I couldn’t be more disappointed with Snap’s management. Not only the lack of guidance but the lack of willingness to describe exactly what the issue is with their business.  

In the call, the management said they are seeing 9% growth to-date this quarter yet are modeling revenue to be flat year-over-year. This is an absurd comment to not substantiate. Why would August be 8% growth, October 9% growth and the holiday season be negative growth, which in turn weighs on October’s progress? I’m not sure which is worse, was this a flippant comment they made and we will see 9% or higher growth come next quarter? Or, are they really seeing such a serious headwind that November and December will greatly decelerate? I believe I have identified the serious headwind with no help from Snap’s management team, which I detail below. 

Here is one comment that was made on the call regarding the expected revenue deceleration during the holiday season:

“By the end of August, when we shared 8-K about the restructuring, the quarter-to-date revenue had improved to about 8%, and so that implied things accelerated a bit. With the full quarter number at 6% this quarter, obviously, things slowed down into about the low single digits in September, so. And then we’ve seen things move up a bit in the beginning of this quarter with the early weeks being at about 9%.”

Here they try to spin the December quarter:

“It’s Derek speaking. I’ll take the first part of that and then hand it up to Evan. I think first, just stepping back for context on Q4. Even flattish year-over-year revenue growth is about a 15% step-up on a quarter-over-quarter basis. So, we are expecting revenue to grow seasonally at a pretty good clip. So, the issue that we’re seeing here is that if you look back to a year ago, we grew at over 40% year-over-year in the prior year. And many of the really significant macro impacts that we’ve seen over the course of this year weren’t impacting the business nearly as much as they were a year ago.”

To add to the absurdity, they have relied on excuses such as Ukraine, macro for brand advertisers or Apple’s changes. This doesn’t explain why November and December would weigh on October as both are consistent (not variables) throughout Oct-Dec.

Here, an analyst calls out that it doesn’t totally add up:

“Just on the brand side. I think many are curious kind of why brand will suffer so hard going into a seasonally strong period. Is this more macro-related? Is it — given some of the restructuring, is that having some impact?”

This was the answer, which was not a good one: “And certainly, with the performance that we saw from the brand portion of the advertising business in Q3 gives the — sort of informs our expectation of the decel to move through the rest of the quarter.”

So, I’m sitting here wondering why a 19% DAU growth isn’t translating to higher revenue growth and trying to sift through the garbage being stated on the call. Following strong DAU growth for many quarters, management is providing a 6% growth rate this quarter and “maybe” a 9% growth or “maybe” a 0% growth rate. Something is very wrong here.

Furthermore, how can the 19% DAU growth not give them more confidence in terms of the revenue they can drive next quarter?

Because I’ve worked around mobile global UA, I believe the answer to this question is that Rest of World user growth greatly weighs on this company’s business model. This is the only true explanation that makes sense to me. If the majority of the user growth is in the $0.90 ARPU to $1.00 ARPU, then this is going to pull down revenue. This also means that next quarter — even with strong DAU growth — the company cannot accurately guide because ROW cannot monetize high enough to support YoY growth.

I pointed this out in the analysis here for our Re-Entry when I stated: "My interpretation is that DAU will outpace revenue growth because DAU growth will come from Rest of World where users are monetized at a lower rate than North America and Europe. This has been the trend over the past year in Snap’s key metrics."

It’s one thing to have advertiser falloff and softer ARPU in North America in the $8.00 ARPU range (which you’ll see below has not occurred!!) and another thing to have even nominal falloff in a region that is at the $1.00 ARPU range, because the majority of the user growth is occurring here, then it only requires small decimal points to drag down overall ARPU quickly.

My regret is believing management when they said it was “platform changes” or “Apple’s ATT” or “macro headwinds. Excuse my language in this write-up, but instead here is the total garbage investors were offered:

“Operationally, our advertising business has become a lot more technically complex over the past few years as advertisers are working to better measure and optimize their campaigns. That means that we need to drive increased coordination across our sales, engineering and product teams, which is one of the reasons I’m so excited to have Jerry leading these teams as our COO. I’ve already observed a significant change in the way that our teams are working together, and I’m really pleased to see the focus on our advertising customers driving everything that they do […] We saw about an 8% increase in impressions year-over-year in the quarter, which is really a function of daily active users and engagements.”

My note: again, this doesn’t address why there would be a deceleration in Nov/Dec and why they can’t guide. The company had 19% DAU growth and 8% growth in impressions and they can’t give a guide? Very strange.

They said eyeballs are doing well again:

“So, at a very high level, both in the U.S. and globally, viewership is up. And so that means that our overall opportunity is expanding if we can continue to increase folks’ depth of engagement. And that’s really important, of course, for advertisers who really value the reach that we provide.”

Here’s a question where Snap could have been more forthright:

“Ross Sandler:

I just wanted to throw the macro question out. So, it sounds like it’s mostly brand advertising that was weak in 3Q, and it seems like that’s the area that’s forecasted to really drop off as we kind of go forward here in 4Q. So, could you just maybe elaborate a little bit on what you’re seeing? What’s — we can obviously see what’s going on with the macro broadly, but specifically to like rest of this quarter, what commitments you’re looking at that would cause those growth rates to kind of dip into the negative?

And then, related to one of the prior questions, you’re growing your DAUs almost 20% and impressions 8%. So, it seems like we’ve just got a demand problem here, not a supply problem. Can you just talk to that a little bit? Thank you.”

I’ll save you the answer they gave which was evasive and focused on “restructuring, “advertisers can turn performance based advertising off very quickly” and “future of AR”

There were moments where they brought up EMEA and APAC, but this was buried and not discussed as a direct answer to the issue:

“And the third thing is bringing top talent to our three president roles for the Americas, APAC and EMEA. One of them Ronan Harris is going to join us next week. This will ensure that we’re improving our focus on customers in every region and getting closer to the customers’ needs. I think these priorities will set Snap up to be successful in this current environment.”

