Snapchat: Snapchat+ Key To Profits
Contributor since 2023 / 2053 Followers
Summary:
- Snapchat’s Snapchat+ subscription service has led to significant growth in recurring revenue, boosting company margins and their bottom line.
- The subscription service has driven strong growth in cash flow and EBITDA growth (both past and future), fueling forward projections.
- Despite the recent share price increase, I believe Snapchat remains undervalued with potential for significant upside, supported by strong financial performance and growth prospects.
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Investment Thesis
Since Snapchat (NYSE:SNAP) introduced Snapchat+ in June 2022, the company has benefited from a jump in recurring revenue which I believe changes the trajectory of the company. The premium subscription allows the company to collect SaaS like software revenue and help mitigate the competitive pressures of advertisement networks used by internet giant peers, such as those used by Meta (META) and Google (GOOGL). I believe Snapchat’s subscription-based service is yielding substantial benefits, helping boost overall company margins and therefore contributing to Snapchat’s bottom line. In the latest earnings call, Snapchat reported that Snapchat+ users grew to about 9 million, practically tripling year over year. During JPMorgan’s 52 Annual Global, Technology, Media and communications Conference it was reported that they contributed roughly 7% of the total $1.195 billion revenue for Q1 2024. This is a small piece that I think is set to jump with current growth rates. I am optimistic.
More specifically, Snapchat+ is also already helping drive strong growth in Snapchat’s cash flow and EBITDA. Over recent quarters, Snapchat has shown notable improvements in these key financial metrics which I think is partly why shares have underperformed since their IPO in 2017 (no durable profits means the market will not re-rate the stock higher). The company estimated during the earnings call that the adjusted EBITDA will range between $15 and $45 million in the coming quarter, helping explain why their EBITDA growth will be 28.67% year over year in the forward 12 months, 695.55% above sector median.
With this success from Snapchat, I think shares are severely undervalued (even more so than my last coverage piece). I believe the market is not yet pricing in the explosive growth in profits this subscription program will generate, which I believe will cause upward pressure on the stock (see the valuation section). We are already seeing promising results, despite the subscription service being only 2 years old. I think it will continue to drive profits as Snapchat improves the subscription’s value proposition and it gains in popularity. Given this, I believe Snapchat is still a strong buy.
Why I Am Doing Follow Up Coverage
Since my last analysis of Snapchat in March, the company’s shares have surged by an impressive 37.20%, significantly out beating the market, as the S&P 500 rose by 5.31%. Although I do not believe the market has fully realized Snapchat’s potential growth, I think this increase in stock value demonstrates that investors are somewhat starting to catch on. In my previous article, I highlighted the potential of Snapchat+ and its ability to transform Snapchat’s revenue model, which so far has held true.
With this, and given I have not covered the stock since the last earnings report or post Tik-Tok ban, my analysis shows (I believe) there is now even more room for Snapchat to expand with Snapchat+, still making the social media company a strong investment. With this, I am providing follow up coverage so the readers can price in how this subscription service is beating expectations.
How Is Snapchat+ Impacting Financials?
Snapchat+ has boosted company financials, becoming a key driver of the company’s recent growth. Starting with subscriber count, the recent growth of subscriptions is steady and I believe promising. In September of 2023, the subscription had about 5 million subscribers. In December of 2023 it was 7 million. Flash forward to today, this number has reached 9 million. This is incredible growth and currently running at well over 100% year over year growth (annualized).
This growth in their consumer base has been highly beneficial, as Derek Andersen, Chief Financial Officer, mentioned during the most recent earnings call:
We also continue to make progress towards diversifying our revenue sources with other revenue up 194% year-over-year to reach $87 million. Other revenue includes all non-advertising revenue and consists almost entirely of Snapchat+ subscription revenue – Q1 2024 earnings call.
This is powerful growth. We are not seeing this type of software growth from many of the traditional software giants post ZIRP era.
If the subscriber base has grown to 9 million, this means that monthly revenue for Snapchat from this subscription is roughly $36 million based on the $3.99 monthly fee. On a yearly basis, this would total to about $432 million, assuming the user base doesn’t grow ((however I think it will continue to give the impressive 2 million adds per quarter over the last 2 quarters)).
More specifically, my reasoning for strong continued user growth is based on Snapchat’s continual improvement of subscription value proposition. For example, during the JPMorgan’s 52 Annual Global, Technology, Media and communications Conference, Evan Spiegel, Snapchat CEO, stated
It’s been really fun building the Snapchat+ product. Our team really loves to innovate, and we get all these requests all the time for our community for specific features that they want -JPMorgan’s 52 Annual Global, Technology, Media and communications Conference.
