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Investment Thesis
Snap Inc. (NYSE:SNAP) is the leading augmented reality-focused (AR) "camera company" among its US social media peers. However, the company delivered a shocker in its FQ3'21 report card as it telegraphed that it was hit hard by Apple's (AAPL) IDFA changes. It contrasted greatly with Evan Spiegel & Co.'s optimism at the beginning of the year. Back then, it telegraphed its support for the Cupertino company on its belief that "privacy is a basic human right."
Nevertheless, we believe that the sell-off in SNAP stock was highly justified. First, it traded at astronomical forward EBITDA multiples before its FQ3 report card. Second, it penalized management for not being transparent with its guidance on the iOS impact. Third, as a mobile-only platform, SNAP falls directly within the cross-hairs of Apple's App Tracking Transparency (ATT) framework. Therefore, even though the stock cratered after communicating weak guidance, we think it's well deserved.
Nevertheless, the rapid markdown has also brought the stock into the buy zone. We discuss whether investors should consider adding the stock now.
SNAP Stock YTD Performance
SNAP stock YTD performance (as of 3 December'21).
SNAP stock's YTD return of -6.6% belied its incredible performance before its FQ3 earnings call. Until its recent earnings release, the stock has consistently outperformed both the Invesco QQQ ETF (QQQ) and Meta Platforms (FB) stock. Moreover, in early October, the stock's YTD return almost reached 70%.
However, investors who bought at the highs in October are down significantly as the stock continues to underperform FB stock and the market. In addition, we believe that the stock could remain in the penalty box for a while, as SNAP works through its ad targeting and optimization challenges.
How is Snap Coping with Apple's IDFA Changes?
Snap telegraphed that it has been preparing for Apple's privacy changes for some time. However, the impact also took it by surprise. To be fair to the company, it highlighted early this year that the impact would be uncertain. Chief business officer Jeremi Gorman emphasized (edited):
The reality is we admire Apple, and we believe that they are trying to do the right thing for their customers. Their focus on protecting privacy is aligned with our values and the way we’ve built our business from the very beginning. Overall, we feel really well prepared for these changes, but changes to this ecosystem are usually disruptive and the outcome is uncertain. (from Snap's FQ4'20 earnings call)
In our previous Apple articles, we wrote that Apple is set to benefit tremendously from its ATT framework. But, of course, it will come at the expense of the mobile digital advertising incumbents such as Snap. While Snap and its peers faced headwinds in their FQ3, Apple reported a record quarter in its FQ4 (same calendar quarter), as the company saw robust growth across all its segments. Apple CFO Luca Maestri emphasized (edited):
It's difficult to single out a specific area because we set all-time records across the board, AppleCare, music, video, advertising, payment services, the App Store was a September quarter record. So it was strong across the board. (from Apple's FQ4 earnings call)
Bernstein also wrote a report recently detailing why Apple's advertising segment is thriving. It highlighted that "Apple's advertising business — which is largely Search Ads on the App Store — is and will likely continue to be a beneficiary." It also added (edited):
Apple's own Apps are not prompting users about tracking. Apple also uses its own API for its Ad network which allows for more granular attribution data. The company is benefitting from competitive advantages tied to IDFA. It's also "actively" preventing workarounds to its privacy rules. (from Insider article)
Moreover, Snap has found it challenging to effectively implement SKAdNetwork (SKAN). Apple designed SKAN as a way for advertisers to "measure the success of ad campaigns while maintaining user privacy." However, Snap CFO Derek Andersen emphasized that the company observed multiple limitations when using SKAN. Andersen articulated (edited):
We anticipated that we would have to make significant changes to both our ad targeting and optimization. We were able to largely close the gap on our targeting and optimization capabilities prior to the launch of these changes. However, as we moved through Q3, as newer versions of iOS accelerate and the limitations of SKAdNetwork became far more apparent. And so it became pretty clear over time that from advertisers, that was not going to be the only solution and may not be the reliable solution for a lot of partners. (from Morgan Stanley European TMT Conference 2021)
Therefore, let us be clear here. Snap is not out of the woods yet. The company will likely need at least a few more quarters to work on its enhanced "privacy safe measurement solutions." These include "Advanced Conversions" and "Estimated Conversions." Snap believes that these will be vital products to help its advertisers measure and optimize their ad campaigns moving forward. Moreover, Snap also reminded investors that its targeting opt-in rates have been better than expected. Therefore, Snap continues to have "deterministic measurement data on a large portion of its users."
We think it's still early, but Snap seems to have made encouraging progress. Given Snap's mobile-only business model, the company must make the transition successful. Moreover, the company has been executing well before the IDFA changes. Therefore, we believe that management will pivot accordingly to ensure its survival in the post-IDFA world.
So, is SNAP Stock a Buy Now?
Comparison of Snap's revenue mean consensus estimates. Data source: Seeking Alpha, S&P Capital IQ
Snap adjusted EBITDA mean consensus. Data source: S&P Capital IQ
Readers can quickly glean the marked revisions in Snap's revenue consensus estimates since its FQ3 earnings. Notably, the estimates have been revised downwards through FY25. FY25's estimates have also been downgraded by almost 21%. Consequently, its revenue growth estimates through FY25 have also been significantly adjusted. Snap's pre-FQ3 estimated revenue CAGR from FY20-25 was a phenomenal 48.7%. Its most recent revenue CAGR has been revised to 42%. Nevertheless, despite the significant downward revisions, there's little doubt that SNAP is still expected to grow remarkably fast.
In addition, Snap is also still expected to gain operating leverage rapidly. Its adjusted EBITDA is estimated to increase at a CAGR of 85.1% through FY25. Therefore, we believe that Snap's growth opportunities are still at their early innings in a massive digital advertising market.
SNAP stock EV/NTM Revenue 3Y mean.
Moreover, SNAP stock is trading at an EV/NTM Revenue of 14.9x, just slightly above its 3Y mean of 14.5x. Our internal fair value estimates also show that SNAP stock is reasonably valued now, although it's not considered cheap.
Nevertheless, for investors who have high conviction over Snap's thesis, we believe that SNAP stock is within the buy zone now. But, given the current market volatility over high-growth stocks, investors should continue to expect volatility if they add now. But, if you have a five-year horizon, you should not be unduly concerned.
Therefore, we rate Snap stock at Buy.
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