Before doing any research on the Q3 results of Snap (SNAP), an investor needs to absorb that the $34 stock (initial after-hours trading) has a market valuation of $55 billion based on 1,624 million shares outstanding. The company had a blowout revenue quarter as analysts failed to fully appreciate the rebound in ad demand as the economy improved during Q3. My investment thesis remains negative on the stock due to a scary valuation and engagement trailing that of competitors.
Image Source: Snap website
Despite an economic shutdown where users all around the world were forced to stay at home, Snap only generated 18% daily active users (DAUs) growth to 249 million. Snapchat is back to consistent growth, but the social site didn’t see blowout engagement numbers, with Snaps created on a daily basis only up 25%.
DAUs were up 11 million sequentially to 249 million. The amount just matches the sequential growth during Q1, when Snap saw DAUs grow from 218 million to 229 million. Even worse, all of the user growth was from the ROW, with quarterly sequential growth of 10 million to 87 million, up from 77 million DAUs in Q2.
Source: Snap Q3’20 presentation
The stock is surging over 20% due to the massive revenue beat. The big revenue beat was due to Snap growing North America ARPU to $5.49 from $3.75 last Q3. The North America ARPU surged 46% in the quarter, leading to 52% revenue growth.
Source: Snap Q3’20 presentation
The revenue growth has absolutely nothing to do with an expanded user base and everything to do with ARPU growth. The company got $1.74 per user in additional revenue over last Q3 and up an incredible $2.09 from the prior quarter. The 90 million North America DAUs contributed $157 million additional revenues this Q3, with additional ARPU growth in Europe contributing $27 million more revenue.
The stock is definitely a story based on growing monetization, but these stocks ultimately grow based on engagement, and Snapchat didn’t generate the engagement growth one would’ve thought during the best environment in the company’s history. One can only think TikTok is taking time away from Snap.
Regardless, the company generated an impressive Q3 revenue total of $679 million. The COVID-19 impact to Q2 revenues makes the quarterly results difficult to analyze. The revenue total is about $120 million higher than the previous Snap record of $561 million back in Q1. The company didn’t provide Q4 guidance, leaving the market in the dark as to whether these numbers are repeatable going forward or whether some advertisers had catch-up ad spending during the quarter after a weak Q2.
Despite these positive revenues, Snap still managed to burn free cash flow at a rate of $70 million in the quarter. The company even reported an insane GAAP loss of $200 million. A main issue remains stock-based compensation, which pushed the diluted share count up by 59 million shares over last year to 1,624 million shares now.
A lot of stocks are difficult to value in this environment, with ad spending and engagement warped due to COVID-19 impacts. Snap now trades as if the engagement levels from Q2/Q3 will grow going forward, while the likely outcome is a period of tough comps in 2021. With a vaccine and better virus treatments, the global economy is unlikely to see a repeat of shelter-at-home requirements next year, thereby reducing engagement of most users.
The stock is now priced for perfection based on engagement and sales growth next year matching this year. Snap trades an incredible valuation of 16.5x forward revenues. Even if 2021 revenue forecasts surge to $3.5 billion, up from $3.04 billion current estimates, the stock trades at 15.7x those boosted estimates.
Snap has now disconnected with all of the other social media stocks. Pinterest (PINS) is the closest in valuation at 14.5x forward revenue estimates, while both Facebook (FB) and Twitter (TWTR) still trade below 10.0x estimates.
The crazy part here is that Pinterest grew users by a far faster clip at 39% in Q2, with MAUs surging to 416 million. If anything, Pinterest has far higher upside potential with global ARPU at only $0.70, while Snap is up at $2.73 already.
The key investor takeaway is Snap now has a scary valuation. The stock no longer has the best engagement in the sector, and revenues will eventually follow engagement with other sector players playing catch-up on the monetization side. Investors should use the after-hours surge to sell the stock.
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Disclosure: I am/we are long TWTR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.