• The chart shows the performance of social media company SNAP over the last three years
  • Since the stock’s most recent peak on August 31, 2021, it has stalled, falling -31% in a +2% tape[1]
  • SNAP shows up across many of the screens we have run that highlight stocks with outsized risks
  • Despite severe losses, SNAP’s stock value is elevated, and the aggressive use of stock compensation to fund operations stand-out as major risk factors
  • The recent break in the stock price may make it vulnerable to further declines

Snapchat Stock Value: Investor Optimism Run Riot

Snapchat’s primary source of revenue is advertising based on the use of its camera platform capable of taking “snaps” or short videos and images.  SNAP shares have soared on the euphoria around rising levels of “daily active users.”  With 83% of the 41 analysts covering SNAP being bullish, Wall Street’s financial advice is “BUY”.  For those interested, we have discussed how groupthink is a risk in prior missives.

SNAP Absolute Performance vs SP500

Our team believes that Snapchat may have been an outsized beneficiary of herding.  In our view, many investors are creating narratives to justify a valuation we believe is simply untenable. The stalling of the stock in the last few months may point to an opportune time to sell.

According to Bloomberg, with an $82 billion valuation, Snapchat’s short interest stands at only 4.22%.  We believe the enormous market cap reduces the risk of a short squeeze due to a takeout offer.  This in turn could reduce the risk for short sellers looking to pile into money-losing stocks that trade at high valuations with weak technicals.

Snapchat Stock Analysis: A Quick Look at Some Basic Fundamentals

These CFTCs about individual stocks are predicated on the desire to incite thoughtful dialogue.  In instances like Devon Energy and CF Industries, our goal is to encourage investors to contemplate these firms’ superb assets, management, operations and focus on treating shareholders well.  In instances like our Twilio post, which spawned a follow-up rant,  we sought to draw attention to the fact that, despite a $60bn market cap and -$700ml in losses, the company’s quarterly presentation had almost no GAAP compliant financials.

In this piece, we would like to highlight the incredibly clear, transparent, and forthright investor material Snapchat provides.  Their material is heavily footnoted, well explained, and thoughtfully organized.

At the same time, we hope to draw attention to the company for an issue totally outside its control (valuation), an accounting issue where Snapchat has been nothing short of terrific in their disclosures (stock-based compensation), and lastly, some brief notes on privacy.

First: Valuation Makes Snapchat Investing Daunting

Snapchat is expensive to state the obvious.  Below you can see the company’s market cap rose from $7bn when it traded at “only” 6x sales to a staggering $120bn as the firm’s valuation soared to north of 35x sales.  Between 2018 and 2020, the firm generated GAAP losses of -$3.2bn.

SNAP Market Cap Valuation

Regardless of Snapchat’s fundamental merits, we believe buying the shares may be a pure speculation with massive downside at these valuations.  From its peak on September 24th, 2021 through October 31st the stock plunged -35%.   Despite this, the company still commands a P/S multiple of 22x – a valuation with few historical precedents.

In our free post Speculation & Margin of Safety Value Investing, you can scroll down and see the disastrous historical implications of investing in firms at these valuations.

Second: Stock-Based Compensation

For the sake of clarity: we believe the large amount of stock-based comp used by Snapchat is not just rational, but the firm might be well-served to accelerate the use of stock to pay people.

While stock-based compensation may “ding” the company’s income statement, as we have documented extensively in Amazon, Stock Compensation & Equity Valuation, The Lost Impact of Large Numbers, and in our in-house Academic’s peer-reviewed piece Stock Compensation Expense, Cash Flows and Inflated Valuations, we believe this add-back is incredibly misleading.

This piece from the Harvard Business Review on stock option accounting in 2003 observes “If a company were to grant stock, rather than options, to employees, everyone would agree that the company’s cost for this transaction would be the cash it otherwise would have received if it had sold the shares at the current market price to investors.”   The piece documents that during the dot.com boom, conservative voices advocating for these forms of expenses to be…. expensed…looked “like spoilsports. But since the [dot.com] crash, the debate has returned with a vengeance.”

Despite appeals to logic, common sense, and empirical evidence, however, our current accounting rules make stock comp an expense in the income statement but allow it to be added back as a non-cash expense in the calculation of cash from the operations portion of the FCF statement.

Snapchat’s October presentation to investors shows that adjusted EBITDA has moved from -$576ml to positive $45ml.  The footnote is superb in its clarity.  Among the many exclusions, they disclose in their adjusted EBITDA number is stock-based compensation expense.

