I was excited about playing the momentum for this stock last earnings season when I released the PDF at about $14 a share and it popped to $17 a share about a week after we published.
I felt confident on the probabilities of a big earnings beat because the company had released new filters that pushed it’s downloads to new highs. They also had announced beta-testing for Audience Network, a way to monetize the 190 million users outside of the Snapchat application.
Funds and institutions will pile in for Audience Network because of what it did for Facebook. However, Audience Network hasn’t opened beyond beta-testing and there hasn’t been an update since April, when the company stated it would be released in the “coming months.”
If/when this does happen, Snap will report higher revenue but I don’t see any evidence that we’re there yet. I also haven’t seen any new filters that would suggest new app downloads or viral popularity (even if short-lived, these are great for momentum plays). We now see Snap testing dynamic ads, which are popular on Instagram. These will not have an effect on earnings this quarter.
TikTok is a looming threat to social media apps, as well. However, if/when I hear anything about Audience Network officially launching, I will be an immediate buyer.
For this earnings report, I am on the sidelines for Snap. I like more confirmation from app download reports than what I’m getting right now.
However, Knox trades more on technicals and he is getting into the trade ahead of earnings. Here is his take on the situation:
SNAP Technicals
By Knox Ridley
After Snap hit my stop at $14, closing the position for nice little gain, I’m getting back into SNAP and here is why:
5 waves up (in purple) that hit all the Fibonacci points.
3 waves down from the recent high (A,B,C), and the C wave hit the 138.2% extension and is turning back up.
Just reclaimed the 10-day EMA – a show of changing momentum.
If we take the length of the uptrend (the bottom of 1- and the peak of 5)and multiply it by the Fibonacci ratios, SNAP turned up right at the 38.2% time marker, which coincides with the MACD turning up, and the Stochastic/RSI turning up.
We now have 5-waves up on the 3 minute chart when you zoom into the most recent push up. This is a tell of the bigger direction that is unfolding.
I’m going long, but cautious of the overall market, hence I’m placing a stop at $13. If you want to give it more room to breathe, I’d place it just under the .382 retrace level in black.
The fundamental analysis and technical analysis provided prior to earnings played out nicely this week. Snap crushed on DAU (daily active users), as our data had indicated the company would. For ad companies, DAU plays into higher revenue. The bigger story for Snap this year has not officially launched – Audience Network.
We will keep you updated if anything changes fundamentally.
Technical Update:
Provided by TA contributor, Knox Ridley:
Snap broke out yesterday. As you can see in the chart above, Snap was following a steady trend channel (in blue), bouncing between this channel until today.
Our previous TA noted that Snap’s support was $14 and resistance was $17. Snap retraced, closed just above $14 on Friday/Monday and then sky rocketed above $17 the day following earnings. It not only closed above $17 but did so with high volume.
This is always a bullish sign. We will likely see it retest the upper trend channel (outlined in the lite blue dotted line, trending up), before testing the $20 resistance level above (in yellow). As long as Snap stays within this upward trend (outlined by the lower blue line), Snap should continue it’s upward movement.
Regarding the internals of Snap – notice the top yellow circle. This is highlighting the current price breaking through the upper Bollinger Band, while the lower Bollinger Band moves down. This is a very bullish indicator, which is supportive of higher prices.
Further supporting the internal strength, the RSI closed above the descending trend line, showing some new found buying pressure. As long as Snap holds the 55-50 region on the RSI, we should continue upward. However, keep in mind that broad market forces can raise and sink all ships, regardless of fundamentals. If the $14 support region is broken due to a weakening broader market, we could see the price fall into the green box on the chart ($12.50-$9.50).
Per Beth’s analysis, fundamentals are strong. The should be seen as a long term hold that will benefit from Audience Network in the second half of the year. If you’re in, mind your stops if the broader market moves downward. If you have yet to make a position, follow Snap’s retrace to the upper trend channel previously mentioned. That would be a good time to enter.
SNAP Forum:
Please check out our forum and post there if you traded Snap or have questions on Snap for community discussion. One user posted some great information on the number of funds moving into the stock over the past two quarters. Here’s the post:
Institutions have been moving into SNAP over the last 2 quarters:
Date # funds:
Sep 2018, 177 funds
Dec 2018, 168 funds
Mar 2019, 198 funds
Jun 2019, 321 funds
Financial analysts and journalists continue to question why Google missed in Q1 2019. Without properly identifying the cause of the revenue miss, which was the slowest sales growth since Q4 2015, it is nearly impossible to predict how Google will perform in the future. Google executives offered very little on the earnings call.
“Alphabet Inc.’s growth is slowing, and analysts don’t have a clue as to why because executives aren’t talking … After releasing disappointing first-quarter results in late April, executives were vague, if not outright unresponsive, about slowing growth.” -Marketwatch, July 19th, 2019
Deciphering exactly why Google missed is impossible to prove, although we believe the quiet contention between Apple and Google on browser ad-tracking may have played a role. The Safari browser captures 58% of overall mobile traffic in the United States with Chrome capturing 33.3%. In the UK, 45% of users use Safari and Mozilla. Therefore, Google’s revenue is susceptible to Apple’s Intelligent Tracking Prevention (ITP), with tighter restrictions going into effect throughout 2019.
There is also evidence of weakening fundamentals that extend beyond any one change to the way ads are targeted and monetized. We lay out these details below.
SECTION 1: PRODUCT OVERVIEW
1A. Apple’s Intelligent Tracking Prevention (ITP 2.1 and ITP 2.2)
Launched in 2017, Apple’s Intelligent Tracking Prevention (ITP) places a limit on how long cookies are available for third-party contexts. ITP restricts cross-site tracking for targeted advertising purposes by removing cookies after 24 hours. Login cookies are available for up to 30 days, however, login cookies do little for targeting purposes as they do not track a user’s activity. After 30 days, the login cookie is purged.
When Apple first introduced ITP in 2017, it did not have an effect on Google as users of Google’s search service and other properties visit these sites daily. ITP 2.0 was aimed towards third-party trackers, such as Criteo and Doubleclick. Some critics state ITP strengthened Google as one of few remaining options to target niche audiences at scale.
