Snap Update: Missing Low End of Q2 Guidance

I’ll have a pre-earnings write-up on Nvidia tomorrow before 2 pm EST on the forum tomorrow and you’ll get a full-length analysis delivered to your inbox by Thursday. You can view a preview of my thoughts here on Nvidia from my appearance on TD Ameritrade Network today where I discuss the gaming segment (main culprit for the current selloff) and the longer-term thesis for the company.view a preview of my thoughts here on Nvidia from my appearance on TD Ameritrade Network today where I discuss the gaming segment (main culprit for the current selloff) and the longer-term thesis for the company.

Pre-earnings announcements don’t give us much to go off of, which is why sentiment and price action can be very negative when these occur. We don’t get a glimpse at the current financials, the forward guide, or an hour with the management team to elucidate what caused the announcement.

We are sticking with our position on Snap right now for the reasons we stuck with it during the October selloff, which is that we like the first-party data, the DAU growth is quite strong, and there is evidence direct response was strong post-IDFA.

Primarily, Snap’s demographic is key for advertisers and we think owning this audience will offer a launching off point for AR/VR. Snap doesn’t need AR/VR necessarily as it’s currently one of the fastest-growing social media companies on the market.

Instagram was growing at 10% year-over-year in 2018 and has leveled off to an estimated 2.2%. Twitter grew 15% year-over-year in Q1. Snap grew 18% and has grown 20% the previous four quarters. I believe DAU growth is critical right now and over the next few quarters as it’ll prove which social media platforms emerge from Covid capable of growth.

Macro has been tough across the board for ad-tech and then there have been additional overhanging changes to how data is collected. Unity’s report a week earlier was another shock dealt to ad-tech investors. We covered this here.

The issue at hand is that Snap had provided a 20% to 25% guide and is now stating: “As a result, we believe it is likely that we will report revenue and adjusted EBITDA below the low end of our Q2 2022 guidance range.”

Below is the transcript of Snap’s discussion around growth as it pertains to Q1 and Q2. We had also covered this in a forum post that Snap was seeing the following revenue growth rates, as discussed in the earnings call.

• 44% growth through Feb 23rd prior to the Ukraine situation and a “10-day pause on ad campaigns”
• 32% growth in March
• 30% growth in April

Here is the quote:

“Total revenue for Q1 was $1.63 billion, an increase of 38% year-over-year. Revenue growth in Q1 initially exceeded our expectations entering the quarter, with year-over-year growth of approximately 44% through February 23. In the days immediately following Russia’s invasion of Ukraine on February 24, we observed that a large number of advertisers initially paused their campaigns. The vast majority of clients resumed their campaigns within 10 days following the invasion. And daily average revenue in March exceeded pre-invasion levels, but the rate of year-over-year growth remained below pre-invasion levels at approximately 32% from February 24 through the end of Q1.”In the days immediately following Russia’s invasion of Ukraine on February 24, we observed that a large number of advertisers initially paused their campaigns. The vast majority of clients resumed their campaigns within 10 days following the invasion. And daily average revenue in March exceeded pre-invasion levels, but the rate of year-over-year growth remained below pre-invasion levels at approximately 32% from February 24 through the end of Q1.”

In the call this caused Snap to issue guidance of 20% to 25%, stating:  

“Given the uncertainty caused by these challenging circumstances, we have opted to share that our growth rate thus far in Q2 is approximately 30% year-over-year or just below the approximately 32% growth rate we observed following the invasion of Ukraine in Q1. That said, we are concerned that the operating environment ahead could be even more challenging, leading to further campaign pauses or advertiser budget reductions. As I noted earlier, our prior year comparisons are more difficult in Q2 than in Q1. Given this, we believe that revenue guidance of 20% to 25% year-over-year revenue growth in Q2 is reasonable.”we have opted to share that our growth rate thus far in Q2 is approximately 30% year-over-year or just below the approximately 32% growth rate we observed following the invasion of Ukraine in Q1. That said, we are concerned that the operating environment ahead could be even more challenging, leading to further campaign pauses or advertiser budget reductions. As I noted earlier, our prior year comparisons are more difficult in Q2 than in Q1. Given this, we believe that revenue guidance of 20% to 25% year-over-year revenue growth in Q2 is reasonable.”

