Snapchat Enters the Maturity Phase of the App Life-Cycle

Snap Inc. (SNAP, Financial), the creator of Snapchat, posted unappealing earnings during the first quarter of 2018, missing the top-line consensus.

Revenue grew 54.1% to reach $230.7 million, which was $12.8 million shy of analysts’ consensus. Snapchat posted a loss of 17 cents per share, which was in-line with analyst estimates. Ebitda plunged from -$188.2 million to -$217.9 million on a year-over-year basis. Analysts were expecting an Ebitda loss of $199 million.

The company ended the quarter with 191 million daily active users (DAUs), up 15% year-over-year and 2% sequentially. The street is not impressed as the stock is down a startling 20% in the earnings aftermath.

Sequential growth remains a problem

Active user growth is slowing down for Snapchat. The company posted a mere 2% DAU increase during the first quarter of 2017.

It can be seen that Snapchat has been struggling with user growth since the second quarter of 2016. During the last two years, the company managed to add only 50 million daily active users. This doesn’t bode well for the company given it is faced with stiff competition from Instagram. In short, the app life cycle has entered the maturity phase. Just look at the incremental user additions during the last few years.

Source: SEC filings Snap Inc.

After reaching an all-time high during the second quarter of 2016, DAU additions are on a constant decline. In fact, the DAUs addition during the first quarter of 2018 was the lowest of the last four years. As total active users stand at around 191 million, Snapchat isn’t expected to surpass Instagram anytime soon. As of year-end 2017, Instagram had 500 million daily active users on its platform.

Due to a slowdown in user growth, revenue growth is also taking a hit. The company grew its revenue by 54% during the current quarter as compared to an astonishing year-over-year growth of 285% during the same quarter last year. In short, the slowdown in revenue growth is quite notable. Moreover, incremental revenue also tells the tale of maturing app life cycle.

Except in the fourth quarter of 2017, the incremental revenue was flat, or showed a decline since 2016. During the most recent quarter, revenue declined by around $55 million compared to a near $20 million decline during the first quarter of 2017. The continuous decline in incremental revenue indicates that the app has entered the maturity phase of its life cycle.

Overall, slowdown in active user growth alongside declining incremental revenue paints a bleak picture for Snapchat. Given Instagram is keeping Snapchat on its heels, performance will probably deteriorate further going forward.

Instagram continues to challenge Snapchat’s going concern

Instagram has more than 500 million daily active users, up from just 150 million since the start of 2017. While Instagram continues to post serious growth, Snapchat is facing hard times in touching the 200-million subscriber mark. According to Omnicore, Instagram is expected to generate around $1.5 billion in mobile advertising sales this year and $5 billion in 2018. On the other hand, analysts expect Snapchat to add $1.3 billion to the top line during 2018. “Over the next five years, we're focused on building out the business ecosystems around our apps like Instagram, WhatsApp and Messenger,” noted Mark Zuckerberg during the earnings call. Facebook’s (FB, Financial) focus on Instagram isn’t good news for Snapchat.

Is there refuge in valuation?

Despite shedding 21% of its market cap in reaction to earnings, Snapchat is trading at around 8 times 2018 revenue. In contrast, Facebook is trading at a forward price-sales of around 9. Note that Facebook supports more than 1.5 billion active users compared to Snapchat’s minuscule user base of 191 million. Assuming a $49 billion valuation for Instagram, the app is trading at 9.8 of expected 2018 earnings. An approximate 8 times forward sales seems to be a stretch for Snapchat as growth prospects of Snapchat are in extreme disconnect from Instagram’s prospects. All in all, a high price-salesratio is not justified for Snapchat.

What if Snapchat replicates Instagram’s growth?

Assuming Snapchat replicates the growth of Instagram and generates comparable margin, the stock reveals an upside.

Notes to the table: Instagram’s value is based on revenue of $5 billion during 2019 and 20% p.a. growth for the next five years. Margin is assumed at 38%. A discount factor of 8% is applied. One percent growth is assumed in perpetuity.

Relative valuation reveals an upside of 31% over today’s stock price. The bottom line is that there’s an upside to Snapchat if you think that the company can replicate the growth of Facebook’s Instagram. Otherwise, avoid the temptation of buying on today’s decline.

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