Snapchat's exploding videos a few years ago, I thought it was a neat idea. It could save teens the embarrassment of having their videos seen by people other than who they were intended for. Just because something is a neat idea does not necessarily mean it should be a publicly-traded company. Snapchat went public a year ago. Its revenue has grown, but like most start-ups, Snapchat is hemorrhaging cash.

In Q4 2017, its revenue of $286 million was up 72% Y/Y. Its daily average users (DAUs) of $187 million rose 18%; growth in average revenue per user ("ARPU") rose 46% and outstripped 6% growth in cost of revenue per user ("CoRPU"). Snapchat is growing its infrastructure in order to sell more ads and generate new revenue opportunities. Its R&D and SG&A expenses more than doubled versus the year earlier period. EBITDA and cash flow suffered for it. Snapchat generated EBITDA of -$342 million, down from -$159 million in Q4 2016.

Free cash flow for Q4 2017 was -$197 million, and -$819 million for full-year 2017. The company raised $1.2 billion of preferred stock in 2016 and another $2.7 billion in common stock in 2017. At year-end, its cash and securities were just over $2.0 billion. At its cash burn rate how long will its liquidity last?

Snapchat Needs To Better Monetize Its Platform

Snapchat has an interesting, value-added platform but can it monetize it? Twitter (TWTR) had a similar situation a few years ago. Its platform had tens of millions of active users, but would advertisers pay for it? To generate more ad dollars, Snapchat increased the number of companies that could market their products on its platform. CEO Evan Spiegel recently revamped the site to separate [i] photos and videos generated by users' friends from [ii] content from publishers, creators and influencers.

In separating the "social" from the "media," Spiegel is taking a big risk. He practically has to in order to increase user engagement and generate more ad dollars. In Q4 2017, the company's ARPU and CoRPU were $1.53 and $1.00 respectively. That created $0.53 per user to cover other costs like R&D and SG&A.

Snapchat's R&D and SG&A were a combined $2.36 per user, yielding EBITDA per user of -$1.83. To become EBITDA positive, the company must rapidly grow its user base, increase ad rates, increase user engagement or cut costs.

Tasks within its control could be cutting costs or amplifying user engagement. Snapchat recently laid off over 200 employees related to advertising and engineering as it seeks to right-size the business. I believe the next evolution is to amplify user engagement and keep people interacting longer with one another on the site. This could potentially generate higher ad dollars. In my opinion, the more incendiary the content, the more engaged users can be.

That is why I believe Snapchat's ad featuring Rihanna and Chris Brown was not an accident, it was likely strategic. I believe Snapchat understands how incendiary and controversial content can spark engagement. Secondly, the public cannot get enough of celebrities and the Internet and social media have given us a closer glimpse into their lives. Certain sites and influencers have practically made a living writing about Chris and Rihanna and other celebrities. When I first heard the story about the Snapchat ad, I suspected the company was in trouble and needed to take risks to amplify user engagement.

After examining its financial results, I am practically certain of it. The company cannot cover its operating expenses and needs to take risks. The blowback from purposely posting incendiary content is that the site could become too toxic and push users and potential users away. That appears to be have been the case with Rihanna. I also would not be surprised if Twitter or Facebook (FB) are not also attempting to create their own video sharing platforms to compete with Snapchat. A real threat from another social media giant could cut into Snapchat's ad revenue and amplify its cash burn.

Conclusion

The Rihanna tete-a-tete likely implies Snapchat is having trouble financially and needs to amplify user engagement. I do not think the PR debacle will crush Snapchat, but consistent operating losses and cash burn could. Sell SNAP.

Analyst’s 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. I have no business relationship with any company whose stock is mentioned in this article.