Snap Is Back!

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About: Snap Inc. (SNAP)
by: Value Growth Master
Summary

Snap has delivered strong earnings in 2019, and in Q2, its user base returned to growth following several quarters of stagnation.

Snap's focus on engagement has led to improvements in its content platform, something that has attracted more advertisers.

Snap’s new gaming platform and AR technologies provide more features for users and are helping to turn the app into an ecosystem, rather than just a messaging service.

However, many of the same problems Snap once faced remain and investors should wait for more clarity.

Snap’s (SNAP) 2019 earnings revived hope in a company that has suffered greatly since its IPO in 2017. In both Q1 and Q2, it beat on users, revenue, and EPS, pushing the stock above its IPO price for the first time since early 2018. In Q2, it reported growth of 8% in daily active users (DAU), a pleasant reversal from past quarters of stagnation or even DAU decline. This reversal in Snap’s fortunes has led to renewed optimism in the company once considered by many to be the future of social media. Strong recent performance has pushed one analyst to predict a turnaround and even call the stock a “Cinderella Story.”

Snap’s revival has been driven by a focus on engagement and the increase in more interesting content on its platform. Instead of being content with simply dominating messaging, it has expanded to other areas such as video and shows, gaming, and AR. This article will analyze Snap’s efforts to expand its service while increasing capabilities for advertisers while discussing the issues still facing the business.

Growth Through Increased Engagement

An early concern for Snapchat was the lack of engagement on the platform beyond simply messaging. Management recognized this, which is why they have consistently focused on turning Snapchat from a messaging app into an overarching ecosystem that users can turn to for everything in their lives from following their friends to learning about the latest news. A key part of this is their Discover platform. First introduced in 2015, Discover was meant to be Snapchat’s content platform, providing news and TV shows to users. After its launch, though, the feature was not met with overwhelming success. It was reported that less than a quarter of users even used it and it was far from the go-to media source Snapchat envisioned. The company tried to boost Discover in 2018 with a major app redesign, but instead, it angered millions of users and was threatened with the loss of some of its most valuable influencers from the platform.

While those efforts failed horrifically, the company has since taken more subtle actions to boost the feature. These efforts include working with publishers to create more interesting and engaging content for users. One such example is ESPN. While in the past ESPN’s content on Snapchat consisted primarily of previously published articles from its website, it has since shifted to more video content and now offer to Snapchat users their popular “SportsCenter” and “ESPN Daily” programs. This shift has been successful for both parties and has pushed ESPN to increase its activity on Snapchat with the new weekly “ESPN MMA Show.”

New content has been successful at driving more usage of Discover. In the second quarter, its audience grew by 35% YOY. Along with that, people were using Discover more and the average time spent on it per day grew by over 60%. These increases were also helped by Snap opening Discover up to new non-exclusive video shows. In Discover, publishers have found that they can attract a new audience for content after it has already appeared on Facebook and YouTube. Popular shows, such as BuzzFeed’s “Worth It” and Complex Networks’ “Sneaker Shopping,” have appeared on Discover after they were specifically edited to fit a Snapchat audience.

Beyond content, Snap has looked to increase engagement by expanding its app into gaming. In April 2019, it introduced Snap Games, a platform where users can play real-time multiplayer games with their friends while texting. On this platform, it launched its first original game, Bitmoji Party, along with several others that so far have received surprisingly good reviews. The platform is monetized through short ads which users can watch in order to receive advantages in the games. Later, Snap may add in-game purchases to further increase its monetization.

Snap is also developing other projects that it believes will be important in the future. One important area it has been building is its augmented reality (AR) features. It recently launched AR Lenses, something that has quickly become popular with over 200 million users using it in just the first two weeks. In response, Snap has invested heavily into its Lens studio, a desktop program for creators to make AR experiences, which Snap calls Lenses. Over half a million Lenses have already been created and engagement with these new AR experiences has been strong.

Attracting Advertisers

Snapchat has always been able to offer an extremely valuable asset to advertisers: the ability to promote directly to the valuable 13-34 year-old demographic. However, demand for advertising on Snapchat in the past has always been lower than one would expect. The combination of high prices, poor data capabilities, and the need for custom-designed commercials made it difficult for most to effectively promote on Snapchat.

