Snap's (SNAP) shares have been on a tear since the start of the year, up almost 85%. That increase has handily outpaced the performance S&P500 and the Nasdaq over the same time period, as well as that of most of its peers, including Facebook (FB) which is up roughly 40% year to date.
And while Snap has more going for it than it might at first glance appear to, I nevertheless argue that investors are better off avoiding this investment as its current valuation leaves no upside potential.
Reaching The Hard To Reach
Snap's revenue during Q1 2019 was up strongly at 39% year-over-year. However, despite this strong revenue growth, the pace of revenue growth continues to decelerate at a rapid pace.
Specifically, Snap finished 2017 up 104% while for 2018 its revenue finished up 43%. While an increase of 39% in a single quarter seems impressive, if we compare with how it was performing just 18 months ago, it starts to appear to some investors that Snap is potentially just a fad, which in time might fade away.
Management is certainly cognizant of this perception. Hence, Snap is attempting to persuade investors that although its Daily Active Users (DAUs) is flat year-over-year, they should not be overly concerned, since Snap's average revenue per user (ARPU) is up 39% year-over-year. It also emphasizes that its ARPU growth is not reliant on the United States, because, in fact, Snap's ARPU metrics globally are performing incredibly well.
Next, Snap highlights to investors how it reaches 75% of all 13-to-34 year-olds in the United States, with stronger penetration in this cohort than Facebook's Instagram. Having said that, Snap is not shy about noting that its long-term opportunity is reliant on keeping its fickle user base engaged.
Snap's whole business model is contingent on being able to reach Millennials and Gen Z who might otherwise be challenging to reach. To that end, Snap continues to build on the success of its Snap Originals content. What's more, Snap believes that Millennials and Gen Z respond better to short-form video and other mobile experiences over desktop and television. Thus, Snap is working closely with advertising partners to help brands target these consumers where they spend a large portion of their time.
Accordingly, on the surface Snap's business model has strong elements which are gaining traction. But when we dig deeper, it is not all rosy.
Bottom Line Improvements?
Snap spends a lot of time highlighting to investors the progress it continues to make on the bottom line. For instance, it highlighted during this most recent earnings call that this is the second consecutive quarter where more than 100% of its incremental year-over-year revenue flowed through to its bottom line -- which sounds impressive.
The problem, though, is that despite making strong progress here, ultimately investors are clamoring for a company which fails to generate any cash flows. On the other hand, one could argue that it's only a matter of time before Snap becomes free cash flow positive.
Valuation - No Margin Of Safety
Snap's Q2 2019 mid-point guidance points towards Snap's top-line growth hovering around the low 30 percent year-over-year mark. Consequently, for now, it appears that investors are willing to grant a $14-billion market cap to a company whose revenue growth rate is nowhere near as strong as this time last year.
And as we can see in the table above, while its peers are all trading with subdued multiples compared with their historical valuations, both on a cash flow and revenue basis, Snap is the only one which continues to trade with excessive positive investor sentiment, leaving new shareholders with little to no upside potential.
The Bottom Line
Snap offers investors a lot of promise. There is no question that its platform continues to be highly engaging and resonate well with its key audiences. The problem for investors is that shareholders are not likely to be better off by deploying their savings into Snap at its present valuation.