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Snap - disappointment despite revenue growth

Nicholas Hyett, Equity Analyst | 5 February 2020 | A A A
Snap - disappointment despite revenue growth

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Snap Inc USD0.00001 A

Sell: 78.98 | Buy: 79.04 | Change 2.96 (3.89%)
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Revenues of $561m in the fourth quarter were broadly in line with market expectations, rising 44% year-on-year. Adjusted cash profits moved into positive territory for the first time reaching $42m.

However, at a reported level the group remains heavily loss making, at -$240.7m. That's largely down to $166.7m of share based compensation for staff and a $100m settlement relating to the group's IPO.

The shares fell 9.1% in premarket trading.

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Our view

Snap is an advertising driven social media business. That means picking-up new users, keeping those users engaged for longer and ultimately attracting advertising dollars is the order of the day.

Increasingly advanced launched filters and lenses allow users to animate and annotate images. It might sound simple, but with 218m people around the world using the app every day, it's also hugely popular.

Facebook has proven how profitable advertising-driven social media can be, and since most users are in the valuable 18-34 age group, Snapchat is potentially very attractive for marketing teams. As an audience, millennials are harder to reach through conventional mass media like television and newspapers.

However, for Snap to follow in Facebook's footsteps, it'll need to prove it's more than just a filter-filled gimmick.

The group's investing heavily in improving the quality and duration of user engagement. Short form TV content looks to have been a success, ranging from news to dramas - think Netflix for those without the required attention span. It's still early days, but original content seems to be doing well and creates advertising opportunities while snapchat based games are also looking promising. It helps that a revamped Android App is improving user experience for millions of users.

It's not just users that are getting some TLC either. The groups invested heavily in increasing the functionality for advertisers. Together with a larger user base that will have contributed to the impressive revenue per user growth of late.

Unfortunately developments a little further down the financial statements are less positive. Adjusted cash profits turned positive for the first time in the last quarter of 2019, but that excludes some very real costs - not least $686m of share based remuneration and a £100m settlement relating to its IPO. Include that cost and Snap's still some way off translating revenue growth into bottom line profits and dividends.

It doesn't help that free cash flow is stubbornly negative. That may not seem like an urgent problem, given the $1bn+ cash pile, but the current burn rate of $340m a year can't be sustained indefinitely.

As with most digital businesses scale is key; if its largely fixed costs can be spread over a growing number of customers, losses should fall. However, since user growth is both important and very difficult to forecast, we fancy Snap will experience more volatility going forwards.

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Fourth quarter results

Revenue growth reflects additional users, with Daily Active Users (DAUs) up 17% year-on-year to 218m, and improved Average Revenue Per User (ARPU) which now stands at $2.58 a quarter.

ARPU growth was driven by Commercial revenue more than tripling year-on-year while Story Ad revenue more than doubled. McDonald's and Coca-Cola have signed up as the group's first brand partners for its recently launched Scan technology, which recognises logos and provides related augmented reality experiences.

Free cash remains substantially negative and came in some way behind market expectations at -$75.9m. As a result net cash fell from 11.5% compared to September 2019, to $1.2bn.

Snap expects revenues in the first quarter of 2020 to be between $450m and $470m, compared to $320m in Q1. Underlying cash losses in the quarter are expected to be between $90m and $70m.

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