SNAP Oct presentation

In the chart below we have reproduced the bars above in dark blue.  In light blue, we have demonstrated the evolution of EBITDA if we deducted stock compensation.  The results are staggering.  We noted how incredibly egregious the “abuse” of EBITDA, a non-GAAP metric, had become when making risky loans in our piece Debt to EBITDA Ratios: The Spiral Higher ContinuesThat stock-based compensation alone can swing results so wildly is a testament to its importance for investors to understand.

Adj EBITDA Post Stock Based Comp Deduction

In their presentation of Q3 results, SNAPs Chief Financial Officer, Derek Andersen, commented, “Q3 marks our second quarter of positive free cash flow, and we are also free cash flow positive on a year-to-date basis, which marks an important milestone for our company as we transition towards self-funding our investments in the future of our business.”  The exhibit below displays the company’s FCF defined as OCF – CAPEX with and without stock-based compensation.  We believe Snapchat serves as a valuable exhibit for FASB when contemplating just how misleading current accounting rules are. 

Snapchat, which is a paragon of transparency around stock compensation[2], can state that they are “self-funding” with a clear conscience and in a manner compliant with GAAP.  Yet the fact remains: if they had to pay their employees in cash or had to account for the issuance of stock compensation as if they were issuing stock, the firm’s financials would show it was very clearly bleeding cash.  In the trailing four quarters, the company has issued over $1bn in stock for compensation.

FCF With Without Stock Based Comp

Privacy:

The last item we are going to bring up is privacy.  People and governments around the world have started to object to the incredible intrusion into their privacy at the hands of some tech companies.  For those living in a cave, we have provided some links below.

Snapchat is hardly “big tech” in our view.  But as their disappointing Q3 results showed, they are very much dependent on the data collection and feedback from the Big Tech complex.  Snapchat professes a “…commitment to privacy and empowering self-expression…over the long term, these privacy changes and protecting privacy for users of iOS and, of course, the Snapchat community is really important for the long-term health of the ecosystem.  It’s something that we fully support.[3]

Aside from supply chain constraints which, according to SNAP, reduced ad-spend from companies that were already sold-out, the Q3 miss stemmed from privacy changes enacted by Apple in their new operating system. Specifically, users of Apple’s iOS now need to double opt-in for companies like Snapchat to get the “signal” they used to from Apple’s unique device identifier for advertising.[4]

If you are wondering just how close your life is being monitored, tracked, and sold, Snapchat’s Q3 explanation was startling even to us.  One of the problems stems from the fact that “…advertisers are no longer able to understand the impact of their unique campaigns based on things like the time between viewing an ad and taking an action or the time spent viewing an ad.”[5]

Let that sink in.  The absence of that type of granularity is enough to create headaches for Snapchat.  And by no means are we criticizing Snapchat’s Chief Business Officer, Jeremi Gorman.  She is a model of transparency in our view.  Rather, we think this is part of a broader evolving trend as consumers become increasingly aware of a comment we first saw in Forbes in 2012 If you are not paying for it; you are the product.

Summarily:

  1. We believe Snapchat is simply too expensive
  2. We believe Snapchat’s accounting, while perfectly GAAP compliant and superbly footnoted, shows a company that has and continues to lose billions
  3. We believe Snapchat could be on the wrong side of an increasingly ferocious movement to protect consumer privacy

Please note CFTCs normally go every Friday but we published today under the assumption many would be out for a long holiday weekend.  KCR and its research team would like to wish everyone health as we head into the holiday season!

New poll reveals 7 in 10 people want governments to regulate Big Tech over personal data fears –Amnesty International

What Does Big Tech Know About You? Basically Everything –PC Magazine

Privacy activists are winning fights with tech giants.  Why does victory feel hollow? –The Guardian

Be wary when Big Tech says it’s defending your privacy, Often its real goal is to squash the competitionBoston Globe

Department of Justice: Big Tech’s data collection creates ‘avenues for abuse’ –Compliance Week

[1] 08/31/2021 – 10/31/2021, SNAP total returns and S&P 500 Total Return Index

[2] We mean this – at the very outset of  Snapchat’s Q3 conference call, Betsy Frank, Senior Director, Investor Relations states: “Please note that when we discuss all of our expense figures they will exclude stock-based compensation….” – you cannot ask for more transparency and integrity than that.  With the publication of this CFTC however, we hope investors in the stock consider themselves warned.

[3] Even Spiegel, CEO and Co-Founder, Q3 comments to investors

[4] Jeremi Gorman, Chief Business Officer, Snapchat Q3 comments to shareholders

[5] Jeremi Gorman, Chief Business Officer, Snapchat Q3 comments to shareholders

Disclaimer
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