It’s difficult to be bullish on Snap's (NYSE:SNAP) stock. Shares of the social media company that developed and maintains the Snapchat messaging app, which is hugely popular among teenagers and the celebrities they follow, seem to be stuck in the mud.
After all the positive coverage the company received prior to its IPO in early March 2017, when it began trading at $17 per share, the stock initially rose, but then began slipping lower over the longer term. Renewed expectations after the company blew past analysts’ forecast for the fourth quarter of 2017 back in February have also dimmed, and SNAP shares are back down and heading lower.
The biggest question we have ahead of the company’s first quarter earnings report on May 1 is whether Snap will be able to emulate the path of its biggest rival, Facebook (NASDAQ:FB), and crush expectations quarter after quarter.
There are two major risks for Snap: one is the redesign of its app which hasn’t gotten favorable reviews. The second—which is not Snap-specific but does have implications for the app—is the possibility of regulatory actions against the social media companies in order to prevent the future misuse of user data after the Facebook / Cambridge Analytica fiasco.
These risks are reflected in the stock's recent performance. It plunged as much as 8% on April 25 on the news the company was altering Snapchat's not-very-well-received redesign. The updated redesign will mix user and celebrity, brand and publisher stories together, similar to how the app functioned before the recent tweak.
Our view is that it won't be a straight-line journey for Snapchat. When it comes to the viability of its platform to generate a consistent revenue stream, Snap is still in its trial-and-test phase. Investors, on the other hand, are not sure whether Snapchat's prospects are still the same as they were when it first IPO'd: a strongly hopeful but with a reasonable level of underlying fear. It's difficult to know yet if the company has turned the corner in any meaningful way.
Tuesday's Q1 2018 report should provide some insight on which way the wind is blowing. The biggest challenge for Snap is to continue with the kind of daily active user growth reported for the fourth quarter. Snapchat ended that quarter with 187 million daily active users, up 18% from the same quarter a year ago and ahead of the 184.3 million analysts estimated. A number close to 200 million will send a very positive signal, triggering another short-term rally for Snap shares.
The other key performance metrics for Snap are to show investors that its advertising revenue is strong enough to improve gross margins which have been extremely low when compared to other technology companies that went through the same cycle of growth. During the last quarter, that ratio was a record 33%, a huge turnaround from the negative 1% in the third quarter and just 16% in the previous period.
We remain highly skeptical of Snap’s short-term prospects and its revenue potential. There is no doubt that the company is trying hard to improve its platform and attract additional ad revenue, but this is happening at a time when the operating environment for social media companies has deteriorated amid global regulatory scrutiny.
For Snap, snatching ad dollars from its much bigger competitors Facebook and Alphabet (NASDAQ:GOOGL) is a steep uphill climb. It’s better to stay on the sidelines right now and avoid this highly speculative stock. Snap still has a lot to prove.
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