Apple continued to battle data collection on the Safari browser in 2018 by shutting down finger printing, a method of triangulating who a user is through fonts, screen dimensions and plugins.
We’ve seen statistics from publishers where they get half the CPM value as a result of ITP’s impact. If they can’t have good targeting, some of their sites become less worthwhile for their advertisers.” – Google, CES 2019
In March of 2019, Apple announced ITP 2.1, which prevents third-party cookies from being stored as first-party cookies. This update also puts a limit on how long first-party cookies can be stored of up to 7 days. To put this in perspective, a Google Analytics cookie, in theory, would last for up to two years. Safari can now delete it within 7 days.
The final hammer was dropped in May of 2019, when Apple announced ITP 2.2. This update is intended to limit any workarounds by limiting all tracking to 24 hours. This includes Google and Facebook. The result will be weakened attribution, which in turn, lowers CPMs due to weakened ad targeting.
Here’s a description from Digiday that puts into context how ITP 2.2. works:
“ITP 2.2 cuts the first-party cookie’s lifespan from seven days to one day. As a result, the first-party cookies that Facebook and Google have introduced in order to continue measuring site traffic and attributing ads will be deleted after 24 hours. As a result, if a person clicks on an ad for a product on Friday and decides to take the weekend to think about buying, then the cookie wouldn’t be around on Monday to register when the person returns directly to the site to buy the product.” -DigiDay, May 2019
ITP 2.2 will have more of an effect on Google and Facebook than the previous ITP releases. This release will prevent Facebook’s pixel and Google’s tag from using unique identifiers to store information. These tracking mechanisms allow Facebook and Google to track a person’s visits long after they have clicked on an initial link, as the first-party cookie had not expired due to their strong first-party relationships (most people use Google and Facebook every 7 days).
As DigiDay states, Google and Facebook are the companies most affected by ITP 2.2.
1B. GOOGLE’S CHROME BROWSER
The privacy changes implemented to the Safari browser and Mozilla’s Firefox puts Google between a rock and a hard place on the privacy terms and conditions for the Chrome browser. Either Google proactively follows Apple and Mozilla, or Google risks Chrome’s reputation.
On April 9th, 2019, an insider leak in Adweek stated Google is “contemplating a number of changes to its consumer and advertiser-facing tools.” The translation is that Google may follow ITP 2.0 by disallowing thirdparty ad tracking software across browsing sessions. The market penalized Criteo with a 30% stock pullback, TradeDesk with a 15% pullback, and Alphabet’s stock was penalized with a 5% pullback.
“According to sources, certain Google teams want to placate the growing zeitgeist around the protection of consumers’ data privacy, which has grown ever louder since the Cambridge Analytica scandal last year. These internal discussions also follow the implementation of third-party tracking restrictions on Apple’s web browser, Safari, and similar moves from Mozilla’s Firefox and Brave’s offering in recent months. Although the various businesses within Google advocate similar measures, the breadth of the company’s interests (i.e., the dominance of its Chrome browser and ad-tech stack) make its decision-making process more complex.” -Adweek article Google Mulls Third-Party Ad-Targeting Restrictions:
And as part of that, we will have more changes through the course of this year, be it Chrome — Chrome is super committed to making sure it's best-in-class in privacy and security, and we always put user experience first and follow through. -Q1 2019 earnings call
Privacy restrictions have not been implemented for Chrome, however, we are watching this closely.
PRODUCT OVERVIEW CONCLUSION:
Google’s revenue is susceptible to stricter browser ad-tracking policies. Due to some iterations occurring in Q1, this may have affected the decrease in revenue that was reported. Regardless, Apple’s ITP 2.2 is specifically aimed at Google and Facebook.
We know that ITP 2.0 affected third-party ad companies by reducing CPMs by nearly 50%. If targeting is weakened through ITP 2.2, we will see a decline in click-through rates (CTRs) and CPMs as the people seeing the ads are not as likely to engage with the ad due to a lack of tracking/targeting. There is evidence that ITP 2.0 and ITP 2.1 may have already affected CPMs and CTRs (see below).
If this is the cause of the minor revenue miss, the situation should surface by Q3 – and most certainly by Q4.
Recommended Reading: Fallout from Apple’s ITP is Severe
SECTION 2: FUNDAMENTALS
2A. Q1 EARNINGS
Google is transitioning into a slower-growth company across most metrics. Earnings per share are expected to grow 4% to $45.46 although analysts are calling for a rebound of 18% EPS to $53.65 per share in 2020[1].
Google on April 29 reported earnings that topped expectations, excluding a $1.7 billion European Union fine. However, revenue fell short of estimates. Google’s advertising revenue rose 18% to $30.7 billion, missing estimates of $31.5 billion. This caused Google’s stock to sell off, falling below 1,236.54.
Analysts have a consensus of $11.49 EPS for the upcoming quarter (source: NASDAQ). Notably, Google beat on earnings but missed on revenue in the last quarter.
· Google’s 2019 revenue is expected to grow 17.3% to $160.5 billion from 23% sales growth in 2018.
· Revenue is projected to slow to 16.7% to $187.3 billion in 2020.
· Operating margin fell 21% in the December 2018 quarter, down from 26.5% in the first quarter of 2017.
· Capital spending rose to 18% of revenue in December 2018 quarter, up from 10% two years earlier.
Notably, EBIT, EBITDA and FCF were all stronger than expected, but the concerns around slowing growth in the Websites revenue segment is likely to affect stock price in the near-term.
"As expected, Google ad revenue growth has been slowing amid downward pressure on ad prices, especially for revenue coming from international markets," -Monica Peart, senior forecasting director at eMarketer.
“We appreciate quarterly results can be volatile and acknowledge the company’s long-term focus, but the magnitude of the deceleration on a constant-currency basis marked the largest sequential move down since 3Q12,” -Deutsche Bank’s Lloyd Walmsley.
