Snap: For Now Valuations Are Irrelevant
Summary
- Snap's auditors put out critical comments on Snap's financials.
- I question whether Snap's growth in users will be strong enough to offset its decline in pricing.
- Exuberant valuation with no upside left, asides from speculative.
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Investment Thesis
Snap (NYSE:SNAP) remains shockingly valued. The company continues to trade at approximately 14 times sales, even though its revenues are set to decelerate meaningfully for the remainder of 2020.
Given that Snap's auditors put out a critical matter over Snap's revenue recognition, I am further troubled by its excessive valuation.
State of Play
To argue that the market appears to be losing its mind is to sound like sour grapes.
Particularly, when you are aiming these comments at a cult stock, which continues to be priced at exuberant valuations and shows no sign of slowing down -- so I'm flummoxed.
Of course, shareholders would declare that my style of investing, which puts prudence above gains is outdated. So what's actually happening with Snap? Investors clearly have come to terms, by now, that Q2 2020 will be carnage. But at the same time, investors appear to be more than satisfied to look past this.
Thus, the question that matters here is how far past Q2 are investors willing to look? Are investors expecting that by Q3 2020, Snap will be back to normal, with a nothing-to-see attitude? Or are investors cognizant that 2020 will be unimpressive, but that 2021 comparisons will be so strong, thereby ultimately justifying paying this high valuation today?
Breaking Down Snap's Revenue Stream
The graph below reminds us that nearly 70% of Snap's revenues are derived from North America.
Source: author's calculations, Q2 2020 10-Q
Consequently, whatever dynamics take place in advertising in North America has an overarching impact on Snap's performance.
Why is this important? Because know from numerous companies, including Alphabet (GOOGL)(GOOG), Facebook (FB), and Twitter (TWTR), that have exposure to largely similar advertising dynamics that the market weakened in earnest starting the second half of March.
Further, although the advertising sector stabilized into April, that simply means it stopped weakening. It does not mean that as we enter the final month of Q2 2020, the advertising sector has bounced back to where it was at the start of 2020.
For Q2 2019, Snap's North America ARPU was $3.14. This figure is going to come out lower in Q2 2020. Hence, important questions which are truly critical here are:
1) How much lower will North America's ARPU come in Q2 2020?
2) Will Snap's North America ARPU bounce back quickly over the remainder of 2020?
3) Will the increase in DAUs be strong enough to offset the decrease in ARPU for the remainder of 2020?
Realistically, I don't know the answers to the questions. What I do know, is that 2019 and into early 2020, the advertising sector was operating at its peak strength.
Consequently, common sense implies that ARPUs will be lower for the remainder of 2020, with the last three quarters of 2020 faring weakly when compared with the same period a year ago.
Management knows this too, hence why guidance was pulled, not to spook investors. Thus, even if DAUs continue to increase, particularly given that during the lockdown, there's likely to be an uptake of social media platforms, I am unsure whether DAUs increasing is going to be strong enough to offset my expected drop in APRUs.
Source: author's calculations, Press Statement
Indeed, during the earnings call, Snap's Chief Business Officer Jeremi Gorman noted that during the latter parts of March DAUs were higher. The question is just how much higher? And whether those newly found users will stay on the platform past lockdown?
Note, I've focused my analysis on North America, as this is where Snap derives close to 70% of its revenue from.
I'll attempt to make a brave assumption that in the best-case scenario, Q2 2020 saw North America's DAU increase by 20% year-over-year, thereby jumping 1,000 basis points sequentially.
Even if that was the case, I can't see how it would be high enough to mitigate my expected drop in ARPUs in Q2 2020.
Critical Audit Matters
As you see below, analysts are still expected that 2020 comes out at close to 22% growth year-over-year.
Source: SA premium tools
Given that Q1 2020 was up 44%, this would require as very strong performance for the rest of 2020. And I can't see how Snap can indeed reach these figures.
Further compounding issues, for now, Snap is still being priced at close to 15 times trailing sales. Stocks that get priced at north of 10 times sales are stocks where their business model locks in customers into multi-year contracts.
Moreover, as Snap's auditors noted, there are question marks over how Snap recognizes its revenues. Ernst & Young LLP stated, among other issues with Snap's accounting, that the way Snap recognizes the timing of its revenue recognition, is 'complex'.
The Bottom Line
Snap is simply too expensive at approximately 15 times revenues, when we know that its revenue is going to decelerate over Q2 2020 and Q3 2020, if not for the whole of 2020.
For Snap's valuation to be justified, it assumes that by 2021, the advertising sector is back to full strength, as if nothing happened during 2020.
On balance, I believe that there are substantially safer investment opportunities elsewhere.
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This article was written by
Michael Wiggins De Oliveira is an energy specialist whose primary focus is capitalizing on “the Great Energy Transition” - the confluence of decarbonization, digitalization with AI, and deglobalization - to achieve greater investment returns. Through his 9+ years analyzing countless companies, Michael has accumulated outstanding professional experience in the energy sector and a following of over 40K on Seeking Alpha.
Michael is the leader of the investing group Deep Value Returns. Features of the group include: Insights through his concentrated portfolio of value stocks, timely updates on stock picks, a weekly webinar for live advice, and "hand-holding" as-needed for new and experienced investors alike. Deep Value Returns also has an active, vibrant, and kind community easily accessible via chat. Learn more.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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (31)
DAU = Daily Active Users
Sadly, the sign of a declining nation (3 centuries?).
See you at $25
unproductive companies that have jumped 8%..10%..even 15% today alone. The "Hanging Man" chart formation forming is an apt name.
From the graph of Snap at the bottom of the article, it appears to me that neither bears or bulls are winning. What do you think?
Very exciting comments.
Personally I'm not getting involved with FB because I think I can do slightly better amongst my stocks. Having said that, by far and wide, Facebook is the one stock I would unquestionably buy (Disclosure: I have no position).Also, even though you are correct about FB's Q2 (and GOOGL for that matter, I wouldn't mind owning that one), I would not wait to market time my entry. If it makes sense to you now, go in now. Don't wait for it to fall 5% and hope to be ready to buy into a sell-off. In my experience, buying into bad news is very, very difficult.Good luck.
Michael
Thank you for you comment, Kaiser.Many different aspects we need to unpick here.1) Yes, users will go up. I noted this throughout. But if the APRU, that means pricing, goes down, then your increased users MAY not be enough to offset pricing.2) Facebook is not comparable. Yes, Facebook has a huge market cap, but it trades at a LOW MULTIPLE. Snap is trading with a small market cap, but its multiple is extended.3) I'm not too concern about the political side. So no comments on that front. 4) I have no doubts that their fan base is loyal. What I have trouble about is whether the stock is priced for sustained growth and whether that growth will continue in the next few quarters, into next year. Good luck. Thanks for your comment, Kaiser.
Michael