Trefis is launching coverage of Snap Inc. (NYSE:SNAP) with a price estimate of $17 per share, which is nearly 20% lower than the current market price. Snap – whose flagship smartphone app Snapchat allows users to communicate via short videos and images – had 158 million average daily active users as of the fourth quarter of 2016, with about 68 million users in North America. Snap earns revenue primarily via advertising in its Snap stories and also via sponsored creative tools such as Sponsored Geofilters and Sponsored Lenses. The company ventured into the hardware space in late 2016 with a product called Spectacles, which are essentially sunglasses that allow wearers to capture short video clips.
In our analysis, we break down the company into the following value streams:
The Evolution Of The Ad Market Will Benefit Snap
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Snap stands to gain from three broad trends in the advertising market. Firstly, mobile advertising constitutes the fastest-growing segment of the ad market, and is expected to grow from $66 billion in 2016 to $196 billion in 2020, per IDC. In contrast, all other advertising spending is expected to decline by about $15 billion during the same time period. This should prove to be a significant tailwind for Snapchat, as it is a mobile-only platform.
Moreover, the shift away from traditional media also means that advertisers are having difficulty reaching younger audiences. For instance, according to Nielsen, people between the ages of 18 and 24 spent 35% less time watching television in an average month during Q2 2016 compared to Q2 2010, as they spend more time consuming media on mobile devices. This should prove beneficial for Snapchat, given that roughly 85% of its users in the United States are in the 13 to 34 age group, compared to under 50% for Facebook.
Snapchat’s user base is largely concentrated North America (43% of DAUs based in North America, versus ~15% for Facebook), where ad spends are likely to remain significantly higher for the foreseeable future. For instance, mobile ad spending in the United States is projected to stand at $88.8 billion in 2020, per IDC, which is greater than the next nine top ad markets combined.
Significant Scope For Improving Monetization
Snap’s average revenue per daily active user for North America stood at just under $6 in 2016, compared to levels of around $60 per user on Facebook, implying that the company has barely scratched the surface of its monetization potential. Snap’s young user base, its visually rich and engaging advertising formats – such as Snap Ads and Sponsored Creative tools – should provide the company significant scope to boost ad rates over the long term. More importantly, Snap has significant room to improve its ad load, as the frequency with which it displays ads is much lower compared to other platforms. Moreover, Snap’s ads are designed to be non-obstructive and often skippable, in order to maintain a positive user experience. As the company works to optimize its ad load, while increasingly relying on programmatic ad sales, it could scale up its ARPU considerably. We project that Snap’s North American ARPU will rise to over $70 by 2024.
Challenges In Driving User Growth
Focus On The Core Platform Will Be Crucial To Justify Valuation
Snap ventured into the hardware space with its Spectacles wearable camera in late 2016, and the company referred to itself as a camera company in its IPO prospectus, stating that it was willing to take risks to create innovative and different camera products.  While such products could help Snap improve revenues, the core Snapchat platform – which engages over 150 million users daily – will remain the company’s most important asset. Accordingly, Snap will likely look to ensure that its other endeavors – such as hardware – primarily serve to enhance the platform, either via increased customer loyalty or engagement. To the extent that Snap keeps its hardware ambitions in line with bolstering the core platform, while delivering ARPU growth, the company should be able to sustain its impressive revenue growth trajectory over the coming years.Notes: