Snap: $7 Target Turns Optimistic

Summary

• Snap reported disastrous Q1 results.
• The company faces DAUs turning negative in Q2.
• Snap continues to produce larger free cash flow loses.
• A previous $7 price target is now far too optimistic.

All of the indications pointed toward Snap (NYSE:SNAP) disappointing the market with quarterly results. The social messaging stock did not disappoint with a disastrous Q1 report that places our previous $7 price target as now highly optimistic.

Source: Spectacles.com

User Revolt

The redesign of the mobile app got horrible views as highlighted in my previous research. Not surprising, the Q1 results continued to show a weakness in DAUs (daily active users). The sequential growth dipped to only 4 million users, but the scary part is the comment that DAUs were lower in March, though still above Q4 levels. Otherwise, Snap is now facing losing DAUs on a monthly basis.

When investors via the DAUs based on the reality that limited growth has occurred since Q3'16, the investment story turns highly bearish. Recode questioned the process to redesign Snapchat again and highlighted how DAU growth has struggled for quarters now.

Source: Recode

The bad part of the Snapchat redesign was the intent to place a higher focus on professional content. The content is needed to drive advertising revenue for a service generally designed for users to send private messages that aren't as easily monetized. If anybody has a data privacy issue, it is Snap with the service built around the concept of disappearing messages.

The company continues to optimize the redesign, but one shouldn't even approach the stock at mark value of $20.0 billion before the report. Even a nearly 20% loss places the market cap at close to $15 billion with 1.457 billion shares on a fully diluted basis.

The problem is that Snap actually still trades at a premium valuation considering revenues won't top much above $1 billion this year. At $7, Snap would still top a $10 billion market cap.

Cash Flow Nightmare

In the public markets, the only way to run negative cash flows is to produce significant revenue growth and convince the market that the growth will eventually improve the cash flow position. Snap isn't generating the DAU growth that convinces anybody that operations will improve much beyond the current levels.

Not a huge problem if the social messaging site was generating massive cash flows. The reality is that Snap is far away from turning cash flow positive that the process is starting to appear hopeless.

Snap has huge locked-in hosting costs that clearly aren't turning more efficient with the added users. Q1 costs actually grew to $0.73 per DAU, up from $0.70 sequentially despite higher user totals.

Without any leverage in costs of revenues, a minor dip in operating expenses did nothing for improving cash flows. In fact, Q1 free cash flow dipped to negative $268 million. Snap reported an incredible decline beyond the previous cash burn rates despite commentary contradicting this chart.

Source: Snap Q1'18 presentation

Average revenue per user is only $1.21 and far below the other social companies. Snap would have some hope if users were still growing at a decent clip. The stock is an avoid and even a short until the Snapchat app regains momentum. One can't make the case for the stock at just about any price with quarterly cash burn rates far in excess of $200 million and DAUs potentially turning negative.

With the company bringing back the Spectacles after writing off $40 million in excess inventory and barely reducing operating expenses following headline grabbing layoffs, the situation isn't ripe for a turnaround. The disconnect with actual costs controls appears wide with another push into hardware when cash flows are this negative.

Takeaway

The key investor takeaway is that Snap has to fundamentally show that a redesign of the app returns the social messaging site to user growth. In addition, the company must show more cost controls. Only then would the business story turn more positive.

Snap is a clear short to below our now optimistic $7 price target. After all, the stock trades at nearly 13x '18 sales estimates that do nothing to remove the massive negative cash flows. A combination of a user base stalling while the company is in a bad financial position is where shorting makes sense because the investment story is absolutely broken.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.