He further went on to mention specifically how the community is generally reacting:
And so, building Snapchat+ was, I think, a really helpful way to align the interest of our community and all the features they want with the investments we’ve been able to make on the product and design side to be able to continue innovating and testing new products with people who really love our service and are willing to pay a little bit to get access to some of those futures -JPMorgan’s 52 Annual Global, Technology, Media and communications Conference.
He then went on to discuss the results:
So, so far, the traction has been surprising to us in the beginning really just started because we knew we had to meaningfully ramp our ML investments. And so, we wanted to take a little bit of the edge off the ML investments while the ad business overall was experiencing some challenges. And so far, it’s been helpful certainly in doing that and has been contributing more to revenue -JPMorgan’s 52 Annual Global, Technology, Media and communications Conference.
Based on this, I think it is clear that not only has Snapchat+ proven to be successful, but it was even beating management’s expectations. Typically, this is often the most bullish group in the room.
Looking at their recent revisions, it seems the market is just starting to realize the true potential of this company. For instance, in the last 3 months, Snapchat has experienced 18 upward EPS revisions, and only 3 downward. Looking at revenue, the numbers are even better. In the last 3 months, the company has seen 36 upward revisions, and zero downward. With this, I truly think the market is increasing their confidence in this company.
Valuation
Since March, Snapchat’s valuation has re-rated up, driven (I believe largely) by the performance & growth prospects of Snapchat+. For example, looking at their growth revisions in the last 6 months, revenue estimates for December 2024 are up 2.11%, reaching $5.36 billion. In addition to revenue, in the last 6 months, EPS estimates for December 2024 have grown by 72.77% to $0.25/share. The only way the company could have such a high upward variance in EPS but a small upward revision in revenue is if the company is incorporating high margin additional revenue. This is Snapchat+.
Looking at the company’s growth valuation, their forward EBITDA growth is roughly 28.67% which is 695.55% higher than the sector median. Their forward operating cash flow growth is 60.03%, 1,022.14% higher than the sector median. I believe this is largely attributed to Snapchat+ which is very inexpensive for the company to run but now is on track to bring in almost ½ billion in incremental revenue over the next 12 months.
In my last analysis, I projected 96% upside for Snap’s shares, based on revenue growth and improving financial metrics. Since then, share value has grown by approximately 37%, reflecting increased market recognition of the social media company’s potential. However, I think there is still room for Snapchat’s valuation to expand. Comparing Snapchat to Reddit (RDDT), which trades at a forward price to sales ratio of 9.98, Snapchat trades at a significantly lower ratio, of 4.92 despite the company now having strong recurring revenue potential. If they were to trade at the same forward multiple as Reddit, this would mean upside potential of 102.8% per share.
On this note, I think another notable aspect of this company is that the award winning Seeking Alpha Quant system now rates Snapchat as a “strong buy” starting as of mid-May (when I last rated the stock it was rated a Hold). I think this is a solid sign that the market is catching on and beginning to realize Snapchat’s growth potential.
Yet, at the same time (despite higher revenue and EPS targets) Wall Street doesn’t seem to be in the same boat with the median forward price target currently sitting below the current share price. Snapchat shares are currently listed as a “hold” on Wall Street with a downside estimate of 5%.
Risks
While Snapchat+ has provided substantial growth and financial stability for the company, risks remain. For me, one of the most pressing risks is the potential impact of a slowing economy. Consumer discretionary spending is usually one of the first areas to get hit in a recession, and Snapchat+ is the quintessential consumer discretionary purchase. Snapchat (having been founded in 2011) has only been through one major recession: the COVID-19 pandemic, which caused Ad revenues to face pressures. We could easily see their ad revenues dip in a normal economic downturn which damages the heart of this bull thesis (the market is under-appreciating growth).
However, I actually see this on the whole as a net-low probability. While ad revenue is still at risk in an economic downturn, Snapchat+ (since it mainly caters to younger Gen-Z customers) may be more resilient than thought. Many Gen-Z consumers on Snapchat live at home with their parents which means while their income is low, the proportion of the income they have that is discretionary is high. This provides more breathing room in their personal budgets for expenses like Snapchat+.
Bottom Line
Snapchat+ is continuing to help power Snapchat’s now stronger financial performance, and I think this platform opens up doors for an even larger potential for growth and profitability than what I thought existed in March. The service has significantly boosted their revenue, allowing for Snapchat to diversify their revenue streams and decrease their reliance on ad revenue. Despite the recent 38.63% increase in share price since my last coverage, I believe the market still undervalues Snapchat’s potential, as evidenced by the largely pessimistic Wall Street targets. With this, I still believe that Snapchat shares are a strong buy.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of SNAP, GOOGL, META either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Noah Cox (account author) is the managing partner of Noah’s Arc Capital Management. His views in this article are not necessarily reflective of the firms. Nothing contained in this note is intended as investment advice. It is solely for informational purposes. Invest at your own risk.
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