Gadfly

Snapchat's Revenue Gap Is an Opportunity

In some ways Snapchat is a mess, but valuations compared with Facebook don't look too crazy  for investors.
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Photographer: Andrew Harrer

It feels weird to write this, but here goes: Depending on how you evaluate Snapchat, the young technology company may not be an overvalued stock. 

I hardly believe my own words. Snapchat has a confused strategy and disappointing financial performance since it went public in March. But based on one -- though certainly not all -- of parent company Snap Inc.'s financial metrics, the stock is relatively inexpensive compared with its peers including Facebook Inc.

Snapchat is hardly a sure bet for investors; far from it. Let's just say that a 22 percent stock swoon from Snapchat's IPO has made buying the company's shares look slightly less like an act of lunacy, although it still requires a big leap of faith. 

Here's how the surprising math works in Snapchat favor: The company in the third quarter generated an average of $2.17 from each of the people who used its app daily in North America. This figure, average revenue per user or ARPU, is a common yardstick for internet companies.

The numbers are useful because in the internet economy, digital hangouts with lots of people are good, and even better are digital hangouts that are expert at turning those fans into money-making opportunities by showing them advertisements. Snapchat's ARPU is derived from its North American revenue of $167 million in the third quarter, and its quarterly average of 77 million daily users of its app in that region.

The company's older and wiser rival gives almost everyone ARPU envy. For each of Facebook's daily users in the U.S. and Canada in the three months ended Sept. 30, the company pulled in about $27.35 in revenue on average. Lack of consistent disclosure in the technology industry makes direct comparisons tough, but it's likely that only Google's web search business generates a better ARPU than Facebook.  

A quick glance will show Facebook's average revenue per user is nearly 13 times the figure for Snapchat. To be precise, Facebook calculates its daily users slightly differently than Snapchat does, and Facebook excludes Mexico and the Caribbean from its domestic ARPU calculations while Snapchat includes those countries. That makes the ARPU comparison close but not exact.

Given how important ARPU figures are for internet companies, it could be expected that the ARPU gap between Snapchat and Facebook would be mirrored in the companies' stock valuations. Instead the valuation canyon is much wider. Facebook's total stock market value is $511 billion as of Friday, or 30 times Snapchat's value. By one measure, then, the younger and struggling company looks like a bargain relative to Facebook.

By other measures, though, Snapchat's valuation remains out of whack. Facebook's stock market value is about 9.6 times the company's estimated revenue for 2018, and Snapchat trades at nearly 13 times the average of analysts' estimates for its revenue next year. In fairness to Snapchat, it might be reasonable for the company's shares to command a higher multiple of its future revenue. Snapchat is young and growing very quickly, and investors might be willing to pay more relative to Facebook's share price in order to own a slice of a growth rocket. 

On the other hand...there are so many on the other hands. Facebook is a great business, dominates the fast-growing category of online and mobile advertisements with Google, and generates loads of profits. By contrast, Snapchat is a mess. It can't seem to predict its own financial performance, it is competing for revenue and people's leisure time with those Google and Facebook powerhouses and it will probably spend more cash than it brings in for several more years. 

Through an optimist's lens, though, the ARPU gap between Snapchat and Facebook is an opportunity. If Snapchat can creep closer to the standard Facebook has set by effectively squeezing more money from each of its users, the financial and valuation gap between the companies will close. The trouble for Snapchat is that it hasn't proven it can effectively cross that canyon. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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