11 May 2017

Snap Inc. - Price of opposition

Twitter is in a better position

Twitter is in a better position. A poor set of maiden results highlights that Twitter is actually in a better position because although it is stuck in a niche, it remains unopposed in that niche. Management even had the temerity to laugh off the threat from its much larger and far more powerful rival, Facebook, which is successfully replicating Snap’s innovations to great effect. Q1 17A revenues and adj-EBITDA were $149.6m / LOSS$188.2m slightly below consensus at $158m / LOSS$180m. User numbers also disappointed with 166m daily active users (DaU) compared to consensus at $168m. This is not nearly good enough for a company valued at 31x 2017 EV/Sales which triggered a 23% decline in after-hours trading. The company also burned $155m in cash from operations.

Commentators are already drawing the comparison to Twitter, but this comparison does not go far enough. Twitter is stuck in a niche that it has fully monetised and its attempts to branch out into video are faltering. This means that its outlook for growth remains very bleak. However, in the Digital Life Pie segment of microblogging and related messaging, there is no opposition. This means that once it stops spending money in trying to grow, it should make good but static returns from monetising that niche.

Snap Inc on the other hand still has plenty of growth ahead of it but its core business competes head to head with Facebook’s dominant properties of Messenger, WhatsApp and Instagram. This is where the problems begin as Facebook can easily afford to outspend Snap in every instance and has 7.8x more DaUs than Snap does. Both of these businesses are network based where there is an exponential relationship between the value that can be created and the number of connections that the network has. Furthermore, to continue its growth, Snap has to monetise outside of USA as its US ARPU already looks full at $1.81. Outside of the US the relative strength between Facebook and Snap Inc. is even more in Facebook’s favour making Snap Inc.’s task all the more difficult.

These results were bad because the company has a very high valuation and then missed expectations rather than anything in particular going wrong. However, Facebook’s announcements and the intentions that it made clear at F8 are a concern. Consequently, we see no reason to change our position on Snap Inc.’s fundamental outlook or our valuation of $15.4bn or $16 per share in a blue-sky scenario. Given the increasing risks involved, we would not consider buying until the shares were meaningfully below this value. Between the two, Twitter is the better long term investment but given the choice, we would not have either.

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