Probably the most thorough was this quote from Derek Anderson, although there are others packed into the call:

“Hi, Ross, it’s Derek speaking. I’ll take the first part of your question, and then I’ll hand it over to Jeremi to help with the second part. So, at a high level on what we’re seeing as we look forward to Q2, the operating environment remains challenging and forward-looking visibility, as I noted earlier, is more difficult than probably at any point in recent memory. We have shared that our business has grown at a rate of approximately 30% quarter-over-quarter to-date, but we’re concerned that the operating environment could be even more challenging going forward. More specifically, the headwinds that impacted our business in Q1 have persisted into Q2, and we believe the impact of the war on Ukraine has been significant, and this impact is particularly difficult to predict going forward. As a result, we are concerned we could see additional campaign positives or advertiser budget reductions in the future. The comparisons, as I noted are also getting tougher. As a reminder, our top line growth accelerated by 50 percentage points in Q2 of last year to reach 115%. So, all of these factors together have informed our guide of 20% to 25% year-over-year in Q2. Importantly, though, I’d say the fundamentals of our business remain intact. We’re pleased with what we’re seeing and the strong growth in DAU. We continue to have deep penetration of hard-to-reach demos in the most important advertising markets. And of course, we’ve got a sophisticated ad platform that delivers measurable returns and results. So we are focused on investing in our teams and our products and delivering measurable return on advertising investment to our advertising partners. So hopefully, that gives you some background and context on how we’re seeing the outlook going forward and what uncertainty – what’s uncertain about that. I’ll turn it over to Jeremi to take the second part there.”“Hi, Ross, it’s Derek speaking. I’ll take the first part of your question, and then I’ll hand it over to Jeremi to help with the second part. So, at a high level on what we’re seeing as we look forward to Q2, the operating environment remains challenging and forward-looking visibility, as I noted earlier, is more difficult than probably at any point in recent memory. We have shared that our business has grown at a rate of approximately 30% quarter-over-quarter to-date, but we’re concerned that the operating environment could be even more challenging going forward. More specifically, the headwinds that impacted our business in Q1 have persisted into Q2, and we believe the impact of the war on Ukraine has been significant, and this impact is particularly difficult to predict going forward. As a result, we are concerned we could see additional campaign positives or advertiser budget reductions in the future. The comparisons, as I noted are also getting tougher. As a reminder, our top line growth accelerated by 50 percentage points in Q2 of last year to reach 115%. So, all of these factors together have informed our guide of 20% to 25% year-over-year in Q2. Importantly, though, I’d say the fundamentals of our business remain intact. We’re pleased with what we’re seeing and the strong growth in DAU. We continue to have deep penetration of hard-to-reach demos in the most important advertising markets. And of course, we’ve got a sophisticated ad platform that delivers measurable returns and results. So we are focused on investing in our teams and our products and delivering measurable return on advertising investment to our advertising partners. So hopefully, that gives you some background and context on how we’re seeing the outlook going forward and what uncertainty – what’s uncertain about that. I’ll turn it over to Jeremi to take the second part there.”

Obviously, this kind of thing is disappointing and it can be hard to see the forest through the trees when the market dumps a stock like it did with Snap. I believe Snap investors need to determine if they trust management as the long-term goal for this company is for 50% revenue growth on a high revenue base of over $1 billion annually. If you trust the management when they say it’s macro, then you’d stay in the stock. If you don’t trust the management, and an investor believes it to be inherent to the product, then it’ll be a long road until we get the next earnings call.

The other reason we are sticking with Snap is that this is not an isolated incident by any means. We’ve seen bad news from management teams across the board: Google, Facebook, Snap, Roku, and Unity. As you know, we’ve been clear that we view this as transitory and a buying opportunity. If supply constraints had eased, if there was no war in Ukraine, and if Apple had not made any data collection changes, then we could point to consumer. I think it’s a mix of all four that has led to ad-tech trading at 1/3 to 1/2 it’s reasonable top-line valuation (for the sector) of 10 forward P/S.

I guess if we were to drill deeper into whether its product-related for Snap, it would either be seen in DAUs – which grew steadily – and then also the timing of Apple’s changes. If we use Meta as a baseline for a company where management has agreed they will see IDFA headwinds, revenue growth decelerated from 35% growth in Q3 (pre-IDFA changes) to 20% growth in Q4, 6.5% growth in Q1 and 0% growth at the midrange for Q2. In other words, the impact began much earlier in Q4 and was on full display in Q1.

Snap reported 42% growth in Q4 and 38% growth in Q1. This would point to something unique happening in Q2 which management has stated is due to European ad spend and coming up against tough comps. What we know now is that Snap will not meet guidance for 20% minimum growth this quarter.

Overall, Unity is guiding the lowest across the more major ad-tech companies with 7% growth at the midpoint for next quarter. Roku’s guide is for 25% growth next quarter and The Trade Desk is guided for 30% growth. The market is concerned these guides won’t pan out but the correlation may not be as strong as the market is pricing in if Snap’s is mainly due to the Europe segment. The Trade Desk likely resilient here compared to YouTube, Facebook and Snap as the company does not need to suspend advertising as a publisher due to Russia-Ukraine war. The company also doesn’t have to manage supply/shipping issues like Roku. Again, we think these are transitory issues for publishers and hardware-related companies.

Quick Note on DAU:

Snap is reporting high DAU growth and according to a few analysts, they expect this to be a beat according to their channel checks. We also noted that upfront commitments grew 60% last quarter. We will be watching these two numbers very closely in the next earnings report. Global ARPU had expanded 17% YoY and gross margin expanded 22% over the past three years. The company was profitable for the first time last year, which is key in this market.

Jefferies analyst Brent Thill lowered the firm's price target on Snap to $30 from $52 and keeps a Buy rating on the shares, arguing that the company's pre-announcement that Q2 revenue growth will likely come in below its initial 20%-25% guidance is "indicative of a rapidly deteriorating macro environment that will likely impact the whole ad industry." He is lowering his FY22 and FY23 revenue estimates for a number of other digital advertising companies by an average of 3% and 6%, respectively, but doesn't view the shortfall in revenue as a competitive issue for Snap as his third-party data checks suggest DAUs could beat guidance, Thill tells investors.

Apple’s WWDC in June:

We covered in the past that Apple and Snap are complementary to one another in augmented reality. It was Apple’s LiDAR scanner that furthered Snap’s R&D in augmented reality and when growth in Snap’s creator community began to grow. There are rumors that Apple will release it’s first AR/VR headset either in late 2022 or in 2023.

That may seem like a long ways off but catalysts are most important to identify when a stock’s valuation is trading at an all-time low. How big could AR/VR get? According to this article, Apple expects it will replace the iPhone with AR glasses ten years from now. Whether AR glasses replace iPhones is not something investors need to necessarily have happened, rather it helps illustrate Apple’s size of ambitions around this area. What we want to know is that there’s a heavyweight in AR hardware and distribution that can create an inflection point on the consumer side for Snap’s R&D efforts.

Fingerprinting Announcements at WWDC:

Are you tired of hearing about Apple’s IDFA changes and Apple’s new App Tracking Transparency (ATT) policy? Well, you can start to focus on fingerprinting now and what iOS 16 may hold for publishers who use IP addresses for conversions. I plan to write about this if we do get an announcement. In the meantime, here is some background information

Conclusion:

Here is what management said in their note regarding both the lower guidance and slowdown in hiring:

“we continue to face rising inflation and interest rates, supply chain shortages and labor disruptions, platform policy changes, the impact of the war in Ukraine, and more.”

Knox cut the position from 6% to 3% on May 4th and we sent a trade alert out to that effect. This helps illustrate why we use technicals. We rarely cut this much in one move. He had spotted a weak chart and Knox asked if I cared to stand in front of that chart. I declined to do so as management was pretty transparent in my opinion about the Ukraine situation leading to impact on the Europe segment in the call.

The position sizing we have on Snap is likely to remain until we get our next earnings call and we will update you if anything changes. With that said, adding back 1% is on the table if/when Knox sees strength in the chart.