• Brett Schafer

Not So Deep Dive: Snap Stock (Ticker: SNAP)



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Show Notes


(Ryan) What they do: Snapchat is a mobile-only messaging and social media app. It’s actually hard to describe what they do in a condensed format because it’s an amalgamation of things. The company started as a messaging app where users could send pictures to each other that would disappear after a certain amount of time. But they then moved into stories, where you could share something with all your contacts at once. Which later became commoditized.


Today it’s much more. I’d describe it almost like a digital magazine, plus picture messaging. As for different features that they have, they’ve got:

  • Maps: You can see where all your contacts are. It also has hotspots, so you can see where there’s a lot of people.

  • AR tools: You can augment pictures in funny ways.

  • Subscriptions: This is like ESPN stories. So you wanna watch a recap of Sunday football, you can subscribe to the ESPN story.

  • Discover: This is for “influencers” that are trying to grow their following.

  • Spotlight: This is basically their TikTok-like competitor.


And each of those different features has its own sort of advertising solution. That’s how they make money. Pretty intuitive business model.


(Ryan) History: They actually have a semi-controversial startup story. So apparently, Reggie Brown approached Evan Spiegel in 2011 (both Stanford students at the time) about an idea for a disappearing pictures application. The 2 of them then brought in Bobby Murphy because he could code. And after a few months of work, they launched an app called “Picaboo” and shortly after launch, Brown was ousted from the company.


It was later relaunched as Snapchat and after a while of Brown being gone, he sent an email to Spiegel about renegotiating his stake. Company lawyers responded saying that he had no creative connection to the product. They claimed that Brown was entitled to nothing. But after years of legal battles, the two settled giving Brown $157.5M and he got to be credited as one of the original founders. Since then it’s just been a series of new features and the company finally IPO'ed in 2017.


(Brett) Industry/Landscape/Competition:

  • Social media is a large industry as we all know, just look at Facebook’s market cap

  • TAM is also very easy to identify, it is anyone with a smartphone around the world, which is projected to hit 7.5 billion in 2026

  • Competitors: Facebook, Instagram, Tik Tok, Discord, Reddit, all the social media companies we all know. Curiously, they do not list Roblox as a competitor, but I think that is their biggest threat in the United States and western Europe for getting new users.


(Brad) Management and Ownership -- Note this company does not file proxy statements so this information is as of December 2020 from their annual filing


Management


CEO/Co-Founder Evan Spiegel

  • Spiegel was a Red Bull and Intuit Intern… then the founder of Snap in 2011 at the age of 21

  • 82% Glassdoor rating

  • Some random workplace culture awards sporadically spread out but that’s pretty much it.

CTO/Co-Founder Robert Murphy

  • Stanford Grad directly recruited by Spiegel out of College after a failed startup on college rec ideas

  • Murphy actually created the foundation of Snap called Picaboo which had its name eventually changed to Snap

  • Worked for a POS system for restaurants until Snap could pay him

  • even used his paycheck to fund some of the early endeavors

CFO is Derek Andersen

  • Been there for almost 4 years and started as the VP of Finance

  • Previously the VP of Finance with Amazon and an SVP of Finance at Fox Media

A lot of Fox and Amazon alums on the leadership team


3 Classes of Shares -- Class C drives the vast majority of the voting power

  • Spiegel owns 4.3% of class A; 24.7% of class B; and 53.4% of class C for 53.1% of the Class C common stock

  • Robert Murphy (Co-founder/CE)) owns 6.9% of class A; 46.6% of class B; and 46.6% of class C for 46.4% of the total voting power

  • Together these 2 own 99.5% of the combined voting power of Snap Inc.

  • All other company higher-ups own 0.8% of the class A shares in total

  • Tencent owns 43.7% of the class B float


(Brett) Valuation:

  • Market cap of $88 billion, ticker SNAP

  • P/S of 23.8

  • P/GP of 44 (using 54% gross margin, not their adjusted number)

  • No profitability metrics that make sense to use (cash flow is fake)

  • Around 100 million unvested RSUs and options vs. 1.6 billion shares outstanding. Seems like the pace has slowed a bit but the previous years have had very bad dilution


(Ryan) Earnings: Just reported earnings this week, they usually set the tone for general advertising revenue. I’ll give some TTM numbers for the full picture but then dive into Q2 more specifically.

  • TTM Revenue is ~$3.7B, up 73% YoY

  • 55% gross margins, up from 44% 2 years ago.

  • Barely operating cash flow positive.

Q2: Dropped 31% after the report.