“Overall, we expect GOOGL shares to be under pressure in the near-term given sub-20% revenue growth & downward earnings revisions. As noted above, the exact drivers of GOOGL’s slowing topline are unclear, & we believe frustration around GOOGL’s lack of transparency will only increase.” – JP Morgan
SECTION 2.2: Key Metrics
Aside from regulatory pressure, Google is already seeing some weakness in its core business with ad click volume rising but cost-per-click (CPC) growth trending downward. According to Marin Software and Merkle, CPC has slowed over the past five quarters.
Source: Marin Software
According to last quarter’s earnings, paid clicks on Google properties grew 39 percent, down from 66 percent in Q4 2018. The cost of the clicks also declined by 19 percent.
FUNDAMENTAL ANALYSIS CONCLUSION:
From an analyst’s perspective, it is very difficult to say a debt free company with $110 billion in cash that is growing at a rate of around 17% is at high risk over the next 2-3 earnings seasons. There are plenty of ways the product issues noted above could be alleviated. Placing ads in Google Maps could make up for lost revenue from browser changes, with one estimate valuing ads in Google Maps at $9 billion by 2023.
However, we feel that the changes to Apple’s Safari browser and Mozilla’s Firefox will have an effect on both Google and Facebook. Combined with weak technicals, I am placing a Hold on these two stocks with the anticipation they may enter a Sell recommendation over the next two quarters.
PART TWO: TECHNICAL ANALYSIS
Time Frame Comparison
Currently, Google’s price action is in a weakened state that warrants caution for longs. Some have likened Google’s current price movements to 2011, which a case could be made. I believe its price is eerily similar to late 2014, which is highlighted in the yellow circle in the chart.
That yellow circle shows where we are today vs. where we were in late 2014. What you’ll notice is that in both time frames, we completed a double top pattern on decreasing volume (where the yellow circle highlights the completion of that pattern). The initiation move down then took us below the 50 Day Moving Average.
Also, you’ll notice the similarity of the internals, as outlined in the RSI. Google, on higher volume, was in a strong uptrend in 2014, which can be seen in the elevated RSI levels in green. Then, as volume began to decrease, the RSI suddenly drops below 50 and starts to make lower highs, unable to break back above 60. In fact, at the double top peak in 2014, you’ll notice the RSI dropped below 50 and began the bearish internal pattern in red.
There is similarity between 2014 and today. We have the same double top confirmation with light volume, and very similar RSI changes from bullish in green to bearish in red.
Today, we have broken the 50 line on RSI, attempted to retest it, and broke below it again.
Further evidence of weakness in Google is found in the pink arrows. You’ll notice as the price of Google increased, the RSI was making lower highs, which is negative divergence – and usually indicates weakness in buying pressure and signals a drop in the near future.
And finally, the blue dotted line indicates long term support, which started at the beginning of this cycle uptrend in March of 2009. This is very strong support, which did not break in 2015 or 2016. Today, we are comfortably below this support, which, once again, is not a good sign for the near term.
Elliot Wave Analysis
According to Elliot Wave Theory, the 5 waves up/3 waves down framework is fractal. So, this is happening on multi-decade super cycles to minute moves in the market. In interpreting where we are, the 5-wave impulsive move up started in March 2009 and has completed its Wave 3 (July of 2018), and we are currently in the 4th Wave retrace.
Google, being a major part of the broad market, mimics the same movements. Thus, Google is currently in the middle of an A-B-C, Wave 4 retrace, which began in Late 2018 and appears to end in late 2019/early 2020. I believe we have completed the B wave and are now beginning the C wave down, which has the potential to take us sub $1,000, and in a worst case scenario, as low as the mid $700 region.
Based on my primary count using Elliot Wave as well as the internal structure of Google, I believe a retrace is likely. What would invalidate this count, which would force me to reassess a new count, would be if Google makes new highs – around $1300. An update will be provided if this occurs.
Scenarios:
• If you are long on Google, put a disciplined trailing stop on the stock and re-enter when the technicals and fundamentals agree on a more bullish outlook.
• If you want to trade conservatively, wait for Google to miss on revenue a second time between Q2-Q4 2019 and enter a short position or long-dated put. Especially watch for the effects of Apple’s ITP 2.2 as if/when effects are reported in Q2 or Q3, they will worsen over the course of the year.
• Higher risk scenario would be to purchase OOM puts that ends in March of 2020 prior to earnings.
• Any short positions should be closed if Google makes all new highs around the 1300 mark. Shorting stock is all about timing and discipline. We will update as we go along if support or resistance is broken.
There was a new web analytics report from SimilarWeb released last week that showed an increase of traffic to Snap’s advertising URL, up 23% YoY, compared to Facebook’s URL, up 4%. The comparison is provided to illustrate a common growth metric for ad URL traffic on social ads with the understanding FB receives much higher traffic volume.
This is positive news. The report also confirmed that the popular filters maintained an increase in daily active user growth, up from 10 million to 11.6 million (peaking around 13 million with the new filters). One concern was if the filters had created an artificial new high, which does not look to be the case.
Due to the increase in app usage from this past quarter, illustrated in the PDF, the probability that Snap will beat earnings is the more likely scenario. If for some reason Snap does not beat earnings, I will still have a buy rating on the stock due to Audience Network. This will be a major breaking out point for the company’s revenue (Audience Network in testing as of April).
In the article released 7/19, Audience Network is what Goldman is referring to as “Our checks with advertisers also lead us to believe that the company’s continued innovation in its ad-stack, particularly in self-serve, should allow SNAP to substantially improve monetization of user time spent on the platform over time.”
Technical Update:
Snap is currently trading at the $14 support level, and is holding as of today. Per our technical analysis, if Snap closes below $14, we could see it trade within the green box on the original chart ($12.50 – $9.50 range), before taking us up beyond the $20 range. Listen to your stops, and understand that Snap’s growth story regarding Audience Network is a matter of when, not if. The increase in app usage should also translate to an increase in quarterly revenue.
Keep in mind, there is high volatility in this stock. With the price retreating down to support levels as we head into earnings, there is likely to be a strong reaction tomorrow after- hours. Snap has jumped as much as 22% after a strong earnings report and dropped as much as 14%.
