November 06, 2018 - 11:47pm EST by
2018 2019
Price: 7.09 EPS -0.60 -0.43
Shares Out. (in M): 1,310 P/E NA NA
Market Cap (in $M): 9,287 P/FCF NA NA
Net Debt (in $M): -1,414 EBIT -840 -678
TEV ($): 7,873 TEV/EBIT NA NA

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Snap Inc (SNAP) was written up as a timely, well-researched short by jcoviedo on May
28, 2017, and with the stock down from $21 to $7 over the ensuing 18 months, we
think it's pretty clear that the author nailed this one. We've been watching this slow
motion train wreck from the sidelines and while SNAP still leaves much to be desired,
we believe there is a very high likelihood that SNAP will ultimately be acquired by
Tencent, an event that is arguably not priced into the stock.
As most people know, Snap Inc is a camera-centric social media platform that was
incorporated in 2012 and is built around the premise that the camera screen is a
starting point for most products on smart phones. Its flagship product Snapchat is an
app that opens directly into the camera and allows its users to communicate through
short videos and photos, which the company refers to as Snaps. Snaps are
ephemeral in that they are auto-deleted after a specified time frame, and are able to be
modified with several creative tools such as Lenses (interactive animations overlaid on
a persons face), Geofilters (filters that can be applied after a Snap is taken, such as
location, weather or time), and Bitmojis (cartoon likenesses of a user). Snap monetizes
the platform primarily through advertising. Sponsored Lenses and Geofilters are ways
businesses and brands offer unique filters around their product offerings, with the
ability for users to interact with the Snapchat app just as they would with some of the
free filters and lenses.
So what went wrong?
The stock since peaking a couple days after the IPO in 2017 is down over 70%. Much of the blame lies in
its deceleration in user growth following the August 2016 launch of Instagram’s stories feature, which
has only gotten worse, with SNAP’s first quarterly drop in daily active users (DAU) in 2Q18. SNAP also
made a strategic error in focusing narrowly on iOS in its first 4 years or so, resulting in some product
issues in its Android app. As highlighted in jcoviedo’s short piece, SNAP also has a significant
disadvantage vis-à-vis Facebook in terms of targeted advertising capabilities, resulting in an inferior
advertising platform. In late 2017, Snapchat made arguably it’s biggest strategic mistake, rolling out a
new interface that met with so much backlash that 1.3M signatures of users petitioned to roll back the
update. Instead of listening to the poor feedback, Evan Spiegel stubbornly said “it’ll take time for people
to adjust.Without getting into the details, Spiegel should never have attempted a sweeping overhaul
of its app’s identity. Facebook’s family of apps have survived over the years by changing so gradually
that they have never shocked users into rebellion. Not surprisingly, there has been quite a bit of
executive turnover at SNAP. Since March 2018 Snap has lost lost its VP of Product Tom Conrad, its CFO
Drew Vollero, its Chief Strategy Officer Imran Kahn, its Head of Spectacle Mark Randall, Head of Sales
Jeff Lucas and VP of Engineering Tim Sehn. The downward trajectory of the stock simply reflects the
slow-motion train wreck that is just as clear to investors as it is to the users of Snapchat.
What are we missing?
Its easy to dismiss SNAP as a fad gone wrong, but hidden amidst the chaos, there are some valuable
aspects that we think are being overlooked. SNAPs 186M daily users still spend an average 30 minutes
a day on Snapchat. Daily active users visit the app 18 time a day and create about 16 Snaps each day.
Less than half of Twitters 326M monthly users are daily, meaning that SNAPs daily audience is bigger.
Twitter has 2.5X SNAPs revenue and investors are currently valuing it at 3X the market cap. SNAP grew
revenues 43% last quarter, while Twitter grew 29%. Snap has almost half the monthly user count in the
US and Canada as Facebook (where Facebook generates half its revenue), yet investors value Snap at 2%
of Facebooks market cap. Yes, Twitter and Facebook users are doing different things from Snapchat
users, with the latter heavily into messaging while the former are browsing tweets, articles and videos
which are more appealing to advertisers, but SNAP has an engaged audience in the coveted 13 to 34
year old demographic, which is especially hard to reach with old media alternatives like TV, magazines,
newspapers and billboards there is much room for improvement in monetizing this user base.
In addition, 3Q18 results had some promising elements. Revenue was ahead of the Street at $298M vs
$283M expected (up from $262M in 2Q18 and $231M in 1Q18), the EBITDA loss narrowed, coming in at
-$138M vs expectations of -$167M (up from -$169M in 2Q18 and -$218M in 1Q18). Cash burn dropped
sequentially from $234M in 2Q18 to $159M in 3Q18. The company is now targeting profitability in 2019
