Snap: Users Will Grow, Profits Will Too (NYSE:SNAP)

Investment Thesis

Snap Inc. (NYSE:SNAP) owns one of the most popular social networking apps in the world. As of its Q3 2023 earnings report, it has 406 million daily active users (DAUs) and 750 million monthly active users (MAUs) in over 25 countries. Snap estimates that over 75% of people aged 13-34 use its app, and 90% of people aged 13-24. Snap is growing at a respectable rate and steadily gaining users with its fun and easy-to-use app that helps people around the world stay connected.

Snap’s first goal to drive growth is adding users. They see a huge global opportunity to continue adding users, as evidenced by the main growth in DAUs and MAUs coming from international expansion. I believe this trend will continue, and so does Snap management.

Snap’s second goal is innovation and monetization. It is constantly innovating its product offerings to better monetize its platforms. Snap struggled to maintain profitability last year but has shown better signs this year. It has a small market share in the ad market that it is looking to expand as it grows users and app usage. Spotlight, Snap’s version of TikTok or Reels, saw a 200% increase in total time spent watching Spotlight content in Q3.

This shows me that Snap is executing on innovation. It has a huge total addressable market (TAM) and has just begun to monetize its 750 million and growing MAUs. Snap believes that anyone with a smartphone or who is present on current social networking apps (like Facebook, Instagram, or TikTok) is a potential user. This only helps management’s case that the ad market is moving in their direction, toward digital, mobile, and video advertising.

I believe that Snap will use both of these catalysts, global growth, and platform monetization, to grow the company and return capital to shareholders. The stock currently trades at just under $10 a share with a market capitalization of just over $16 billion. Snap has built a huge platform with a strong user base and brand awareness.

Year after year, Snap has delivered new products and technology to app users. Management has diversified the platform and is now focused on profitability to spark share price growth. Snap has been around for over 10 years now and shows no signs of slowing down. The business is only getting bigger and offering more with Snapchat Plus, augmented reality, Spotlight, lenses, and more.

I believe that Snap has a strong hold on the younger generation, as they love its digital platform and staying connected with friends through instant pictures and videos. As its current users age and new users reach their teenage years, they will consistently see more users on its platform.

I like SNAP as a long-term investment because it is a dominant player in the social media industry. I believe that global growth and platform monetization will drive the stock higher. I know that it has been a rough ride for shareholders the past two years, but I think that buying in now for a small position could be a good investment for long-term growth investors.

Fundamentals

The problem that has haunted Snap for years is making money. It is still not profitable on a GAAP basis but is finally showing profits on non-GAAP EPS, with the exception of a blip last quarter. Snap has barely any free cash flow (FCF) on hand, with only $2.3 million, spending most of it on internal growth and M&A.

FCF peaked at $221 million in 2021 and has shrunk since then, as ad spending pulled back. However, ad spending has shown signs of life again, with positive growth in the past quarter and increasing average revenue per user (ARPU).

FCF and cash from operations will be two key numbers to watch going forward, as they will indicate whether:

• Snap’s monetization strategies are working.
• Ad spending is increasing.
• Traffic is growing.

The firm will need to start generating more cash to continue to invest in itself and compete with competitors’ technology. Research and development (R&D) and mergers and acquisitions (M&A) will drive the company’s future and its ability to gain users. These are the strategies Snap has used in the past, with some ventures working really well and others failing completely. Either way, they are necessary steps to continue to innovate and compete.

The good trend we’ve been seeing with Snap is that gross margins have been trending up. Snap is becoming more efficient in running its operations, maximizing its workforce and spending. GAAP gross margins came in at 61% last year, which is nearly double what they were in 2018 (32%).

If Snap can continue to grow sales and focus on efficient growth, with economies of scale making the process easier, I like the stock’s future. It has executed well in the past, and I believe its loyal app users are here to stay.