Regarding stops, we purposefully suggested wider stops to keep you from exiting prematurely, but also to get you out with a minor loss in case a correction occurs. We may be early to Audience Network compared to the broader market, but that’s by design.
Snap has seen remarkable volatility in its stock price this year, down 80 percent from its peak in March of 2017 at $29 to a low of $5 in December of 2018. The stock is currently trading in the $15 range, at time of writing.
Previously, in August of 2018, I had a sell recommendation on Snap. I am changing this to a buy
recommendation due to a few key reasons. For one, Snap should report higher than usual user growth, which has become known to the market. Secondly, Snap is extending its monetization methods and this is not widely known to the market. The increase in user growth should be reported in Q2 and the new monetization method should take effect by Q3.
Background:
Snapchat is one of the best platforms for Millennials and Gen Z audiences. The company reaches between 75% to 90% of people aged 13 to 35. The issue that Snapchat has faced is flat to declining daily active users (DAU) and monthly active users (MAU). Overall, the company does not report enough growth to command a social network multiple.
Revenue growth and profit margins have been problematic for Snap. The most recent quarter showed an improved gross profit margin of about 36%, however, in the quarters following the IPO, Snap reported negative gross profit.
The company switched to selling ads programmatically through software algorithms instead of through salespeople – this led to lower ad prices and resulted in lower revenue. Snap also had a redesign that halted Snapchat’s user growth.
2A. App Sessions Skyrocketing
Snapchat’s new gender-swapping filter has been extremely popular and this should show up in the earnings results for Q2 2019. Downloads and sessions have surged causing Snapchat to rank #4 overall in China’s App Store, its highest rank there in more than four years.
According to app intelligence provider, Adam Blacker of Apptopia, Snapchat had its most downloads ever dating back to January 1st, 2015 at 2 million compared to the average daily downloads of 665,000. As Apptopia has noted, retention will need to be proven, with retention likely higher for Snapchat Games than Snapchat filters.
Regardless of retention, the surge in user activity will be a welcome relief for investors.
Predictably, this app activity placed Snapchat as the number one downloaded app in the United States for the first time since March of 2017. We will be monitoring this intelligence closely to see if Snapchat places in the top spot for June of 2019, as this would indicate further additional strength in the stock’s key metrics for the upcoming quarter.
3A. Average Revenue Per User
Snap’s average revenue per user (ARPU) is on an upward trend. This helped cause the stock rally we saw in the past few quarters.
4A. Audience Network
Less widely known to the market is Snap’s plans to monetize its Millennial data across other mobile applications. Snap will no longer be confined to monetizing the 190 million users on the platform, and instead, will use the data to broker ads across various mobile applications. This will have a parabolic effect on the company’s average revenue per user (ARPU).
Audience Network is a software development kit (SDK) that allows advertisers to use Snapchat data to reach audiences outside of Snap on the applications that install the software. The flat daily active users (DAU) growth on Snap will become less important as Snap will effectively broker ads to a scalable audience outside of the native Snap application. Full-screen, vertical video ads will appear across third-party mobile applications.
Snap has data on a lucrative demographic that few companies have ownership of, as both Facebook and Twitter are out of favor with this age group. Snap’s Audience Network will open up the ability to reach the Millennial and Gen Z audience segments across a much larger total addressable market.
The product was announced on April 4th, however, the company will now need to sign up application developers and advertisers before the revenue shows up in quarterly results. The formal launch will occur later this year.
Conclusion: Buy recommendation on Snap with price target of $17-$23
Catalyst: Audience Network should not be underestimated. Facebook launched an Audience Network in 2014 when the average revenue per user (ARPU) hovered around $12 in the United States. Audience Network was the turning point for Facebook’s ARPU reaching the $26 we see today in the United States region. The market is preparing for renewed user growth from Snap in the current quarter, however, Audience Network is what will cause the stock to climb and is still relatively unknown to the broader market.
SECTION 2: SNAP – Technical Analysis
Technical Analysis provided by Knox Ridley
Background:
Snap is out of favor with a tarnished sentiment – and for good reason based on a string of bad earnings and questionable management decisions in 2018. As mentioned in the fundamental analysis, the stock was down 80 percent from its peak in March of 2017 at $29 to a low of $5 in December of 2018.
However, Snap currently is in a quiet and strong uptrend. We do not think the market will ignore Snap for long, and we believe their next earnings report could be a turning point. Regardless of the upcoming earnings, we want to enter Snap before Audience Network goes live and becomes public knowledge.
The technicals of Snap are strong, as it just confirmed an inverse Head and Shoulders pattern by breaking the $14.47 neckline, then re-testing that support, and trending upward from there. Holding for 6-18 months will be important to let Audience Network take effect, while keeping a close eye on privacy laws. Because of this time frame, we can get a clear picture of Snap’s price pattern on the daily chart – below.
2B: Technical Overview
Using the RSI to measure Snap’s internal strength, Snap is clearly in a bullish position (holding above 65). However, you’ll notice that the buying pressure is starting to falter. This is evident in how the RSI is making lower highs while the price of Snap is making higher highs. This is Negative Divergence, with a sign of weakening buying pressure, and could signal a short term draw down. As long as Snap does not break below 60 on the RSI, it will remain in a strong bullish position.
Regarding the price pattern of Snap, we can a see a classic Inverse Head and Shoulder pattern, outlined in blue, that was recently confirmed once Snap broke above the neckline around $14.47. This is a bullish pattern that has played out. As long as Snap can hold the $14 support, the stock has the potential to trend higher to the $20-$23 range.
If the RSI breaks 50 and then moves below 43, which has recently been a strong ceiling for Snap once it enters a sustained downtrend, we will be looking to our stops to exit our position, or add more depending on the price action. However, in a market environment like the one we have, where we see a divergence between the upwards price of the broad market and the decelerating data in the economy, using stops is highly suggested. This will allow you to lower risk while investing in the remaining upside of this bull market.
