Wall Street investors seem to think social media will be a winner-take-all game. Our view is that just as there were many TV shows vying for audiences in the last era of media, there will be many new-media ‘shows’ such as Twitter, Spotify and Tinder where audiences divide their time. Snap, the maker of the popular Snapchat app, priced its offering Wednesday night at $17 per share and jumped more than 50% by Thursday afternoon, giving it a market cap of $29bn, or 72x trailing revenue. Snap is a show that’s valued as a network.
The company builds social media apps focused on the smartphone camera. It was founded around the idea of sending photos to individuals that would vanish and has since built out other capabilities such as filters and lenses to augment the pictures and stories to share with larger groups. Those features have made it popular with 18-34 year olds in North America, a demographic that’s highly coveted by advertisers and increasingly hard to reach as they spend less time on TV than older audiences. That demographic, mixed with ad offerings such as sponsored lenses and other nontraditional, interactive products, has led to scorching revenue growth.
Snap only began to generate sales from its ad offerings in mid-2015 and annual revenue grew almost 7x to $404m in 2016 (its losses are even larger thanks to hefty IT infrastructure costs). Early signs suggest that revenue will continue to grow rapidly – at least in the short term. High-ranking advertising executives have publicly lauded the company and the results that it generates for their clients. And Snap had an ARPU of just $2 last quarter for its 68 million North American users. By comparison, Facebook generates about $20. Yet Facebook trades at just 12x revenue, meaning that Snap’s newest investors have priced the company as if it has already closed that gap. Facebook took more than four years to grow its North American ARPU by that amount.
The key nuance for us is that where Facebook offers a broad identity platform that touches most of the US Internet population, Snap is limited to a single (albeit valuable) demographic. Facebook has a platform that can (and does) bolt on other social networks (or shows, to stick with the analogy). And Facebook is protected by a network effect that Snap doesn’t benefit from.
Snap’s pitch that it could be an Internet powerhouse is built on the assumption of continued growth of revenue and audience through new product development (both new ad offerings and new consumer products). Its total daily average users grew just 3% over the fourth quarter to 158 million. Compare that with its quarterly growth rate of 14% a year ago and it looks like Snap is running out of steam. By contrast, Facebook put up 9% quarterly user growth leading up to its own IPO (off an audience that was then three times as large as Snap’s current count).
A broken promise to be the third leg of the Google-Facebook digital media stool led Twitter’s stock to shed two-thirds of its value since its 2013 IPO once it became obvious that its audience size had plateaued. Snap could be setting itself up for the same trap. Twitter currently trades at 3.5x trailing revenue. Snap’s coveted demographic and unique ad formats give it better growth potential than Twitter, even if audience expansion does indeed stall. Yet Snap’s current valuation forces it to chase an audience with Facebook-like scale and the window for it to be a solid but not dominant media company has now disappeared.
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