  • They reached 306M DAUs, which is a 23% increase YoY

  • Revenue grew 57% YoY to $1.067B. But this came in under their guidance. And the headline/reasoning for that was around the iOS data tracking changes.

  • Had 58% gross margins, vs 56.8% last year

  • Had $70M in OCF but spent $300M on SBC

  • FCF wasn’t too far away from OCF (both are certainly trending in the right direction)

  • And shares outstanding increased 5% YoY


(Brad) Balance sheet and liquidity (Dilution)

  • Raised a billion in convertible senior notes last year to get to roughly $2 billion in cash and equivalents + $1.5 billion in marketable securities. Flushed with cash.

  • $2.25 billion in net senior notes

  • Most of its debt comes with a near 0% interest rate and aggressive credit-holder conversion rights. I’d read into its latest debt offering if you’re interested in the general structure of its offerings (SoFi Upstart)

  • Still burning through cash but a $510 million first 9 month of the year burn rate gives then 3ish years of cash on hand


(Ad)


Anecdotal Evidence:

  • (Ryan) I’m a DAU. Have been ever since they introduced the streaks feature.

  • (Brett) I think it is dumb, but usually when I say that for a consumer product that means it is a good investment opportunity.

  • (Brad) I use it occasionally. Match Group should buy it.


Future growth opportunities:

  • (Ryan) I can’t think of anything they haven’t already done. They’ve got maps, they’ve got stories, they’ve got spotlight (kind of a TikTok style offering), they’ve got subscriptions, they’ve got discover mode, they’ve got random AR tools to play around with. The most important thing for them to do is get users away from just using the core functions and maybe make better use of maps.

  • (Brett) Rest of World user growth. DAUs at 130 million vs. only 77 million in Q2 of 2020. That is a good sign as long as ARPU can follow suit since it is so low vs. North America and Facebook in that region. For reference, FB ROW ARPU is $3.14 while Snap is $0.98.

  • (Brad) AR shopping


Highlights and lowlights:

  • (Ryan) Highlights: Users stick around. They are super innovative. They generate way more revenue than I would have expected. And of all the social media apps, it feels like they have the most consumer trust. Lowlights: Maybe it’s just me, but the app actually feels too crowded. It’s so overwhelming that I don’t bother using most of the features. Secondly, and this is a more pressing issue than my personal feelings about the app, but I have no insight into what the lasting impacts will be of the iOS changes or how the company will be able to adapt. Also, Snapchat isn’t immune to supply chain issues either. Retail companies can’t fulfill any more demand so they’re pulling back on marketing.

  • (Brett) Highlights: The user growth in the rest of world, and the potential for ARPU expansion outside the United States. Lowlights: share dilution, worries about durability, poor capital allocation decisions in my opinion, hard to see areas for growth.

  • (Brad) Young users & India 100M MAUs Lowlight is TikTok --> came in and at their (and everyone else’s) lunch. Made me think of these social media platforms as more of stages of MySpace rather than one platform just automatically remaining relevant with product innovation. Lowlight: They’re expected to do $4 billion in sales next year (awesome growth) and they’re FAR from GAAP profitability. Makes me think when does that ever come? Can this company turn off sales and marketing spending and allow that gross profit to flow down effectively?


Bull Case:

  • (Ryan) They continue to grow users and those users continue to become more active. Right now, from the outside looking in, it seems like they’re having to rebuild their advertising solutions and performance measurement tools from the ground up. That sucks, but so does everyone. And Snapchat still owns the demand. So if they can keep innovating, they’ve got a really unique platform for advertisers to utilize. I think $20B in revs within 7 years isn’t crazy far-fetched.

  • (Brett) At an $88 billion market cap that is closer to $100 billion fully diluted, you gotta expect to get to $20 billion in revenue with strong gross margin expansion that leads to strong true cash flow generation.

  • (Brad) Big picture: This company needs to find a way to enhance monetization and cross-selling to translate this large user base into a fantastic business as Facebook did. Facebook is the bull case in my view


Bear Case:

  • (Ryan) The iOS 14 changes prevent Snapchat from being one of the top destinations for advertisers. Doesn’t seem likely but it feels like a reset. AR just ends up gimmicky, maps ads never materialize, and it forever stays used for its core functions, messaging, and FOMO.

  • (Brett) The combination of a risk of durability concerns, poor capital allocation decisions, and a slow down in revenue growth could get very dangerous.

  • (Brad) Twitter


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Disclosure: The author and podcast guests are not your financial advisors. Ryan Henderson and Brett Schafer are general partners and portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this show.

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