Could Snap Run Out of Cash?

It's been about a year and a half since Snap (NYSE: SNAP) went public, raising roughly $2.6 billion in the process after underwriters exercised all options. The company promptly blew over $400 million on questionable acquisitions in the following months, even as the core advertising business was still trying to find its legs. Management appears to have recognized the error of its spendthrift ways and suddenly became frugal, implementing numerous rounds of layoffs in an effort to cut costs.

Snap's dwindling cash position, in addition to a slew of other concerns, is contributing to a major downgrade.

Losing patience with "Snapchat's excuses"

BTIG Research has downgraded shares of Snap today to sell after sticking by a neutral rating since the company went public in March 2017. Analyst Rich Greenfield tried giving Snap the benefit of the doubt initially, believing it just needed time to hammer out monetization while user engagement was impressive, but user engagement trends have deteriorated lately, thanks in large part to Snapchat's redesign. Greenfield is "tired of Snapchat's excuses for missing numbers" and believes the stock will get cut in half over the next year, assigning a price target of just $5.

Greenfield highlights several areas that have been challenging Snap lately, including the success of Facebook's Instagram in replicating Stories, the absence of any meaningful product innovation, ad quality declining, poor executive retention, and misguided continued investments in Spectacles "that nobody is buying or wearing," among many other reasons.

Feel the burn

Snap is also running out of cash, as it has burned over $500 million in the first half of 2018, after starting the year with over $2 billion in cash, Greenfield notes. The company could potentially end up burning over $800 million in cash for the full year, despite its cost-cutting efforts. This could necessitate some type of capital raise by 2020, but that will be easier said than done given the company's uninspiring execution. Investor sentiment in Snap is awful right now, and with share prices hitting fresh all-time lows today, Snap would need to sell a ton of shares -- diluting current shareholders significantly.

It's also worth remembering that Snap is still on the hook for billions in cloud spending commitments at its third-party infrastructure vendors over the next several years, with those commitments escalating every year. Those commitments have long been a major risk, in my view, as they add even more incremental pressure for Snap to grow its inchoate advertising business. Those commitments currently exceed the roughly $1.6 billion in cash that Snap had at the end of the second quarter, for instance, underscoring how much it needs to grow ad revenue to pay those bills.

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Evan Niu, CFA, has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.