Trefis recently launched coverage of Snap Inc. (NYSE:SNAP) with a valuation of $20 billion, or $17 per share, which is nearly 20% lower than the current market price. Snap had 158 million average daily active users (DAUs) as of Q4 2016, with about 68 million users in North America. In our analysis, we break down the company into the following value streams:
- North America Advertising (~85% value)
- International Advertising (~11% value)
- Spectacles (0.3% value)
- Cash (~4% value)
In this note, we discuss a bear case scenario for Snap, which could bring down its intrinsic value by 35% to about $13 billion. Our valuation estimate for Snap of $20 billion is based on a discounted cash flow model, in which we estimate the company’s future cash flows from its three major divisions. We estimate the company’s growth across geographies based on its history, potential, market realities and competition. If those expectations are not met, future cash flows could get impacted, bringing down the company’s fundamental value.
Three of the most important drivers impacting the company’s value are its North America average revenue per user (ARPU), North America DAUs and R&D costs. Lets discuss how they impact Snap’s valuation.
- North America Average Revenue Per User (ARPU): Snap has seen impressive growth in its ARPU in North America in the last two years, from $1.33 in 2015 to $5.83 in 2016, as it began monetizing its platform. We expect it to grow to at a compound annual growth rate (CAGR) of about 37% to almost $73 per user over the next eight years.
Bear Case: If Snap’s user growth stagnates significantly over the next 2-3 years (like Twitter‘s user growth story) and advertisers aren’t incentivized enough to increase ad rates at a rapid rate, its ARPU could witness lower growth rates. If Snap’s ARPU in North America grows only to about $60 (15% higher than Facebook’s ARPU in North America in 2016) by the end of our forecast period, its value could drop about 15% to $17 billion or $14.50 per share. You can modify the forecast in the interactive chart below to see this impact yourself.
- North America Average Daily Active Users (DAUs): Snap’s average DAUs have increased from 30.8 million in 2014 to 62 million in 2016. Its growth rate witnessed a slight decline in the fourth quarter of 2016, sparking concerns of a slowdown in user growth early on in the company’s growth journey. We forecast Snap’s average DAUs in North America to increase at a CAGR of 6% to 100 million by the end of our forecast period.
Bear Case: If Snap’s average DAUs in North America increase at a CAGR of just 5% to about 90 million by the end of our forecast period, our estimate for Snap’s value could decline by about 10% to $18 billion, or $15.20 per share. Drag the forecast line graph in the interactive chart below to see this impact yourself.
- R&D Costs as a Percentage of Revenues: Snap is a dynamic young company focused on introducing new and unique features to keep users engaged. Owing to its solid revenue growth, R&D costs as a percentage of revenues declined from 123% in 2015 to 40% in 2016. We estimate this trend to continue and reach a value of less than 8% by the end of our forecast period.
Bear Case: If this figure doesn’t decline as much as expected – due to slower-than-expected revenue growth or higher-than-expected R&D requirements – and only reaches around 12% of revenues by 2024 (similar to our estimate for Facebook‘s R&D Costs as a Percentage of Revenues), our estimate for Snap’s value could decline by about 15% to $17 billion, or $14.50 per share. You can modify this forecast below to see the impact on the company’s value.
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It is important to note that all of the aforementioned drivers are not mutually exclusive, and any change in one metric is likely to impact the other drivers as well. For instance, if user growth stalls, advertisers might not increase ad rates at the same rate and Snap might need to increase its R&D costs to introduce new features to combat these negative trends. Accordingly, all three of these bear case scenarios could come to pass simultaneously. If all of the aforementioned bear case scenarios occur, Snap’s value could decline by as much as 35% to $13 billion, or about $11.20 per share.