And then again, it was their last comment before closing the call:

“I think one thing I’m watching specifically is on the sales side. We’ve got these president roles. Ronan Harris is joining a bit later this month as our President of EMEA. We will also have an APAC President and an Americas President, and we’ll be putting folks into those roles as soon as we can. And in addition to that, we’re also thinking about how to better organize our sales teams to go to market in a way that best serves our customers. And we’re sort of thinking about Q1 as the time line for that.”

Yet, if this is what’s going on — and it’s my speculation that it is — the management did nothing to connect these dots and continues to rely on many other trivial excuses that don’t add up to the 6 month variability we are seeing (July-Dec).

I believe they are not connecting the dots because it signals something systemic (not that it matters given the severity of the selloff – they could have not shown up to the earnings call and the stock would probably be doing better today).

It’s systemic because the very regions they can grow DAU will, in turn, weigh on their revenue.

I’ve noted the ROW could be a concern in our previous write-ups, but now that I’ve gotten more information on just how disconnected DAU growth is from revenue growth in Q3, and now in Q4, I feel fairly confident we are looking at company struggling to keep up with previous ARPU that had a higher mix of North America and European growth.

Below is Snap’s overall ARPU. Quick glance shows that it’s declining YoY for Q2. It declined again for Q3 Average revenue per user was $3.11 in Q3 2022, compared to $3.49 in Q3 2021 (not pictured below).

In fact, we can see further evidence of this as ROW declined (9%) and North America only declined (1%).

This makes my bullshit detector go off even more with the Apple excuse because iPhones are not used in ROW regions, instead these regions primarily use Android. Android has not gone through the privacy changes (yet) that Apple has.

If Apple was the issue, North America would have fallen off in ARPU by more than (1%) bc this is the highest concentration of iPhone users. Europe’s (5%) also contributes but the Apple excuse is debunked bc Q3 2021 was when these changes occurred and the YoY would be more drastic in North America if Apple was contributing.

If we look at Q2, another big miss in the earnings report, we see the same pattern. North America was up 8% debunking the Apple issues and ROW is down (11%). This creates a (4%) drag on ARPU.

You can see the largest comp for ROW is approaching, which is Q4’s $1.12. All quarters have a high comp in Q4 but you can see the other regions have been doing a decent job of keeping pace.

On a side note, the company states Russia falls within Europe revenue, so the (9%) in the $1.00 region is also not satisfied by the Russia-Ukraine war excuse. Europe (the Ukraine region) up 2% last quarter in Q2.  

So now, it starts to make sense that Snap is not confident about the holiday season as the drag is coming from ROW.

Obviously, I’m incredibly disappointed because the company used the Apple ATT excuse and my understanding is this should be something they can overcome as Snap does not use third party data.

On another note, I firmly believe the company is not selling off due to margins but rather the opaque issues with revenue. This company is going to become FCF positive between $1 billion to $1.5 billion next year and this is well understood. Scanning the analyst notes today, they were encouraged by the bottom line in the report. Not one mentioned ROW revenue, however, despite it’s clear decline in ARPU.

It’s easy to glance at the margins and draw a quick conclusion that the company is very unprofitable, but the well-publicized budget cuts across the board has resolved this issue for the most part.  

The market is forward-looking and as soon as next quarter, the shift toward profitability will begin. In fact, the company beat on the bottom line across the board on top of moving toward greatly improved operating income next year. If anything, this was a positive as market expected ($105) million FCF and company reported +$18 million FCF.

If it were the bottom line, it’d be much more straight forward. Instead, I feel the management is dodging the real issue as to why DAU growth does not translate to revenue growth. The longer the DAU strength continues and the longer the revenue weakness continues, the more of a red flag it has become.

Management is responsible for discussing the real issues with shareholders and ROW should have been directly called out in this earnings call and the previous earnings call.

Even worse, to have so many different storylines that don’t add up … Apple, Ukraine, Macro, Brand Ads – during the holidays nonetheless — supposed to get worse from Oct to Dec …? It simply doesn’t sit right.  

Conclusion:

I had posted this on the forum in the comments and it sums up my thoughts:

“Snap is pulling levers to not burn cash and will have a 20% FCF positive margin, maybe 25%, and this is well understood at this point. Some people point towards SBC which at $700M net (minus buybacks) is 14% of annual revenue. Not the worst I've seen — cloud is certainly much higher with some favorites in the 30% SBC range.

I believe it's the disconnect between user growth and revenue growth that is causing the selloff, and I think it's important to identify the issue bc Snap will be FCF positive moving forward around $1B to $1.5B — so will Snap's new cash profile (which is widely understood to show up in Q4 and beyond following the layoffs and the shutdown of ancillary products with one-time related costs recognized in Q3) fix the issue? If so, it's a buying opportunity.  

I don't think this is a buying opportunity bc what we have is a major disconnect on DAU growth from revenue growth. Why can't the company post a higher growth rate given the 19% DAU growth — usually audience precede revenue growth. If this isn't fixed and the FCF issues are fixed, it may still be problematic business model.” 

This write-up was intended to describe what I truly think the problem is with the business model, with no help from management. This correlation would have been much easier to see if Snap had not created many smoke screens to deter from the real issue.  

I believe institutional analysts are in the same boat, where Snap’s narrative and excuses has distracted them from looking more deeply at the issue. You can sense on the call, they can’t quite grasp it. It’s not terribly difficult to put together – it’s simply a matter of searching for it, which no one is doing because management is feeding so much garbage on the call.  

The conclusion is we are out of the stock with a serious and lingering concern about this management team.