Snap's Newest Layoffs Are a Bad Sign for Investors

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In February, it looked like Snap Inc. (NYSE: SNAP) had finally turned a corner as a publicly traded company. On the strength of better-than-expected fourth-quarter earnings, shares of the company rocketed past the company's $17 IPO price. Since then, shares of the company have trended down as Wall Street has become bearish on social media companies in light of the recent Facebook scandal.

Industry issues aside, Snap has company-specific concerns that give investors reason to pause. Last quarter, the company reported a free cash flow loss of $197 million, a worse result than the $188 million loss it reported in the year-ago quarter, even though the company grew its top line 72%. Adjusted EBITDA, a heavily watched supplemental metric, is also worsening, even though the company is growing.

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Snap has been laying off employees and recently confirmed it was letting go roughly another 100 workers, mostly in the advertising and sales units. This latest round of layoffs may help metrics in the short run. But are they cutting to the bone?

Snap's latest job cuts are concerning

Snap's investors are used to layoffs. Last year the company laid off workers in its hardware division amid a $40 million charge-off related to its Spectacles product. Later, approximately 18 employees were laid off from the recruiting department. In January, it was reported that Snap laid off approximately 20 employees, with cuts affecting the content department. Then there was a cut of 120 emoployee on its engineering team, which occurred after the company's redesign failed to please.

The newest round of layoffs, the company's third in 2018, was recently announced. Snap is cutting 100 jobs in the advertising and sales division. The company has about 3,000 employees, according to S&P Capital IQ. In a filing with the SEC, the company said it expects to save approximately $34 million per year because of these recent layoffs. This latest round of job cuts is particularly worrisome for investors because it's in an area where Snap needs to be investing in.

Snap is the worst house on a decent block

Snap is situated in a growing industry as digital advertising is taking money from television advertising. Last year was the first year since 2009 that marketers spent less money on television than the prior year. The reason was last year's increased spend allocated to digital outlets, and this will likely continue. However, the digital advertising market remains a duopoly with Facebook and Alphabet taking approximately two-thirds of all digital ad spend.

Snap needs strong relationships with brands to break through and become a strong competitor as it lacks the user information and targeting prowess of the two giants. Firing salespeople appears to be a short-term solution to a long-term problem. Snap recently went to automated ad sales, which require less human interaction. However, it's likely that without a strong sales staff, brands are going to stick with Facebook and Alphabet's Google.

In the short run, investors may react favorably to the changes and Snap will continue to be the fastest-growing social media company in both MAUs and revenue on a percentage basis, but it's likely the company cannot cut its way to prosperity. At some point, investors must wonder if Snap is a viable business model on a unit-economics basis.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Jamal Carnette, CFA owns shares of Alphabet (C shares). The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Facebook. The Motley Fool has a disclosure policy.