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Snap - shares fall on margin guidance cut

Nicholas Hyett, Equity Analyst | 27 October 2021 | A A A
Snap - shares fall on margin guidance cut

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Snap Inc USD0.00001 A

Sell: 12.21 | Buy: 12.22 | Change 0.62 (5.34%)
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Snap announced third quarter results on the 21 October. Revenue rose 57% to $1.1bn, reflecting user growth outside Europe and North America, together with increased average revenue per user (ARPU) in these more developed markets.

Despite the revenue growth, the group reported an 8% increase in operating losses, to $180.8m. That reflects ongoing investment, as well as the return of travel and event costs which disappeared during the pandemic.

The group updated guidance for fourth quarter revenues to around $1.2bn, with underlying cash profits of between $135m and $175m. That implies a profit margin of not more than 15% and perhaps as low as 11.2%, a significant decline from the 18% achieved in the same period last year.

The shares fell 26.6% on the day following the announcement.

View the latest Snap share price and how to deal

Our view

Snapchat's user growth has continued its recent rapid growth, while increased sales investment has boosted ARPU. The larger and more engaged the audience that spends more time on the app, the more attractive to the all-important advertising buyers that ultimately drive Snap's revenues.

Progress is testament to the ongoing investment in the platform. Proprietary video content and augmented reality filters are improving the experience for users. Crucially Snap's also investing in the backend tools that allow marketing teams to target and assess the effectiveness of their advertising dollars.

While Snap's net loss remains substantial, operating costs as a proportion of revenue have started to fall. Unfortunately, the disruption caused by the pandemic and increased regulatory action are set to undermine that progress next quarter.

The new iPhone operating system, iOS 15, makes it more difficult for advertisers to track ad performance. Making it more difficult to measure advertiser return on investment has inevitably put off some spending. The group also cut guidance for the fourth quarter as advertisers advised that supply chain problems were making it difficult to get hold of inventory, and with no ability to supply demand, they were cutting back on marketing.

Hopefully those headwinds will short lived. Long term, the path to profitability requires investment in technology and content - driving user and revenue growth that would ultimately create huge economies of scale and more than cover current losses. A sizeable cash pile gives it the firepower to invest, and it's a model that has worked nicely for Facebook over the years. The fact Snap's ARPU languishes at $3.49 compared to Facebook's $10.00 (Q3) lends weight to the argument.

However, we worry about whether that all-important growth is achievable. Teenagers are a fickle audience - with an ever-present risk they vanish off to the next big thing. Even in the current market, advertisers are spoiled for choice when it comes to social media platforms, and the likes of Facebook and TikTok are formidable opponents.

Costs are also a problem. The group may be edging into positive free cash flow, but that doesn't account for eye wateringly high share awards to employees. Stock options may be costless in cash terms, but they have a real effect on other shareholders by spreading any future returns more thinly. Add to that the fact ordinary shareholders have no voting rights and CEO Evan Spiegel controls a majority of voting shares, and governance could potentially be a real concern.

Recent trends have been encouraging. But competition, cost and governance concerns, together with a price to sales ratio well above rival social media groups mean we remain wary of Snap.

Snap key facts

  • Price/Earnings ratio (next 12 months): 91.9
  • Average Price/Earnings ratio since listing: 194.1
  • Prospective dividend yield (next 12 months) yield: 0.0%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Third Quarter Results

Snap reported 306m Daily Active Users (DAUs) in the third quarter, a 23% year-on-year increase. That was driven by a growth in Rest of World, up 49% to 130m, although both North America and Europe also showed positive progress.

ARPU rose 28% to $3.49, with very strong growth in North America, up 49% to $8.20, and Europe, up 34% to $1.92. Rest of World ARPU stands at $0.98.

Operating costs rose 47.5% to $1.2bn, with significant increases across Research & Development and sales & marketing.

The group reported free cash flow in the half of $51.7m, a significant improvement from the $69.6m outflow reported a year ago. However, that excludes, among other things, $300.9m of share based compensation paid to staff. Overall shares in issue, including underlying stock based payments, rose 4.6% year-on-year.

The group's net cash at the end of the quarter stood at $1.2bn, up from $862m a year ago.

Find out more about Snap shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.

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