Why Snap Inc. Stock Could Crash 50% or More

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Struggling social media company Snap Inc. (NYSE: SNAP) received an analyst upgrade on Tuesday, the first after a string of downgrades. Barclays believes that Snap is reaching a turning point, and that the company "may start hitting or exceeding consensus revenue estimates and accelerating growth in 2018." Barclays raised its price target on the stock to $18, a level not seen since July.

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An analyst from Evercore ISI also weighed in on Snap on Tuesday. The firm rated the stock "underperform" and slapped on a $7 price target, more than 50% lower than the current stock price. Shares of Snap are already down about 45% from their post-IPO peak, so this rock-bottom price target represents quite a bit of pessimism.

If you've read anything I've written about Snap, you know that I'm not a fan of the company or the stock. Growth is slowing, losses are astronomical, every major Snapchat feature is being copied wholesale, and the valuation is ludicrous. The stock could absolutely crash another 50%, and it's not hard to see why.

It just doesn't add up

Snap is currently valued at around $17.4 billion. That's far below its peak market capitalization of about $30 billion, reached soon after the initial public offering. The company has produced revenue of $705 million over the past 12 months, along with a massive net loss of $3.2 billion. That loss was mostly due to one-time stock options related to the IPO, but even excluding those costs Snap is still hemorrhaging cash. Trailing-12-month free cash flow, which backs out all stock-based compensation, is a loss of $818 million.

Investors buying shares of Snap today are paying nearly 25 times TTM sales. They seem to be ignoring a few things:

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  • Daily active users increased by just 3% in the third quarter compared to the second quarter.
  • Snap shares come with no voting rights whatsoever, a fact that led the S&P 500 to exclude Snap from the index.
  • Snapchat is far less popular than Facebook-owned Instragram, which has copied some of Snapchat's features. Instragram reached 700 million daily active users in June, and its Stories feature surpassed 250 million. Snapchat reported just 178 million daily active users in its third-quarter report.
  • Snap's price-to-sales ratio puts the stock at a massive premium to both Facebook and Twitter (NYSE: TWTR).

That last point is the reason why Snap stock could easily crash by 50% or more. Here's the comparison, based on TTM revenue.

Company

Price-to-Sales Ratio

Snap

24.7

Facebook

14.1

Twitter

6.5

Even down nearly 50% from its peak, shares of Snap still have an irrational amount of optimism baked in. Why is Snap's valuation richer by a factor of four compared to Twitter? Twitter, at least, is moving toward profitability, although its revenue has hit a wall. Snap's growth also seems to be hitting a wall, but it's not even in the ballpark of being profitable.

If Snap was valued at the same price-to-sales ratio as Twitter is today, the company would be worth just $4.6 billion. That would represent a 74% decline from the current stock price, even more pessimistic than that $7 price target.

Perhaps Snap really is reaching an inflection point. Perhaps its redesign of the Snapchat app will reignite user growth. But Snap is going to need to put up Facebook-like growth numbers to even come close to justifying its valuation. Given its performance so far as a public company, I'm not holding my breath.

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Timothy Green has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Facebook and Twitter. The Motley Fool has a disclosure policy.