Snap’s debt had been rising into 2022 before the economy started to weaken. Since March 2022, the firm has started to address its sizable debt levels by paying off $60 million in the past 18 months. Most of its debt is now long-term, over the next 5-10 years, but it is always something to keep an eye on when a company has not yet shown signs of consistent profitability.

With Snap, we also want to keep an eye on shares outstanding, which are up 26% in the last 5 years. Management has been raising money/equity to help finance growth. I had no problem with this when the stock price was $60 or higher, but at $10 a share, I do not think diluting shareholders more is the right answer.

Overall, Snap is not perfect. It is still young and in its growth phase. It needs to take risks and spend money to continue growing and progressing. It is turning its focus toward profitability, and I believe these efforts will pay off. Ad spending will come back, and Snapchat+ seems like one of the ways it plans to monetize its platform.

Price Targets & Valuation

Snap is hard to value on a price-to-earnings (P/E) multiple because it is only non-GAAP profitable and has just started to be profitable. It currently trades at a crazy 142x 2023 P/E, but if it sees EPS grow as it hopes, that multiple will come down. On a 2024 forward EPS, the stock trades at 66x. Using the stock’s estimated valuation along with analyst estimates, we can create a next twelve-month (NTM) price target scenario table using both P/E and enterprise value to sales (EV/S).

The EV/S multiple has come down for Snap in the past few years and seems to have found a range that it is trading in for now. Our price target table shows us that the reward is big, but so is the risk when investing in Snap.

The risk-to-reward (R:R) ratio at $10 a share is not great at 2x, but the chance of 80% plus returns in our bull case is appealing to growth investors willing to take on some risk, as you can see above.

Investors should be aware that SNAP is down 88% from its all-time high (ATH), so a lot of risk has already been flushed out of the stock. The stock price has been consolidating between $8 and $12 a share, and I think under $10 is a great place for growth investors who use and believe in the app to park a sliver of money for growth. SNAP presents an interesting opportunity and should not be overlooked.

Risk

The first risk to address is the company’s lack of profitability in the past. When interest rates were close to zero, Snap could take on as much debt as it wanted to try to spark growth. Now, everyone cares about earnings and profitability, and that has caused Snap to cut spending and assess its decisions.

Ad spending also slowed, which did not help the company’s profitability levels. Ad spending tends to be cyclical, which will also affect sales and the stock. Depending on economic conditions, other companies will be more or less likely to spend on marketing. Snap is a great place to market with millions of users, but there have to be customers willing to spend.

The other risk to note is the wide range of competition that exists and could be created. Meta (META) created Threads to compete with X, and Snap made Spotlights to challenge Reels and TikTok. It’s all part of the game. When companies can secure millions of users to a platform, it’s just a matter of time before others copy the product and offer something new and better. This is why it will be crucial for Snap to continue to innovate and invest in its future.

The last risk to note is valuation. If profitability cannot grow at a high pace or Snap struggles to even stay profitable, the stock price will fall, and the multiple will contract, not in a good way. A 142x 2023 P/E is very expensive, and I am surprised that the price has even been holding up in this market. However, the fact that it has shown me that the market and people believe in and like this company.

Conclusion

As a daily user of Snapchat, I have no plans to stop using the app anytime soon. I know that hundreds of millions of other users feel the same way, and I expect management to continue monetizing the platform in the future. They have done a great job of keeping things fresh and offering new and seasonal options, and their latest hit, Snapchat+, already has 5 million paying users.

Cash has been used quickly for growth, both internally and through M&A, but the company needs to start generating more revenue through operations to continue growing and succeeding. The numbers show that people love the app, so the question is whether they can turn that into profits. I believe they can.

Users may not like it, but more ads and special features, like Snapchat+, will be coming. As a shareholder, I am okay with that. Snapchat has a unique hold on the younger generations, and I think that trend will continue. Don’t wait to miss the initial move higher in SNAP; start adding here under $10.