Snapchat Snapped - Is There More to Come?

As envisaged in a previous piece, Snap Inc.'s (SNAP, Financial) fundamentally wrong valuation and overhyped expectations led to an after-hour crash in the stock price. The Snapchat creator lost around 22.5% of its market value in after-hours trading after disappointing but rather realistic earnings results. It took a single earnings report for the market to acknowledge the inefficient pricing of Snap. Anyway, the real question is did the company hit rock bottom?

Sequential decline in revenue

Snap reported revenue of $149.6 million during the first quarter of 2017, translating into an astonishing growth of 286% on a year-over-year basis. Analysts are expecting revenue in excess of $1 billion for the full year of 2017, which should translate into $257.5 million per quarter. Growth in daily active users along with an increased average revenue per user resulted in higher revenue. The company has to show consistent growth going forward in order to meet that target. What is surprising is the revenue declined sequentially, which is not good for a company that is banking purely on growth. Snap’s revenue declined from $166 million in fourth-quarter 2016 to $150 million in first-quarter 2017, as shown in the chart below:

Revenue, Earnings Presentation first-quarter 2017

Regarding the bottom line, Snap reported a loss of $2.31, which is not comparable to the consensus loss of 19 cents. According to Yahoo Finance, the company missed the consensus by one cent on comparable basis. Excluding the share-based compensation of $2 billion, loss still amounts to 22 cents per share. Administrative expenses were 48 times higher compared to the same quarter last year, which explains the huge loss.

Key metric - Single-digit growth?Â

Daily active users increased from 122 million to 166 million on a year-over-year basis. What is alarming is the company only managed to grow its DAUs at 5% sequentially. As the industry is not cyclical, single-digit sequential growth indicates stiff competition from Facebook's (FB, Financial) Instagram and other platforms. Snap's 166 million DAUs is not impressive given the fact WhatsApp status has around 175 million DAUs, which was launched just months ago. Instagram stories stands at around 200 million DAUs. Facebook CEO Mark Zuckerberg pointed toward DAUs during its latest earnings call.

“Instagram Stories now has more than 200 million daily active people using it. And just a couple months after we launched it, WhatsApp Status has more than 175 million daily active people using it.”

Overall, competition is ahead of Snapchat in terms of reach and visibility. Active users is one of the critical success factors for internet companies. Facebook is beating Snapchat on all ends with its Status, Stories and Days. This is reflected in Snap’s sequential decline in revenue and slowing user growth.

Revised valuation

As active users are a key to attract advertisers, a valuation based on this metric is rational. The valuation that follows is based on a multiple derived from Instagram’s daily and monthly active users. Instagram’s value was calculated using the EVA model that revealed a value of around $38 billion, details about Instagram’s value can be provided on request. Instagram’s MAUs and DAUs are assumed to be 700 million and 450 million respectively.

Focus Equity Estimates

Based on an Instagram-like multiple for valuation, things do not look so good for Snapchat. The value of Snap based on daily active users and monthly active users is around $13.8 billion and $9.77 billion dollars respectively, which is well below the market value after the current drop. The $13.8 billion translates into a price target of $11.77. Note that value of Instagram relative to active users is used as a proxy for Snapchat’s valuation. This is an optimistic proxy given Instagram’s seasoned management.

Final thoughts

Snap struggled to post meaningful sequential revenue growth along with single-digit active user growth. The top line appears to be healthy on a year-over-year basis, but internet software, or apps, follow a life cycle that is not cyclical; it grows exponentially at inception, but the growth phases out eventually. Hence, single-digit sequential growth is alarming for Snapchat. Further, the valuation does not look good on a relative basis. All in all, investors should stay away from Snap.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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