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Positive Free Cash Flow Is the Key to Future Success for SNAP Stock

Will Ashworth

As we enter 2020, one thing about Snap (NYSE:SNAP) has become crystal clear: If Snap generates positive free cash flow in 2020, you can be sure Snap stock will move into the $20s. 

Positive Free Cash Flow Is the Key to Future Success for SNAP Stock

Source: Ink Drop / Shutterstock.com

That said, with or without positive free cash flow, 2019 has been a transformational year for Snap, and not just because CEO Evan Spiegel became a French citizen. 

Say what? Evan Speigel is a French citizen?

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Apparently, Spiegel loves France. He became a naturalized citizen in 2018 through the country’s rarely used “Procedure for Granting Emeritus Status.” I guess it pays to be rich. I’m not sure France would accept my application, but that’s a subject for another day. 

I’m here to talk about Snap, not its CEO’s Francophilia.

Snap’s Growing into a Good Business

Although I’ve not been a fan of the Snapchat app, I’ve grown to like its business. 

In November 2017, I included SNAP stock in a group of sell recommendations:

“The social media company lost $443.2 million in the quarter from $207.9 million in revenue. It’s hard to understand anyone investing in a business whose revenues look like earnings and earnings look like revenues,” I wrote at the time. “Evan Spiegel and company have it all backwards.”

Fast forward to today. I’ve begrudgingly come to accept that Spiegel knows what he’s doing:

“In fact, for all the disappointment about revenue guidance for the fourth quarter, it’s hard to ignore that Snap could make money in the final quarter of the year,” I wrote this November.  

“Even though Snap lost momentum in 2018, I sense Evan Spiegel has figured out how to get more out of the business in terms of sales without spending more to get those sales. It’s critical it continues on this path if it wants to get to $20.”

Now trading within $4.65 of $20 as I write this, only a severe setback in its business model in 2020 would slow the stock’s momentum in the year ahead. 

That’s a night-and-day change in just 24 months. 

The Redesign Helps

InvestorPlace contributor Brad Moon, who happens to understand technology stocks better than I ever could, recently discussed why Evan Speigel’s 2017 Snapchat redesign was the right call

If you recall, the redesign was almost universally criticized by analysts and celebrities alike, sending the SNAP stock price lower while also losing sending millions of its Snapchat users to the exits.

As Brad reminds us, losses were mounting, yet Spiegel found the courage to zig when everyone was expecting him to zag, and in the process, put Snap on the pathway to profitability. 

Sure, it still lost $42 million (adjusted EBITDA) using the most attractive financial metric from Snap’s Q3 2019, but that was 69% lower than in the same period a year earlier. Further, its adjusted EBITDA loss for the first nine months fell 53% to $245 million. Go back to Q3 2017, and you’ll see that it lost $179 million in the quarter. 

So, its Q3 adjusted EBITDA loss for the last three years has gone from $179 million to $138 million to $42 million this past quarter. 

Any way you slice it, that’s real progress. 

Spiegel took the most significant chance of Snap’s relatively short life, and it’s paying off. User growth is up, losses are down, and it heads into 2020 with a swagger it hasn’t had in a long time.

That’s excellent news if you own Snapchat stock.

The Bottom Line on SNAP Stock

As I stated at the outset, the key to SNAP stock moving into the $20s and beyond in 2020, has to do with generating positive free cash flow.

Consider this.

In the nine months ended Sept. 30, Snap reduced its free cash flow usage by almost $400 million to $266 million, a 60% decline from last year. Sequentially, it decreased its free cash flow used in the third quarter by 18% to $84 million from $103 million in Q2 2019.  

Assuming it reduces its Q4 2019 free cash flow used by 18% sequentially, it will come in around $69 million, less than half the amount it used in Q4 2018.

More importantly, it will finish 2019 with a negative free cash flow of $335 million, 59% lower than in 2018.

I don’t know if it can deliver positive free cash flow in 2020, but what I do know is that should it be successful, I can virtually guarantee SNAP stock will higher this time next year. 

In 2020, I’d watch free cash flow used like a hawk.

At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.

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