Morningstar | Snap Beats Expectations with Solid ARPU Growth; Maintaining $14 FVE; Shares Fairly Valued. See Updated Analyst Note from 08 Aug 2018
Snap reported second-quarter 2018 results above our expectations and consensus as the firm is more effectively monetizing its users, albeit with continuing difficulties in growing daily average users. While there are some indications of higher user interaction and engagement, similar to Twitter, Snap's lackluster user growth is indicative of the firm's network effects moat source deficiency and supports our no-moat rating of the company. Management's third-quarter revenue and adjusted EBITDA guidance was slightly below our internal quarterly projections. After adjusting our estimates accordingly, we are maintaining our $14 per share fair value estimate on Snap. The shares are flat in after hours and continue to trade in 3-star territory as they have recovered from the 12-month low of $10.55 in late May 2018. We recommend a wider margin of safety before investing in this no-moat and very high uncertainty name.Snap’s total revenue grew 44% year over year to $262 million driven mainly by sales of significantly higher ad inventory which improved monetization and pushed average revenue per user, or ARPU, up 33% from last year to $1.40 during the quarter. While the daily average user, or DAU, count declined 2% sequentially, which according to management was due to a slower adoption of the app's redesign, DAUs did grow 8% year over year to 188 million. These growth rates demonstrate the difficulties faced by Snap when attempting to compete with Facebook's Instagram, which now has one billion users.
We note that for the first time the firm did mention it now has over 100 million monthly active users, or MAUs, in the North America market, which we view as impressive for a couple of reasons. First, with 100 million MAUs and 80 million DAUs, we estimate that the user interaction or engagement measure (DAU/MAU) is now at 80%, much higher than Facebook’s 66% (excluding Instagram) and Twitter's lower-than-50%. While Snap is having difficulty attracting new users, it is successfully keeping its current users engaged, which can still help the firm attract ad dollars. Second, Snap's North America MAU count is significantly higher than Twitter’s mere 68 million. In our view, with more MAUs and higher user engagement, Snap may have the capability to possibly challenge Pinterest and Twitter for the number three social network ad seller in North America, behind Instagram and Facebook, of course.
Snap expanded its second quarter gross margin 11 percentage points from last year to 27%, due to lower revenue share and slower growth in hosting costs. While Snap's revenue grew 44% year over year, we estimate its hosting cost per DAU went up only 17%. In addition, more than 75% of the firm's ad sales is now programmatic which helps control some cost of revenue and SG&A. Combined with a decline in R&D, which we think will return to growth in 2019, Snap's second-quarter operating loss came in at $358 million, a significant improvement sequentially and year over year.
Snap is a camera company. The company's primary product, Snapchat, is a camera application that helps people to communicate visually through short videos and images called Snaps. The company's products are: Camera, which includes tools for people to personalize their Snaps; Chat, which includes interacting with friends on Snapchat; Discover, which includes providing Stories and Shows from publishers, creators, and the community; Snap Map, which shows a live map of the user's location; Memories, which enables users to save the Snaps they create in a personal collection called Memories; and Spectacles, which includes creating Memories by using Spectacles, which are the company's sunglasses that make Snaps.
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