As with a lot of technology companies, Snap Inc. (SNAP, Financial) may be a takeover target. Each day, some 363 million people use Snapchat to send disappearing photos and videos; however, it is unlikely it will ever be the leader in its industry.
For that matter, if it does not either find a buyer or figure out how to book a profit, it could end up dead money for investors.
2022 has not been good for Snap
The company’s share price has been pummeled over the last year, falling from $40 a share to around the $9 level currently.
It remains low after a significant drop following the release of Snap's third-quarter results in October, which showed higher revenue and lower earnings. Revenue growth also slowed during the quarter due to a decrease in advertising demand. So while sales exceeded analysts' expectations, management did not provide guidance for the fourth quarter.
The company also recorded a net loss of $359.5 million, a 22% year-over-year decrease in operating cash flow and a 65% drop in free cash flow to $18 million. During the three months ended Sept. 30, Snap's revenue increased 6% year over year to $1.1 billion, primarily through advertising. However, decreased advertiser demand and increased competition in the industry have impacted the top line.
In the near future, companies looking to reduce costs may decrease their advertising budgets, which could negatively impact Snap's revenue. However, the company did see a 19% increase in the number of daily active users to 363 million.
That is not horrible considering Meta Platforms' (META, Financial) Facebook has about 1.2 billion DAUs. Based on that alone, there is a case for Snap to be worth significantly more. Further, since Snapchat has about 120 million more daily active users than Twitter, and it is harder to produce bot content on the platform, the company at the very least could be worth $45 billion, which is about 3 times higher than its current market capitalization.
On the downside, average revenue per user declined to $3.11 from $3.49 in the previous year. Snap's earnings also worsened from a loss of 5 cents per share to a loss of 22 cents per share year over year. Research and development expenses increased 37% to $564.3 million, driven by higher personnel expenses due to growth in the research and development team and restructuring charges related to the company's strategic reprioritization plan. That being said, management announced in August it plans to lay off around 20% of its employees.
Struggling to grow
Created by former Stanford University students Evan Spiegel, Bobby Murphy and Reggie Brown, Snapchat was first introduced in 2012 and was exclusively available on iOS devices. Today, Murphy and Spiegel jointly own about a quarter of Snap, but have voting shares that give them control over the board.
Although the service has since become available on other devices, the company has failed to show meaningful growth and has yet to book an annual profit. With over 360 million people using the app daily, it should be able to do so with the right guidance from the top. As such, it seems unlikely that Snapchat will ever overtake Facebook or Instagram (not to mention TikTok).
As a result, it is time for the founders to get out while there is still value left and let another company either hold the bag or make the most of the user base.
Who could be a buyer?
I appreciate the idea of not selling while the market is down and facing a recession; however, there are still plenty of tech companies that are overvalued even as they are down 50% or more in 2022. Snap is not one of them. It is more of a target because of that, in my opinion. I certainly do not think it needs three to four times more users to be profitable. According to Pew, people are coming back to Snapchat more than Instagram, YouTube or Twitter, all of which have tried to copy its short-video format with varying degrees of success.
The $15 billion price tag is not really ripe for an all-cash buyout with only two companies having the cash to do so. Meta Platforms tried to acquire it for $3 billion years ago when it was much smaller. It would make sense for Mark Zuckerberg to revisit the public equity even if Instagram is trying to do the same thing with its Stories.
Google parent Alphabet Inc. (GOOG, Financial) also has the cash hoard to complete the deal without giving up stock. Even though it failed with its own social network, Snap could be a nice platform to bring in and add to its creator network.
The bottom line: Market forces are working for Snap
The digital advertising market is expected to grow at a compound annual rate of 15% or more, driven by the rapid growth of video ads on mobile devices. Snap should be a sizable platform for money to flow into, but with 5,600 employees and $3.9 billion spent on operating expenses, it could be profitable in one of two ways.
The first is to cut research and development costs, which, at $1.9 billion, are 42% of its revenue. Meta spends 27% on this same area and it is building an entire metaverse! The second option is to curb selling, general and administrative expenses. At $2 billion, they account for 44% of Snap's revenue. In comparison, Meta's SG&A costs consist of 23% of revenue. Therefore, it seems all Snap needs to do to become profitabile is to become as lean as its competition.
Only time will tell if the headcount reduction will boost profitability or if the need for billions to be spent on R&D is even necessary. Contrary to what some believe, I think Snap is undervalued at these levels. It is not as though growth has reversed, so maybe the cofounders can get out of startup mode and shift into profit mode.