Since then, though, the company has added new features and capabilities that make it easier for advertisers to use Snapchat. In April, it launched a new ad product called Snap Select which allows advertisers to purchase and reserve 6-second unskippable commercials in its premium shows at a fixed CPM. These advertising slots are in some of Snap’s most popular shows and will be extremely valuable for advertisers. David Roter, VP of global agency partnerships, called the new ad product “a direct path to reach Millennial and Gen Z audiences that are increasingly difficult to reach elsewhere.”

In addition, Snap launched Instant Create to simplify the process of creating a Snapchat ad for advertisers. Before, developing an effective ad for Snapchat was notoriously expensive. Instant Create streamlines the process into just three simple steps and offers tools that allow advertisers to quickly and inexpensively create unique designs.

AR ad products have also attracted companies to use Snapchat to promote their product. Using AR, companies can now place their item into a realistic setting and create an ad experience that is more engaging and fun. If users swipe up, they can activate a branded Lens that allows them to virtually explore the new product. This advertising feature has been successfully used by many companies including HBO (for Game of Thrones) and BMW, whose AR campaign let users experience BMW’s new X2 model in a showroom setting. Both of these campaigns were successful and received positive remarks from users. The BMW AR campaign was particularly engaging and received an average playtime of 54 seconds.

Improving Financials

Snapchat’s increased ability to attract advertisers coupled with a user base that returned to growth resulted in improved financial results for the company. Revenue in the second quarter jumped 48% YOY to $388 million. Even as revenue has soared, the company has still been able to limit costs while simultaneously investing into new features such as gaming and AR. Total operating expenses were $259 million, a 5% increase but falling 27 percent to 67% of revenue. In fact, Snap has been able to continuously limit operating expenses while still spending over $90 million per quarter on R&D.

Snapchat has consistently limited its operating expenses.

Source: Snap Q2 Earnings Presentation

As a result, Snap’s loss narrowed in the quarter to just -$0.06 per share, beating EPS expectations of -$0.10.

More importantly than sheer revenue, the company showed in Q2 that it still has the ability to increase monetization while still satisfying users. Average revenue per user (ARPU) came in at $1.91, jumping 37% YOY and 14% sequentially. This was driven by strong growth in its largest market, the United States, which led to North American ARPU to rise 42% to $3.14. ARPU growth elsewhere was robust as well including a 43% increase in Europe and a 25% increase elsewhere internationally.

Concerns

While 2019 has been a great year for Snap, the company still faces several problems that it must quickly address. Most significantly, Snap needs to continue to find ways to grow its user base. While 8% DAU growth in Q2 was strong, replicating this will be difficult considering in previous quarters, its DAU count was stagnant or even in decline. The company has almost reached its ceiling in the US with most people in the 13-34-year-old demographic already on the platform. For growth, Snap is turning to international markets, particularly in more developing countries, where it believes its newly updated Android app will help attract millions of new users. However, growth overseas will be a challenge because Snapchat is seen primarily as a messaging app, rather than a social platform. In messaging, it faces heavy competition from apps such as LINE (LN) or Facebook’s (FB) WhatsApp.

Additionally, Snap still needs to prove that it can continue to increase its monetization of users. While the number of advertisers using the platform has increased, many still prefer promoting on its competitors such as Instagram. This has caused Snap to struggle to find demand to fill its ad supply, causing ad prices to fall to bargain prices. Snap has made efforts to change this with increased engagement and by offering more valuable ad slots on its Discover platform, a valuable asset for advertisers seeking to attract the attention of the 13-34 age group. However, additional work and capabilities are still needed to prove to advertisers that Snapchat is an effective platform.

Conclusion

Snap’s successful 2019 has been driven by exciting developments in its core business. It has worked to become much more than just a messaging app, expanding into areas such as gaming and AR. In addition, new and improved content on its Discover platform has led to increased usage and engagement with the app, a positive sign that attracts both new advertisers and creators. These improvements have led to strong financial growth, with revenue jumping 48% YOY and forecasted to increase an additional 40% YOY in the third quarter. However, despite Snap’s rally, the company still faces similar issues it did before its recovery, namely uncertainty in user growth and demand by advertisers. Right now, Snap’s stock is not yet a buy and investors should wait for more clarity in the future.

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.