2C: Elliot Wave Analysis
With limited price data due to Snap’s IPO in 2017, we’ll use this data as a rough guide to Snap’s general direction. It appears as though we are finishing an impulsive 5 waves up in a Wave (1) of (5). This is very bullish for the intermediate to long term for Snap, while being bearish in the short term. The question remains: how far will the Wave (2) retrace take us? As long as the broad market cooperates, and based on the current strength of Snap’s price action this year, a large retrace is not anticipated. The green box indicates the most likely target if Snap cannot break the $17 range. Above $17, and the Wave (2) retrace will be moved significantly up, making our current entry much safer.
Conclusion:
The line in the sand will be $14. Below $14, and we will likely see the green box come into play. On other hand, above $17 and our next level of pullback will likely be around the $20-$23 range, before taking us higher. Keep in mind that Snap is a volatile stock, so we will set a wide stop to give it room to breathe; however, we do not want to get caught up in a major market downturn, so our stop will allow us to play the upside, while avoid any severe losses. We recommend a 25-35% trailing stop.
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
Summary: According to Q3 earnings calls, Spotify may seek to broker user data in order to keep average revenue per user afloat. Known as programmatic advertising, this method of monetizing data to supplement music revenue may be Spotify’s only hope to stave off competitors who nip at the heels of the music-streaming app
Portions of this article were originally published September 27th, 2018 under 8 Reasons Spotify will be a Sell Recommendation by 2019 at $184 per share. This analysis has been updated to include the recent partnership with Google and programmatic offering Ad Studio.Spotify will be a Sell Recommendation by 2019 at $184 per share. This analysis has been updated to include the recent partnership with Google and programmatic offering Ad Studio.
Half Full or Half Empty? -6% ARPU in Q3 Compared to -12% ARPU in Q2
Spotify Technology met its Q3 forecast for paying subscribers and a few other metrics, but average revenue per user declined due to promotional accounts for families and students. Spotify ended the period with 87 million Premium subscribers worldwide, up 40% year-over-year. Spotify has 109 million monthly active users of its advertising-supported streaming service, up 8 million from Q2 or 20% YoY.
This quarter, Spotify’s average revenue per user percentage has improved but QoQ growth is still in the red. Average revenue per user declined to $5.50 in Q3 from $5.83 in Q2, or -6% following -12% the previous quarter.
Costly Partnership with Google
Spotify lacks the razor-razor blade Gillette analogy for tech companies, which in this case states you should have ownership of a device if you want to bank on the subscriptions. This is one reason I’ve been long on Roku since its IPO. Roku players are the cheap razors that will deliver the razor blades of ad-supported content in the OTT market. (You can read my analysis on Roku here). However, this lack of device ownership is causing trouble for Spotify. Smartphones dominated by Apple and Google are only part of the story. At home assistants such as Alexa are being designed and leveraged specifically for AI activated music services. To get a glimpse of Spotify’s future, consider that major record labels let Amazon offer a reduced Alexa version of the premium service at $3.99 per month and Apple is requiring users to sign in to Apple Music to power the HomePod – which completely shuts out devout Spotify users.
Spotify’s new strategy is to partner with Google to offer free Google Home Mini speakers to users who subscribe to the Family plan as part of a holiday season promotion. The partnership comes at a cost of approximately 50 basis points to the Gross Margin profile in Q4, the company noted. From Google’s standpoint, they get their entry level smart speaker into more homes, while Spotify benefits by having a partner for smart home infrastructure. Ultimately, this is one example of the lengths Spotify will have to go to in order to compete with Apple and Amazon on their home turf.
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Apple has Homefield Advantage
Most certainly, Apple won’t be beat in its own ecosystem. Apple revolutionized digital music with the iPod and iTunes. With smartphone penetration, the Beats acquisition, its Homepod ecosystem and a huge push into connected car infotainment, Apple can surround Spotify in nearly every direction. Keep in mind, that 66% of the world’s paying app users are iPhone users who trend towards higher incomes (vs. only 34% on Android), so Apple users are supremely important for Spotify’s $9.99 subscriptions.
In fact, the turf war has already receded Spotify’s market share. Record industry sources state Apple is adding paying subscribers at a rate of 5 percent in the U.S. versus 2 percent for Spotify, and that Apple Music may have already taken over Spotify as the number one streaming service in the United States.
In addition, Apple was cleared to complete the acquisition for UK-based music recognition app Shazam Entertainment for $400 million. Due to the threat this poses to Spotify and other smaller apps, regulators in seven countries contested the acquisition when Apple’s plans were first announced. Despite these efforts, the acquisition was approved in August of 2018. To date, Shazam has had well over 1 billion downloads, last reported in 2016, and owns a wealth of information on what music is trending with over 20 million searches per day.
Can Programmatic Ads Save Spotify?
Tim Cook is a chief critic on how applications and websites use private data to increase the accuracy of targeted advertising. Therefore, one area Apple clearly won’t compete is in the brokering of programmatic ads based on users’ music choices. Meanwhile, Spotify has every intention of letting advertisers target its users through Ad Studio.
Spotify would not be the first mobile application to supplement its core product with a programmatic offering. Facebook and Twitter owe at least 1/6thto 1/4thof their current revenue to programmatic proving it can substantially increase average revenue per user. Therefore, if Ad Studio is executed correctly, it may have the potential to limit stock losses even with stiff competition from Apple and Amazon.
“Last quarter we said that we expected our Programmatic and self-serve products to become a significant portion of our Ad-Supported revenue. If we’re successful in achieving this shift in revenue mix, then we also expect to achieve significant operating leverage in the ad sales business, increasing our operating margins. Last quarter we reported on our new automated self-serve platform, Ad Studio, which is live in the US, UK, Canada, and Australia. Ad Studio revenues are still quite small, but we’re seeing exponential growth, so expect to hear more about this product in future quarterly updates.”
Note About Tencent Music IPO:
Spotify owns Tencent Music Entertainment (TME) shares and it’s been stated in past financial reports that “a TME IPO would trigger a fair market value adjustment to the carrying value of our investment recognized in other comprehensive income. The gain could be significant.” This one-time, non-recurring event would generate a Net income for Spotify with a Net loss returning in the following quarters. Spotify stock holders should be aware that this one-time wave may be worthwhile to hold on for, but that the long-term prospects of the company are still not proven.