and there appears to be a viable path to get there.
Finally, the company has replaced its top brass with key players with more industry experience. The
new CFO Tim Stone is a 20-year veteran of Amazon. SNAP also hired Amazons Head of Global
Advertising Sales Jeremy Gorman to be its Chief Business Officer, responsible for the companys global
business solutions, global online sales, customer operations, and business marketing. Finally, former
Huffington Post CEO Jared Grusd is joining as Chief Strategy Officer, looking after content, global
strategy, partnerships and corporate development. The company should be in a better position to
grow and scale its business with these new hires in place.
Overlooked X Factor: Tencent and Amazon:
Tencent has been one of SNAP’s early venture backers and further increased its stake to 12% in
November 2017 to become one of SNAP’s largest shareholders.
As reflected in its stock price, Tencent ran into a series of issues during 2018, especially in its video game
business. This segment contributed almost 50% of Tencents revenue and and accounts for 44% of
Chinas market. However, the business showed signed of saturation in 2018 in terms of user growth,
ARPU and profitability. To make matters worse, the Chinese government announced several new
policies to tighten regulations around the video game industry in China. Under the new policy, all new
video games need to obtain a publishing number (i.e. a permit) before their release, however the
government has not approved or issued a single new video game publishing number since March 2018.
The direct impact is that Tencent’s most popular new video games in China now, such as PUBG, cant
charge a penny and therefore Tencent cant monetize its vast user base.
To mitigate this headwind, Tencent has shifted its focus on video games towards overseas markets. It
has launched PUBG Mobile overseas and generated $100 million in revenue in the first 200 days after
launch. This result is good but not great vs its foreign peers. For example, Fortnite of Epic Games got
more than $300 million revenue in the first 200 days after launch, and that was just from iOS. It will be
difficult for Tencent to replicate its success overseas because it does not have similar dominant positions
along the value chain of the video game industry as it does in China. For example in China, Tencent has
a dominant online gaming platform called Tencent Games, it has stakes in video game and eSports
streaming platforms Huya and Douyu, and it owns the largest social media and messaging networks in
China, WeChat and QQ). The dominant streaming platform overseas is Twitch, which is owned by
Amazon. In terms of social media, neither WeChat nor QQ has a sizeable user base overseas.
All the above makes SNAP a great fit for Tencents overseas strategy for its video games division:
1) SNAP is a key social medial player with DAU of over 180 million. SNAP’s core users are
millennials and generation Z which strongly overlap with the targeted user base of video games.
SNAP could be a distribution and promotion partner with Tencent;
2) SNAP has some similar functionalities to those in WeChat, for example, Stories (Moments in
WeChat) and Discovery (Official Accounts in WeChat). This will make it easier to borrow some
social media business strategies directly from Tencent’s playbook in China;
3) SNAPs Lens is unique and has already tested some mini games on it. This is quite similar to
WeChat mini games which is very addictive and has become a key component of the WeChat
ecosystem. More importantly, SNAP is rolling out a desktop version of Lens and partners with
Twitch to let streamers and viewers using the unique lenses in video game streaming;
4) One thing that SNAP has not tried but should is video game streaming or a similar function in its
Stories or Discovery section. It has successfully done live streaming for the World Cup and
Olympics. It might be worthwhile to partner with Tencent to live stream Tencents popular social
media centric games, such as Arena of Valor (a 5v5 MOBA game played among social media
This is not a typical value piece. We could argue that on a market cap to DAU basis, Snap is far cheaper
than peers Facebook, Twitter and Weibo, which trade in the $100s per user vs SNAPs < $50. With ARPU
of just $6 vs Twitter and Facebook in the teens to mid-twenties, SNAP has much room for improvement,
and is arguably under-monetized. But the point of this piece is to show that there is a potential
inflection point coming, and it starts with key senior management hires, a focus on profitability and cash
flow. Most importantly, we believe that this company will end up in the hands of Tencent in the near
future. We think it makes strategic sense for both parties.


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.


  • Further improvement in cash burn, diminishing loss, stabilization in DAU in 4Q18
  • Takeout by Tencent
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