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Snap Inc (SNAP) Stock Has Two More Big Problems

Vince Martin

I don’t have the same animus for Snap Inc (NYSE:SNAP) stock that some investors appear to. I do think Snap Inc stock is overvalued, to be sure. But I also think Snap has been the victim of unfair expectations, and I can see the outlines of a bull case for SNAP stock.

snap inc stock

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At the end of the day, SNAP stock was priced too high at the time of its IPO. That’s not the fault of Snap Inc, which should have raised as much money as possible in that offering. Nor is it the sign of some second dot-com bubble in the market. There is an intriguing growth story here, with Snapchat growing users and Snap finance metrics improving as the company learns how to monetize those users.
But one problem with Snap Inc stock, even now, is that I’m not convinced that growth story is worth ~$15 billion. And the second problem is that both aspects of the SNAP stock story are coming under increasing pressure.

Snapchat Users and SNAP Inc Stock

Snap Inc stock isn’t going to gain in value unless Snapchat grows its user base. The company can improve revenue of existing users, particularly overseas. And as I pointed out back in May, on a per-user basis, SNAP stock actually isn’t that overvalued. Social gaming provider Zynga Inc (NASDAQ:ZNGA) has a similar valuation. And that company is functionally unprofitable (when accounting for stock dilution) and growing at a modest rate. (I also think ZNGA is a strong sell, but that’s a different article.)

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But it’s obvious that one of the key problems with Snap Inc stock post-IPO has been slowing user growth. That deceleration actually started in Q4, according to the company’s S-1 filing. Users grew just 4% sequentially in Q2, which appears to be Snapchat’s lowest rate ever. And there’s reason to see that figure getting worse going forward.

After a report in August suggested Snapchat might be taking users from Facebook Inc (NASDAQ:FB), SNAP stock gained 6%. But I was skeptical of that argument at the time, and it looks even worse now. It’s not Facebook that Snap Inc has to worry about; it’s Instagram.

Instagram is gaining more new users than Snapchat. It now has almost triple the daily active users. Clearly, the efforts made by Facebook and Instagram to mimic Snapchat features are working. And they’re having a deleterious impact on Snapchat’s user growth.

That’s a huge problem for Snap Inc stock. Again, the company can grow revenue simply by monetizing existing users and maybe even hit profitability that way. But, again, this is a company valued at roughly $15 billion plus its net cash. It is not supporting that valuation with something close to zero user growth. And it’s going to have a hard time driving that growth if Instagram is better succeeding in Snapchat’s core demographic.

Snap Finance Metrics Depend on Monetization

Adding to the problem is the fact that Snap Inc continues to struggle in monetizing those users through advertisements. I’ve counseled patience on this front in the past, and still do. It’s easy to forget after all, that the company is barely six years old and only a couple of years removed from being an app used primarily for ‘sexting’.

But even giving credit for growing pains, it’s looking like SNAP is falling behind. Industry research firm eMarketer has pulled down its projection for Snapchat advertising revenue this year by 14%. Snapchat simply isn’t finding a niche in a space dominated by Facebook and Alphabet Inc (NASDAQ:GOOGL).

The ‘dancing hot dog’ from this year has opened up some opportunities, though I agree with my fellow contributor Laura Hoy, who wrote this week that hot dogs simply aren’t enough. Snapchat ad sales simply need to get better, and it’s not happening quickly enough.

Snap Inc Stock Is Overvalued

So the problem for SNAP stock, even as it has stabilized over the past few months, is clear. To create the growth and profitability needed for upside, Snap Inc needs both user growth and vastly improved monetization. To support the stock, it needs at least one (and even that probably isn’t enough).

Right now, it looks like Snap Inc has neither. And that’s a big problem. As weak as the SNAP stock chart looks, this is still a company valued more highly than Twitter Inc (NYSE:TWTR). Given that Snap has most of the same problems, that could change. If it does, Snap Inc stock has 30% downside or worse.

As of this writing, Vince Martin has no positions in any securities mentioned.

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