Conclusion
Spotify is a small fish in deep waters. Q3 earnings prove music streaming is a tough business. The company is attempting to partner with device owners, like Google, but these partnerships will eat away at Gross Margins in future quarterly earnings. I’m forecasting that Spotify will be in sell status through 2019 unless they can prove themselves with a strong programmatic offering through Ad Studio. Note the Tencent Music IPO will generate a net income for Spotify in the current quarter.
This article and previous Spotify analysis written by Beth Kindig has been published on Seeking Alpha. All original analysis contained herein should be appropriately credited to Beth Kindig.
To summarize, the $5 Billion Antitrust Fine on Google is due to the following issues:
Google has required manufacturers to pre-install the Google Search app and browser app (Chrome), as a condition for licensing Google’s app store (the Play Store);
Google made payments to certain large manufacturers and mobile network operators on condition that they exclusively pre-installed the Google Search app on their devices; and
Google has prevented manufacturers wishing to pre-install Google apps from selling even a single smart mobile device running on alternative versions of Android that were not approved by Google (so-called “Android forks”) source: European Commission
New gadgets and the promise of AI have helped to successfully rebrand Google’s search and advertising business, however, it’s important to remember that Alphabet is still an old-fashioned advertising company with nearly 90% of Q1 2018 revenue, or $26.6 billion, coming from advertising and only 15%, or $4.6 billion, coming from these other ambitions.
Therefore, understanding the nuances of advertising especially as it relates to data collection is going to be key for Alphabet investors. Unfortunately, top-rated analysts struggle to understand Alphabet’s business model and CEO Sundar Pichai did not offer any answers. In the Q1 2018 earnings call, Mark Mahaney of RBC Capital Markets asked if the “GDPR or other regulation is likely to impact materially the targeting capabilities that advertisers have on Google?” The CEO replied:
“You know, above everything else as we are working through GDPR we are making sure we are focused on getting that user experience right for our users and our partners. But to clarify your question further, you know, first of all, it’s important to understand that most of our ad business is Search, where we rely on very limited information, essentially what is in the keywords to show a relevant ad or product.”
This answer was over-simplified at best. Yes, Search is a large driver of revenue but what are the other portions of the advertising machine which will be affected? And how much revenue do the higher risk methods currently contribute to earnings?
Data & the $5 Billion Antitrust Fine: The Good, The Bad and The Ugly
The Good: Search Doesn’t Need Data; Gmail, Chrome and Google Maps Have User Consent
Quite a few of Google’s data-driven applications and services such as Gmail, Chrome and Google Maps can easily obtain user permission in exchange for the services these applications and browser provides. In addition, Google AdWords, which is based off search intent, will provide a safe haven for Google’s advertising revenue as this does not require the company to harvest private data. However, even search is not immune as it’s been enriched with data such as location to enhance search results.
The Bad: Android OS Collects Surveillance-Level Data without User Consent through pre-installed applications
While pre-installed applications help cement Google’s search dominance, there is much more going on behind the motivation for risking antitrust violations. It’s hard to know where to start when looking at Google’s sprawl of potential data regulation and antitrust issues. We could start with the fact they have a deal with data brokers that gives them access to 70% of our purchases made with credit cards and debit cards (without consent). The company is literally in your bank account. This is for the purpose of letting advertisers know if you completed a sale following an ad seen on one of Google’s properties. Another place to start is implicit data for advertising purposes, which uses your search history to target ads to you outside of Google search. This is why when you privately email your friend about a trip to Rome, you mysteriously get advertisements for flights to Rome on other websites. In one study of 850,000 internet users last year, mainly in the U.S. and Europe, Google tracked 64% of all pages loaded by mobile and web browsers.
While online tracking and conversion tracking are both invasive, the Android operating system is a surveillance-level behemoth with over 2 billion devices in circulation while littered with millions of applications leaking data to Alphabet’s advantage. Exponentially speaking, Android is impossible to contain. One study by the French research organization Exodus Privacy and Yale University’s Privacy Lab found that more than three in four Android apps contain a third-party tracker which extracts personal information, including location and in-app behavior. The apps the trackers were discovered includes Uber, Twitter, Spotify, and Tinder. The Privacy Lab found the in-app trackers revealed “an extensive data mining market buried within the mobile app ecosystem” enabling physical surveillance including through the use of WiFi, Bluetooth and ultrasonic sound inaudible to the human ear to track geolocations in real time.
Takeaway (from my article dated May 31st): Android will be the most likely source for fines by the European Union as it will be challenging to partition device IDs by geographies. Some have conjectured Alphabet will risk fines before voluntarily reducing their cyber intelligence. The fines are 1.6% of annual global revenue, or $4.4 billion for Google.
Update: Antitrust is a much better approach to breaking up the monopoly Google has on data collection.
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The Ugly: Walking the Razor’s Edge Between Data Violations and Non-Personalized Ads
Data collected from the Android OS augments and enriches data science modeling for Alphabet to monetize the data elsewhere. That “elsewhere” is Adsense, AdX and AdMob. Google’s AdSense and AdX Networks enable non-Google websites to incorporate Google display advertising, and this is what current publishers are in an uproar about.
To summarize, Alphabet is attempting to become a co-controller for data in some instances and a processor in other instances. It’s unknown how the European Union will view data leaks from publishers to Alphabet.
Source: Quora
The level of involvement Google has as either a co-controller or processor is important for investors to understand as these regulations continue to play out. This may be hard to imagine today, but if data collection returns to property-owned data collection only, then the premium price advertisers pay for Google ad inventory may diminish as Google will struggle to differentiate itself from other advertising options from a campaign ROI standpoint if or when it fails to get the proper consent to collect the data and broker the ads.
Source: Statista
The worst case scenario here is that Google has to display “non-personalized” ads where consent isn’t obtained — which Google is already prepared to do: “As previously announced, we’re also launching a Non-Personalized Ads solution (DFP/AdX, AdMob, AdSense) to enable publishers to present EEA users with a choice between personalized ads and non-personalized ads (or to choose to serve only non-personalized ads to users in the EEA).”
