There's certainly nothing pleasing about Snap Inc.'s (NYSE:SNAP) share performance these days.
Since the company announced its first quarter earnings at the beginning of May, its stock has taken a dive, falling 33%, taking with it all the optimism that followed the previous quarter's earnings call, when the company surpassed analyst revenue estimates for the first time in its five-quarter history.
What then might the future hold for this operator of the Snapchat app, a popular video sharing platform among teenagers and the celebrities they follow? Unfortunately, the forecast doesn’t look very bright, not even after a plunge of such magnitude. Though some analysts are calling a bottom for the stock, we think Snap isn't a buy—even at under $10 a share. Here's why:
1. No Path to Profitability
It was never easy for analysts to accurately understand what Snapchat’s revenue model is, nor to discern how the company was going to become a successful social media platform without aggressively pursuing mass market users—the very path Facebook (NASDAQ:FB), Google (NASDAQ:GOOGL) and other internet giants had already followed.
When it IPO'd last year, analysts expected SNAP to generate $2 billion in revenue in 2018. However after one year, it’s become apparent that the company has a flawed business model; as well, it isn't in any way near to achieving the revenue number the market expected.
According to an average of analyst estimates, Snap won’t even reach that target by 2019. The company’s most recent earnings report shows there's a lot that's going wrong. For Q1 2018, the company reported the broadest losses, on both an EBITDA and free-cash-flow basis, out of the past five quarters. Its adjusted EBITDA loss widened to $218 million from $188 million a year ago. Free cash flow was even worse, dropping to negative $268 million from $173 million in the same period a year ago.
This bloodbath was happening at a time that Snap was busy rewarding its executives with generous packages. For the quarter, Snap paid out a whopping $133 million in stock-based compensation.
The biggest challenge for Snapchat is to maintain a healthy increase in the number of daily users each quarter. But that task looks impossible when its loyal users aren’t liking the changes Snapchat has been making to keep its app alive, never mind competitive.
Snapchat’s recent redesign was a disaster. It was disliked by both general users and celebrities. It sank ad views and revenue and led Snapchat’s user count to actually shrink in March. That’s why CEO Evan Spiegel recently announced a big reversal of the redesign’s worst parts.
2. Facebook Threat
For long-term investors, it makes sense to invest in companies which have a wide economic moat, a term coined by Warren Buffett to describe the competitive power of businesses that have a strong barrier from encroachment by rivals in their backyard. Snapchat doesn’t have a moat with which to defend itself against the social media behemoth that currently overshadows it—the big adversary known as Facebook (NASDAQ:FB).
Facebook's Instagram app, with 800 million active monthly users, is an existential threat to Snapchat, no matter how quickly the smaller company might be able to turn things around. Facebook Stories, which is an exact replica of one of Snapchat's bread-and-butter features, has reached 150 million daily active users. That's a number big enough for Facebook to start monetizing that growth. Worse still, beginning this month, Facebook Stories began testing its first ads on the Instagram platform in the U.S., Mexico and Brazil.
Facebook is also savvy enough not to want to repeat the mistake that Snapchat made: it’s bringing future engagement growth for its Stories from the global market that Snapchat chose to neglect for four years. With $44 billion in cash sitting in its bank account, Facebook has deep enough pockets to wait things out and let Snapchat slowly bleed its cash.
The Bottom Line
Currently trading at $10.65 as of last night's close, Snap shares have started looking attractive to many analysts who believe the company is making a variety of efforts to turn things around, including reversing some of its redesign features, shifting to a programmatic advertising model, launching a new Android app, and reorganizing for a leaner organizational structure.
Nevertheless, we think Snap stock is still expensive at 12 times 2018 sales. In the bigger picture, there's nothing to suggest the company will be out of woods anytime soon, particularly when it has a long, tough battle ahead with a much bigger rival, Facebook.
Investors are better off avoiding this falling knife. It's too difficult—if not impossible—to catch.