Snap Inc. is facing a declining digital advertising market with fewer reserves than its better-funded Big Tech rivals, and Wall Street is worried.
The Snapchat parent's third-quarter earnings report included the company's third consecutive revenue miss as well as continued declines in its average revenue per user, a bad sign for a company that relies primarily on advertising.
"This is an advertising market that is struggling significantly. It's definitely the first area that gets hit when you go through recessionary times or an economic softening like this," said Angelo Zino, CFRA Research senior industry analyst.
While this year's downturn in online ad spending has also affected Snap rivals like Twitter Inc. and Meta Platforms Inc., Snap shares are underperforming its competitors.
Snap shares plummeted almost 90% in the 12 months leading up to Oct. 21, the day after the company's third-quarter earnings report. Shares in Meta and Twitter fell 62% and almost 24%, respectively, over the same period. Twitter's stock has been buoyed this year in part by its pending sale to billionaire Elon Musk.
Growth vs. profit
A key problem for Snap has been translating its user growth and engagement into profit. Snapchat's daily active users grew 19% year over year to 363 million in the third quarter. It increased its impressions — the number of times Snap content was displayed on a screen — by 8%. But its average revenue per user dropped 11% to $3.11 during the same period. It was the second consecutive period of declining ARPU for Snap.
"It looks like that trend [negative ARPU growth] is probably going to continue to Q4 and likely going to stay negative for the first half of next year," Zino said.
Snap did not provide fourth-quarter revenue or EBITDA guidance, citing "uncertainties related to the operating environment."
Monetization of Snap's Spotlight and Snap Maps features remains a challenge for the company, which aims to make its augmented reality tools a part of its strategic focus, CEO Evan Spiegel said in an Oct. 20 earnings call.
"I think we can do a better job helping people transition from friend stories or private stories into those types of content," Spiegel said. "And relative to other services where people are spending a lot of time watching content, we believe we have a lot of headroom to increase content engagement, so we are working to improve diversity and personalization to realize that opportunity."
However, increasing engagement and monetization may be more difficult with Snap's smaller employee base. The company said in August that it laid off 20% of its workforce, or nearly 1,300 employees. Snap's chief business officer, Jeremi Gorman, and Peter Naylor, vice president of ad sales for the Americas, left for Netflix Inc. to lead the streamer's new ad-supported tier.
"We worry that SNAP's reorg could lead advertisers to slow or even pause their spending," Brent Thill, an equity analyst at Jefferies, wrote in a research note.
Snapping back
Snap expects to onboard new sales executives for Europe, the Middle East and Africa, Asia-Pacific and the Americas by the first quarter of 2023, Spiegel said. The CEO also acknowledged that a restructuring on the scale of the one taking place at Snap is "always challenging."
Increasing engagement and return on ad-spend should be top priorities for Snap's leadership, MoffettNathanson analyst Michael Nathanson said.
"Snap needs to find a way, given the increasing competition for short-form video product, to out-hustle TikTok, Meta, and YouTube (and maybe even a new entrant or two) for consumer engagement," Nathanson wrote in an Oct. 21 analyst note.
Nathanson said this will not be easy, given that Alphabet Inc.'s Google, Amazon.com Inc., Meta and Apple Inc. have superior data and ad infrastructure, as well as better engineering talent and more funding.
Snap's stock price and business model have been particularly hurt by competition from Beijing Byte Dance Telecommunications Co. Ltd.'s TikTok Inc.
"It perhaps goes without saying that a major reason for Snap's difficulties is direct competition from TikTok, in terms of users and usage and advertisers and advertising," said Scott Kessler, global sector lead for technology, media and telecommunications at Third Bridge. "And while Snap seems to be back on its heels, TikTok has been investing and growing aggressively."
Bank of America research analysts Justin Post and Nitin Bansal similarly cited competition from players like TikTok as a reason for downgrading their rating on Snap to "neutral" and lowering their share price target to $11.