As mentioned above, this is where the premium price can potentially recede. By being forced to serve non-personalized ads, the competitive advantage Google has will diminish in this circumstance.
Bottom Line:
While Search is intact, there are many layers to data collection and ad targeting which will lower ROI campaign performance as the data Alphabet is allowed to collect continues to wane. In this article, we’ve discussed that the Android OS is leaky and the most likely part of Alphabet’s business to be fined. As far as revenue is concerned, non-personalized ads is the potential weakness especially on network sites as $17.59 billion was earned from network sites annually in 2017.
This article originally appeared in VentureBeat.VentureBeat.
By all accounts, mobile advertising is the wave of the future. Mobile ad spend is projected to increase 430 percent between 2013 to 2016, when it’s expected to surpass $100 billion worldwide, according to eMarketer. By 2019, overall ad spend will go on to surge to an estimated $200 billion. This is record-breaking growth, and it’s no wonder we are seeing this level of investment considering we’ve seen mobile usage recently exceed desktop.
It’s exciting to be in mobile today. You couldn’t ask for more users, more eyeballs.
Yet there are still a few unanswered issues. Those spending big dollars on mobile, namely advertisers, publishers driving installs, and also brands and agencies, have a few key indicators they want to meet, including a reasonable level of accuracy, optimization, reach, and of course, performance. The mission is to deliver the correct content at the right moment closely matched to the intention of the person viewing the ad.
But whether this happens or not is an absolute mystery on mobile today. We may know someone installed an app, but they may never open that app again. We can measure clicks, but this has led to fraud and has also prevented brands from feeling confident that a “click” is the result they want from a campaign.
To loosen the bottleneck, we need to look at the yardstick we are using. We need to measure accuracy. We need to measure optimization. We need to measure reach. And we need to measure performance. The common denominator across all KPIs is how to measure both the audience and the campaign performance.
There are three predominant methods for measuring mobile ad performance today and each has its limits.
CPI: Cost per Install. This measurement is unique to mobile and was initiated for mobile publishers who doubled as advertisers. These publishers needed installs on their mobile apps, therefore, user acquisition dictated a new form of campaign measurement. It’s also the easiest (and first) way of measuring effectiveness in mobile video, although it limits the number of advertisers to only those who want to drive app installs.
CPI is also a higher risk to the publisher because they only get paid when the install occurs. As a result, the user experience is often quite bad because the user sees the ad over and over again, with the ad exchange favoring whatever means necessary to procure the install.
Weaknesses: Not every advertiser wants to drive an app install. Plus, users are gravely affected by the repetition of ads.
CPC: Cost per click came from desktop and originated in search, where the main function of the ad was to lead the user to a website or product page to initiate the conversion funnel and close the purchase. On desktop, CPC works best when tied to targeted keywords, relying on search terms to narrow relevancy and qualify who is clicking on the ad. Display ads on desktop naturally became display on mobile, although the screen size and user no longer matches the desktop actions that display was originally intended for.
Weaknesses: Clicks have never been a good measure of media outside of search. Mobile amplifies this problem with many erroneous clicks being attributed to media performance. We’ve seen a rise in fraud from bots, especially among Open real-time bidding markets and other programmatic exchanges. Plus, CPC does not address video, where the mobile market is headed, with 12.8 percent of impressions currently equaling 55 percent of revenue.
CPCV: Cost per completed view. This measurement is more favorable for video, especially when used with hybrid mediation algorithms, because it measures according to the effectiveness of the ad per completed view. Therefore, the correct content, the right moment, and the intention of the person viewing the ad has been achieved, in theory, because the video ad has been completed.
Weaknesses: Factors such as whether the ad is skippable or non-skippable and rewarded or non-rewarded play into why it was completed. CPCV is also not equipped (yet) for cross-device measurement. There have been variations on this form, such as CPMV (cost per 1,000 views), however, this does not take into account if the video ad was completed or not.
Given the shortcomings of these common measurement methods, it’s no wonder we are seeing a push towards new forms of measurement. Interestingly enough, the most recent form of measurement to emerge for mobile isn’t new at all. It comes from an environment where advertisers have been consistently measuring audiences for quite awhile now: television.
GRP: Gross Rating Point is calculated by the percent of the target market reached multiplied by exposure frequency. There are innate benefits to using the GRP measurement: First, having originated from television, the strength of the GRP is in measuring elusive eyeballs on video-produced ads – comparing mobile video to television, you can see why CPI is not conducive (there’s nothing to install). Second, advertisers are comfortable with this measurement system. It makes sense to invite the majority share of ad spend (which is television, at 42 percent, in the United States) to the mobile conversation by speaking in familiar language as to how ads are measured. Last – but definitely not least – the gross rating point is ideal for cross-device measurement because it takes into account exposure frequency. This last point may be the clincher for why the aforementioned three metrics will lose effectiveness over the next few years.
Weaknesses: Because the GRP is a navigational metric, it’s a measurement of how you approach your audience and how the budget is spent rather than providing an analysis of whether your ad was viewed and what action (if any) was taken.
The next chapter in measurement will be driven by people-based metrics and behaviors. Who is watching these ads is what advertisers need to know; completion rate – including CPCV – is not enough information to determine performance. Meanwhile, installs are singular in purpose, excluding most brands, and clicks are troublesome at best. GRP may or may not be the correct answer; however, it is a move in the right direction for mobile video ads. Today, most targeting and optimization is at the app level, not the people level, and this has resulted in inefficient media spend.
Summary: This analysis answers the following questions:
Search is a large driver of revenue and doesn’t require data but what other portions of Alphabet’s advertising model will be affected by the GDPR?
How much revenue do the higher risk methods currently contribute to earnings?
Where is Alphabet most likely to incur GDPR fines?
How will non-personalized ads affect earnings and network sites?
Alphabet (GOOG) was announced in 2015 as a holding company to help separate Google’s advertising business from the sprawling investments in Fiber internet, cloud computing, smart home products and connected car products. While these new gadgets and the promise of AI have helped successfully rebrand Google’s search and advertising business, it’s important to remember that Alphabet is still an old-fashioned advertising company with nearly 90% of Q1 2018 revenue, or $26.6 billion, coming from advertising and only 15%, or $4.6 billion, coming from these other ambitions.
