Editors' pick: Originally published March 10.
In the wake of Snap's (SNAP - Get Report) highly-anticipated IPO, a big part of the fledgling social media company's ability to convince Wall Street investors it will eventually become profitable rests on its ability to kickstart its sluggish user growth.
Snap saw a significant slowdown in its daily active users (DAUs) in the fourth quarter of 2016, which analysts have attributed in part to the delayed impact of Facebook's (FB - Get Report) copycat Instagram Stories. The Venice, CA-based company likely saw its user growth declines continue in the first quarter, while Instagram's DAU growth was almost double that of Snapchat's so far in the same period, said Aegis Capital analyst Victor Anthony.
Shares of Snap were falling 1.4% to $22.39 on Friday afternoon and have had an up-and-down week after rising strongly in its debut last week.
But the data may even be worse than expected: App tracking data shows that Snap's DAU growth is "weak" in most major developed countries, including the U.S., Canada, the U.K. and South Korea. Russia and Germany were the only countries where DAU growth seemed to be strong in the first quarter, Anthony noted. Instagram, meanwhile, has demonstrated solid user growth in most developed markets.
"Snap's model depends almost entirely on its ability to increase its average revenue per user in the developed markets...which constitute the super majority of worldwide mobile advertising spend, ex-China," Anthony explained.
Snap needs to "invest aggressively" in product innovation to drive user growth lest it sputter and slowly crumble like Twitter (TWTR - Get Report) seems to be, or worse, become "irrelevant" like Tumblr, Anthony said.
"Tumblr has been rendered largely irrelevant in the social media game," Anthony added. "A lot of that is a result of Yahoo! (YHOO) having execution issues and monetizing the site."
Yahoo purchased the microblogging site for $1.1 billion in 2013 and Tumblr has been relatively stagnant ever since. Yahoo CEO Marissa Mayer became distracted from Tumblr as she tried to "right the ship" of the internet company's other core assets and, as a result, Tumblr has quietly faded into the shadows behind other, more popular social media platforms, Anthony noted.
Tumblr had about 23.2 million users in 2016, which is less than a third of Instagram's 89.4 million users, according to eMarketer.
If Snapchat experiences a severe drop off in users, it would probably still continue to exist, but people wouldn't use the app with the same frequency as they do now, Anthony said.
"Twitter has this issue but it still has a core user base. There's no real substitute for Twitter right now," he noted. "If [Snap] doesn't innovate and keep people on the app, they're at risk of people fleeing from the platform."
This threat becomes even more relevant when looking at Snap's ad revenue prospects.
Experts have said that Snap revolutionized the way that advertisements are presented on mobile platforms with the introduction of vertical video, but Facebook "brazenly" copied that feature when it added vertical video ads to Instagram Stories in January and, so far, it has seen strong demand from large advertising brands, Anthony said.
"If Snap is unable to reaccelerate its user growth, advertisers will likely seek out alternative platforms where growth remains robust, such as Instagram, which benefits from Facebook's targeting abilities," Anthony added.