Can Snap Move Beyond Being Facebook’s Innovation Lab?

Snap‘s (NYSE:SNAP) shares declined by close to 5% in Thursday’s trading, touching their IPO price of $17, amid investor concerns about the fierce competition that the company faces from social media behemoth Facebook. Facebook has been relentlessly copying Snap features, ranging from its signature Stories, Lenses and ephemeral messaging to more niche tools such as 3D stickers and Scissors. There doesn’t seem to be much that Snap can do to stop Facebook, as these features may not be entitled to patent protection (although the underlying technologies could be). Facebook, with its vastly larger financial resources and user base – around $3.8 billion in quarterly free cash flow and 2 billion plus users across its properties, versus 166 million DAUs on Snap – is essentially beating Snap at its own game, using the company as an innovation lab of sorts to pick out its next big feature. Moreover, Facebook appears to be emulating Snap at an increasing pace. While the company took close to three years after Snap launched Stories to roll out the Stories feature on Instagram, it has copied some of Snap’s latest innovations in a matter of a few months. That said, Snap does have a couple of things going in its favor, which we discuss below.

We maintain a $17 price estimate for Snap, which is in line with the current market price.

See Our Full Model And Analysis For Snap Here

Snap Still Has A Sought After User Base 

The user bases of social media properties often tend to be geographically concentrated (WeChat in China, BBM in Indonesia) and Snap is strongest in the lucrative North American market. As of Q1’17, 71 million of Snap’s daily active users were located in North America (42% of total DAU vs 14% for Facebook), which is likely to remain the most important digital advertising market 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, a sum which is more than the next nine top ad markets put together. Snapchat also has a unique user base, reaching a large portion of users that aren’t active on Facebook properties. Around 35% of Snapchat’s users cannot be reached by Facebook and ~46% can’t be reached by Instagram. Moreover, a majority of Americans between the ages 13 to 34 with smartphones use Snapchat. This makes Snap an attractive platform for marketers targeting millennials who are difficult to reach via traditional media.

Snap’s Efforts To Boost Engagement Are Paying Off

Despite Facebook’s onslaught, engagement levels on Snap’s platform have been on the rise, with the company indicating that people were spending over 30 minutes per day on the app during Q1’17, compared to the 25 to 30 minutes it highlighted in S-1 in February. In comparison, user activity on Facebook’s Instagram is estimated to stand at about 15 minutes per day. Moreover, engagement for Snap is driven primarily by interaction between close friends and to a lesser extent by celebrities, helping the company foster loyalty. In contrast, activity on Instagram is often driven by posts from social media influencers and celebrities. Snap has also been looking to improve engagement levels further by launching a machine learning-based search feature that allows users to search though Stories that are shared with the public – much like Facebook’s search feature.

Making Money Off Fewer Users 

While user growth has traditionally been the most relevant performance yardstick for young social networking companies, we believe that Snap should be able to justify its current valuation if it can prove that it can make more money off its smaller, slower-growing user base. Facebook made roughly $17 off each of its North American users during Q1’17, which implies that Snap could have substantial scope for growth, given that its ARPU stood at under $2 during the same period. Snap has created innovative ad products that don’t necessarily feel like interruptions for users.  The company is also looking to broaden its advertiser base to include more small and medium businesses, as it  rolls out its self-serve advertising tool, in addition to its recent push towards programmatic advertising (see Will Snap’s New Strategy Of Courting Small Businesses Work?). Moreover, the company is also pushing into TV-style video content, which could have higher ad rates. This would allow Snap to at least mitigate some of the competitive pressure that Facebook is increasingly applying.

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