Therefore, understanding the nuances of advertising especially as it relates to data regulations is going to be key for any savvy Alphabet investor. While you can invest in Alphabet for AI or connected cars, we are in the beginning of the hype cycle for these technologies, whereas the current stock price reflects advertising. Unfortunately, top-rated analysts struggle to understand Alphabet’s business model as it relates to the GDPR and CEO Sundar Pichai did not offer any answers. In the Q1 2018 earnings call, Mark Mahaney of RBC Capital Markets asked if the “GDPR or other regulation is likely to impact materially the targeting capabilities that advertisers have on Google?” The CEO replied:
“You know, above everything else as we are working through GDPR we are making sure we are focused on getting that user experience right for our users and our partners. But to clarify your question further, you know, first of all, it’s important to understand that most of our ad business is Search, where we rely on very limited information, essentially what is in the keywords to show a relevant ad or product. And so, you know, we’ve been preparing this for 18 months and I think I think, you know, we have focused on getting the compliance right. It will be a years’ long effort and, you know, we are helping not just us, but our publishers and partners. But overall, we think we’ll be able to do all that, you know, with a positive impact for users and publishers and advertisers, and so our business.”
This answer was over-simplified at best. Yes, Search is a large driver of revenue but what are the other portions of the advertising machine which will be affected? And how much revenue do the higher risk methods currently contribute to earnings?
In addition, while Alphabet has been preparing for 18 months, they recently dropped new terms and conditions on publishers only 8 weeks before the GDPR took effect – and publishers are not happy about it.
Publishers are essential for quite a few elements to the Alphabet’s advertising machine as they provide additional surface area for ad space. By installing Google’s ad software onto websites and applications, publishers allow Google to advertise on their sites.
Most importantly, because this relates to ad revenue from networks outside of Google-owned properties, this portion of revenue is what holds the highest risk in this new era of data regulations – and the revenue is sizeable enough to lead to missed earnings in the future.
Alphabet & Data Regulations: The Good, The Bad and The Ugly
The Good: Search Doesn’t Need Data; Gmail, Chrome and Google Maps Have User Consent
Quite a few of Google’s data-driven applications and services such as Gmail, Chrome and Google Maps can easily obtain user permission in exchange for the services these applications and browser provides. In addition, Google AdWords, which is based off search intent, will provide a safe haven Google’s advertising revenue as this does not require the company to harvest private data. However, even search is not immune as it’s been enriched with data such as location to enhance search results.
The Bad: Android OS Collects Surveillance-Level Data without User Consent
In one study of 850,000 internet users last year, mainly in the U.S. and Europe, Google tracked 64% of all pages loaded by mobile and web browsers
It’s hard to know where to start when looking at Google’s sprawl of potential data regulation issues. We could start with the fact they have a deal with data brokers that gives them access to 70% of our purchases made with credit cards and debit cards (without consent). The company is literally in your bank account. This is for the purpose of letting advertisers know if you completed a sale following an ad seen on one of Google’s properties. Another place to start is implicit data for advertising purposes, which uses your search history to target ads to you outside of Google search. This is why when you privately email your friend about a trip to Rome, you mysteriously get advertisements for flights to Rome on other websites.
While online tracking and conversion tracking are both invasive, the Android operating system is a surveillance-level behemoth with over 2 billion devices in circulation while littered with millions of applications leaking data to Alphabet’s advantage. Exponentially speaking, Android is impossible to contain. One study by the French research organization Exodus Privacy and Yale University’s Privacy Lab found that more than three in four Android apps contain a third-party tracker which extracts personal information, including location and in-app behavior. The apps the trackers were discovered includes Uber, Twitter, Spotify, and Tinder. The Privacy Lab found the in-app trackers revealed “an extensive data mining market buried within the mobile app ecosystem” enabling physical surveillance including through the use of WiFi, Bluetooth and ultrasonic sound inaudible to the human ear to track geolocations in real time.
Takeaway: Android will be the most likely source for fines by the European Union as it will be challenging to partition device IDs by geographies. Some have conjectured Alphabet will risk fines before voluntarily reducing their cyber intelligence. The fines are 1.6% of annual global revenue, or $4.4 billion for Google.
The Ugly: Walking the Razor’s Edge Between Data Violations and Non-Personalized Ads
Data collected from the Android OS augments and enriches data science modeling for Alphabet to monetize the data elsewhere. That “elsewhere” is Adsense, AdX and AdMob. Google’s AdSense and AdX Networks enable non-Google websites to incorporate Google display advertising, and this is what current publishers are in an uproar about.
To summarize, Alphabet is attempting to become a co-controller for data in some instances and a processor in other instances. It’s unknown how the European Union will view data leaks from publishers to Alphabet.
Source: Quora
The level of involvement Google has as either a co-controller or processor is important for investors to understand as these regulations continue to play out. This may be hard to imagine today, but if data collection returns to property-owned data collection only, then the premium price advertisers pay for Google ad inventory may diminish as Google will struggle to differentiate itself from other advertising options from a campaign ROI standpoint if or when it fails to get the proper consent to collect the data and broker the ads.
The worst case scenario here is that Google has to display “non-personalized” ads where consent isn’t obtained – which Google is already prepared to do: “As previously announced, we’re also launching a Non-Personalized Ads solution (DFP/AdX, AdMob, AdSense) to enable publishers to present EEA users with a choice between personalized ads and non-personalized ads (or to choose to serve only non-personalized ads to users in the EEA).”
As mentioned above, this is where the premium price can potentially recede. By being forced to serve non-personalized ads, the competitive advantage Google has will diminish in this circumstance.
Bottom Line:
While Search is intact, there are many layers to data collection and ad targeting which will lower ROI campaign performance as the data Alphabet is allowed to collect continues to wane. In this article, we’ve discussed that the Android OS is leaky and the most likely part of Alphabet’s business to be fined. As far as revenue is concerned, non-personalized ads is the potential weakness especially on network sites as $17.59 billion was earned from network sites annually in 2017.
