How Many DAUs Did Snap Lose?!
Way to go Snap on 4Q'18. And I really mean it, I'm not saying that in a facetious way. I expected a jump, but with a ~21% jump, you really outdid yourself here. And with flat DAUs? Now THAT was a surprise. Never thought I'd be this surprised to say that about a growth-story tech stock, but it's 2019 and here we are.
Snap reported insane headline numbers of -$0.14 EPS (GAAP) vs an expected -$0.19 EPS (GAAP). Their revenue came in on the top side of their guidance at $389.8M and they reported a GAAP Net Loss of -$191.6M against an expected -$252.9M (their non-GAAP EPS was -$0.04 vs -$0.08 expected, but that is the only non-GAAP number from Snap that I will include in this post. Their non-GAAP numbers are only slightly better than made up numbers, and I will get to that in a second).
The biggest surprise coming from Snap's 4Q'18 and FY18 earnings was that they did not lose any DAUs, holding steady sequentially at 186M. Most didn't expect it (including Snap, according to their guidance from 3Q'18) and even more did a double-take when they first saw the number. Along those lines, their revenue was at the high end of their 3Q'18 guidance, but this was easier to anticipate, given that they said as much in a Form 8-K in mid-January. As for 1Q'19, they said that they are "cautiously optimistic and don't foresee a sequential decline in our DAUs."
Most accounts of Snap's 4Q earnings will include all the good from the report and call, and rightfully so, so I will leave it there at just those broad positive themes. What I expect fewer accounts of Snap's 4Q earnings to cover is the bad news created in 4Q and persisting into 2019. That is where I come in.
First off, as more of a housekeeping note, Spiegel and Snap referenced their non-GAAP adjusted financials when discussing all expense figures in their earnings call and company presentation. In these financials, they exclude stock-based compensation (SBC), D&A and non-recurring charges. As you may have been able to tell from my write-up heading into Snap's earnings, SBC is a very important, albeit untalked-of part of Snap's story and the exclusion of it creates a materially different representation of the company. For example, Spiegel mentioned in the call that relatively flat costs "limited our Q4 losses to just 13% of our revenue," implying just a -13% net margin in 4Q'18. In the cold world of GAAP accounting, the net margin was almost 4x lower than the non-GAAP number Spiegel referenced: -49.2% GAAP net margin. This is one of many instances of wide differences in GAAP vs non-GAAP numbers, so just keep that in mind as you skim over Snap's filed materials.
As for the actual content of the call, one major thing that jumped out to me is their seemingly clear communication that their plan for profitability is focused mostly on revenue while settling for a relatively flat cost structure. This seems like good news for a growth company, but not so in Snap's situation where they still need to cut a significant amount of costs in my opinion (if they don't raise capital), especially due to their depleting runway. I want to quickly jump to their runway, but at the end, I will run some rough numbers to put my opinion on their costs in context.
Snap's runway, for reasons stated in my pre-earnings post, is what I consider the sum of their cash and short term investments/marketable securities. At the start of FY18, it sat at just over $2B. Here at the end of FY18, Snap has chewed off around $760M of their runway as the head into 2019 with $1.28B in runway left. At their FY18 burn rate, they have about 1.6-1.7 years of runway left, with possible increases in burn rate due to SBC reasons I mapped out pre-earnings or higher than expected future net losses (there is also potential upside for Snap in slowing down this burn rate by beating expectations).
Before we get to the cost numbers, I wanted to briefly mention two things that remain unchanged or unanswered going into 2019:
Where is employee moral? Do 40% of employees still expect to leave the company? When will the CFO and entire permanent board be in place? Have you regained the experience you lost via departing executives?
Is the DOJ and SEC investigation still ongoing (yes) and if so, why is the DOJ involved as well as the SEC? What are the statuses of the lawsuits from shareholders? Does the DOJ and SEC investigation preclude you (either legally or by way of casting a scarlet letter) from raising capital or being acquired?
I hope that the 10-K will shed more light on these topics, especially #2.
"I busted a mirror and got seven years bad luck, but my lawyer things he can get me five" - Steven Wright
Lastly, I want to make a rough model of Snap's plan to profitability. For this, I will be using the gross margin estimates from analysts and looking at FY19, FY20 and FY21. The two scenarios I want to look at are 1) Snap's internal "stretch goal" from Spiegel's leaked memo to reach FY19 profitability (FYI: this is not official Snap guidance to investors) and 2) a look at Snap over a slightly longer term.
1) Stretch Goal
To look at the internal stretch goal, I am going to use one example with completely flat OpEx and another with "roughly flat" OpEx of a 5% yoy increase.
With no OpEx increase, Snap will need a fanatical 224% yoy revenue growth to achieve an operating profit in FY19
With a 5% yoy increase in OpEx, Snap will need a dumbfounding 240% yoy revenue growth to achieve an operating profit in FY19
2) Long Term
I will look at the long term growth of Snap under the same 2 circumstances I used previously.
If we assume 0% yoy increase in OpEx for every year and staggering 37% yoy revenue growth for every year, Snap will still have an operating loss for FY21 of -$10.7M
If we assume 5% yoy increases in OpEx every year and a blistering 44% yoy revenue growth every year, Snap will still have an operating loss for FY21 of -$6.5M
Needless to say, the runway in these situations would not last until FY21.
All in all, an impressive quarter from Snap, but it is not out of the doghouse yet. I am looking to buy puts sometime in the near future, but this earnings report may provide for a few more kicks before its ripe to short, especially if the shorts cycle through and squeeze it up. Long term, there is always the possibility Snap gets acquired, providing some sort of price floor but right now at ~$8.50, I find it hard to make a case for it doubling up to $15-17 over dropping to $2, for as crazy as that sounds. Especially if it can't raise capital or be acquired as long as the SEC and DOJ are investigating.
(P.S. I apologize for no pictures this time. Believe me, it hurts me as much as it hurts you)
As always, this is not investment advice and do your own research. Good luck.