Snap's User Growth Is Trending in the Wrong Direction

Markets Motley Fool

User growth is critical for any growing social media company, and Snap (NYSE: SNAP) is failing to deliver on the market's expectations -- and giving strange, often contradictory explanations as to why that is.

Continue Reading Below

In this clip from Industry Focus: Tech, analyst Dylan Lewis and senior tech specialist Evan Niu examine the user growth metrics that Snap reported in its most recent earnings call and explain why they were so alarming for investors. Find out why Snap is trying to divert attention from its daily active user number, how Snap is growing in North America versus the rest of the world, and more.

A full transcript follows the video.

10 stocks we like better than Snap Inc.
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Snap Inc. wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

Continue Reading Below

*Stock Advisor returns as of August 1, 2017

This video was recorded on Aug. 11, 2017.

Dylan Lewis: We talked a little bit about user stuff before. Coming back to that, like I said, the overall user number was disappointing. I think the Street was looking for something in the mid 170 million range.

Evan Niu: I think 175 million is what people were expecting.

Lewis: Yeah, and it wound up coming in at 173 million. The North American market grew 4 million to hit 75 million daily actives. So, disappointment there. But the narrative that we've been getting from Snap's management for a long time has been, "Don't look so much at DAUs, we're an engagement-driven platform, we have a lot of really dedicated users that love using our product." And I think one of my frustrations in trying to break down this company is that we get some color on engagement with those users, but it isn't terribly consistent, and we have to do a lot of work on our end, some back-of-the-envelope numbers here, to get a sense of what's going on with some of the engagement metrics.

In Q2, management said that they saw 40 minutes spent per day for users under 25, and over 20 minutes per day for users over 25. So, that gives you a sense of what people are doing on the platform. The previous quarter, they had said that users spent over 30 minutes per day on Snapchat. So, it's like, I think those numbers are generally trending together, and I would hope that means that 30 minutes per day is either holding or slightly increasing, because the platform does slant young and predominantly under 25. But that's an apples-to-oranges comparison, and it's really hard to know for sure that engagement is trending the right way.

Niu: Right. I will give them a little bit of credit in the sense that they are improving monetization, which you can see in their average revenue per user, or ARPU. It improved sequentially from $0.90 globally to $1.05, which is the same as they did in Q4 of last year. So, it's not like some huge, crazy record increase. But they are making some progress, and certainly that's related to engagement. But I agree that the inconsistency in the metrics is a little weird. But, to give them a little bit of credit, they are improving on the monetization, particularly in these low-monetization geographies like Europe and the rest of the world. Those actually did put up pretty meaningful increases sequentially to hit new levels of monetization, $0.39 in Europe in $0.29 in the rest of the world. Still a fraction of North America's monetization, which is at $1.97. But they are making some progress. I don't want to be totally mean on them. [laughs]

Lewis: And that's really how Snap's management and CEO Evan Spiegel are looking at the business. He's repeatedly said that the focus shouldn't be on DAUs, and he really touts the ARPU number as the thing that analysts should be focusing on. I think, to explain his logic a little bit, here's a quote from the most recent conference call. He said, "We would have to add more than 10 million daily active users in the rest of the world for every 1 million daily active users in the U.S. and Canada in order to make the same amount of money. So, obviously, with 10X the number of users, we also incur 10X the hosting costs to make the same amount of money, so that would impact our cash flow profile for our business."

So, with that focus on ARPU, what he's also really saying is, the focus should be on the North American market, because that's where ARPU is the strongest. For the most recent quarter, Snap's North American ARPU was $1.97. It was $0.39 in Europe and $0.29 in the rest of the world. So, that gap helps explain why he feels that way. I'm not sold on the idea of only focusing on the valuable markets, and I'm also not really sold on that being a meaningful indication of how the business is doing, because there are a lot of opportunities for growth in North America, and yet we're only seeing single-digit sequential growth rates.

Niu: Right. I honestly think it's kind of a cop-out. They're both very important. They're arguably the two most important metrics, he's basically saying that only one of them is important. That doesn't make any sense. Obviously daily active users are hugely important to a social media company, and him trying to distract away from it, I think it's a conscious attempt -- they've seen what happened at Twitter, and Twitter gets a lot of criticism about slow user growth, disclosures, and all this other stuff. And I think what they're trying to do is trying to avoid that narrative. But ultimately, you're not tricking anyone. If you don't put up the good user numbers and you're a social media company that's driven by ads, investors are not going to be happy.

Lewis: And again, to give them some credit here, Snap's platform had some limitations that make it tougher for them to grow in developing parts of the world. It's a very data-heavy app, and it requires a lot of time with photos and video, which is not as conducive to low-connected areas. But if the focus is North America, we talked about how they have 75 million daily actives in North America, and a single-digit sequential growth rate in that market. There are over 250 million smartphone users in North America. There's a massive runway for Snap to continue to add those super valuable users that Evan Spiegel is focusing on. So, I'm not sold that that's the only thing we should be looking at. When you see that they could go basically 3X and not even totally fill the North American market and be totally saturated, I can't help but focus on what's going on with DAUs.

Niu: No, exactly. I think the big problem there is, their user growth in North America -- which, as you mentioned, is by far the most important market, and even they're trying to focus everyone on this North American market -- their user growth on a sequential basis is not really doing much. It's just flat-ish. They're adding about 3 [million] to 4 million users per quarter, and that rate of adds is not really accelerating or decelerating. But the point that I'd like to make is that, I think one of Snapchat's biggest problems has always been the fact that it's just not really an intuitive platform, and it's very limited to this niche, younger audience. To get to those really meaningful penetration numbers of the U.S. market, like you mentioned, out of 250 or 260 million smartphones, you have to appeal to the mainstream. And Snap does not do that, and I don't see them ever doing that. I think their ceiling is going to be much lower until they can come out with some breakthrough feature or revamp the interface, or something to make the platform appeal to a wider audience, which I don't think they've done yet....

Lewis: I think two other reasons that people have to fixate on what's going on with DAUs is, when you have Facebook launching Snap-like features on its platform, on Instagram and Facebook in particular, platforms that have massive installed bases, there's a chance that people will use them on those platforms, and they might be in markets that Snap doesn't really operate in, or doesn't really focus on now. And by the time Snap does decide to really prioritize them, the users there are going to be like, "Yeah, so what? I can already do this on Instagram. I don't need this." So, that might hinder long-term growth for them. I think looking at things from the Street, and from our side as analysts, too, we have to obsess over what's going on on the user numbers, because they're so early in monetization that revenue is going to be all over the place. It's great that average revenue per user was up 100% year over year, but they were barely rolling out ads at this time last year. It's a great growth number, but it's off of such a tiny base that it's really devoid of any long-term business impact.

Niu: It's not meaningful, right? [laughs]

Lewis: [laughs] Exactly. This is truly not meaningful.

Niu: That's also because Snap went public so early. Most companies in the space wait until they're a little bit more established, have firmer footing in their core business before they go public, whereas Snap basically had no clue, and arguably they still barely know what they're doing in terms of the ad business. And the fact that they went public so early in their life, you're kind of asking for this.

Dylan Lewis owns shares of FB. Evan Niu, CFA owns shares of FB. Evan Niu, CFA has the following options: long January 2019 $20 puts on Snap Inc. and long January 2018 $120 calls on FB. The Motley Fool owns shares of and recommends FB and TWTR. The Motley Fool has a disclosure policy.