Why Did Snapchat Go Down?

Snapchat parent company Snap (NYSE:SNAP) has taken one of the worst beatings in the stock market this year. The company has shed 78.4 percent of its value so far in 2022, causing massive losses for many investors.

 

In July, shares of the already embattled stock fell even farther. So, why did Snapchat go down? And will SNAP recover?

The primary driver of Snap’s sudden drop in July was the release of its Q2 earnings report. While revenue increased by a respectable 13 percent year-over-year, Snap’s net losses soared to $422.1 million from just $151.7 million a year earlier. Adjusted EBITDA fell from $117.4 million to just $7.2 million.

 

Snap also extended a losing streak in terms of free cash flow. In Q2 2021, the company reported FCF of -$115.7 million.

 

For the most recent quarter, that loss jumped to -$147.5 million. This represented a troubling 27 percent increase in negative free cash flow.

 

Continued burn at this rate could begin to substantially reduce the company’s cash reserves. While Snap retains ample cash at the moment, negative flows could present a problem if they are not resolved soon.

Together, these facts contributed to growing shareholder concerns that the company could have a long road to reliable profitability.

 

Cash burn, in particular, could be a contributing factor to Snap’s sudden decline. If deeper problems begin to emerge in the company’s balance sheet, Snap could face significant headwinds on its path to recovery.

 

Another cause for concern came in the form of management’s unwillingness to offer forward guidance for Q3. Citing market uncertainties, management did not provide any kind of expectations for the upcoming quarter. This level of uncertainty could mean that Snap’s troubles will get worse before they get better.

 

A final factor playing into the decline of Snap is increasing pressure on legacy social media companies from upcoming competitors, specifically TikTok. The short video format platform has achieved extremely high rates of growth and user engagement, sapping users from platforms like Snapchat.

 

Snap’s current woes are far from unique, as 2022 has been particularly hard on social media stocks. Of the major platforms, only Meta is currently trading appreciably above its IPO price. In part, this is due to rising interest rates and growing skepticism around future growth.

 

As with Snap, TikTok has been responsible for many of the broader social media industry’s problems. Increasing competition, lagging earnings and the shift of users between platforms have caused many investors to question assumptions that supported much higher earnings multiples.

 

While social media has certainly taken a beating this year, Snap has fared worse than its peers. Twitter and Meta are down 1.6 percent and 50.3 percent YTD, respectively.

 

Though certainly not positive, even Meta’s drop doesn’t come close to Snap’s fall of more than 75 percent. So, while similar forces are likely acting on all social media platforms, Snap appears to be taking more damage than any of its competitors.

Despite clearly being distressed, Snap still has real chances to mount an eventual comeback.

 

One of the most promising tools in the company’s kit is Spotlight, a feature meant to allow Snapchat to compete with TikTok. In early 2021, Spotlight boasted 125 million users.

 

Continued user and engagement growth could help Snapchat remain relevant and allow it to generate new revenue growth going forward. In Q2, Spotlight achieved a 59 percent year-over-year improvement in time spent by users watching content.

 

Snapchat is also steadily introducing other new features that could help it capitalize on its current user base. In Q2, for example, the company introduced a paid subscription service called Snapchat+ that offers users exclusive features.

 

Snap also created a collaboration feature called Shared Stories that allows groups of people to work together on content creation.

 

Insiders clearly remain firm in their belief that Snap can overcome its challenges. Insider ownership accounts for about 20 percent of Snap’s shares, a healthy indicator that management is still optimistic about the future.

 

Even after several post-earnings downgrades, the consensus view among analysts still shows Snap moving higher over the next 12 months.

 

The median target price for the stock is $14, a 36.7 percent jump from the current price of $10.32. While significant, it’s worth bearing in mind that this would still put Snap at less than 20 percent of its 52-week high.

Snap’s recovery chances could be hindered by rising costs for borrowed money. Much of the company’s outstanding debt is in convertible notes issued when stock prices were far higher than today.

 

To pay off these notes, Snap would need to achieve drastic improvements in share prices, borrow money at higher interest rates or use cash to cover the difference.

 

Given the headwinds Snap is facing, there’s no guarantee it will be able to raise its share price fast enough to cover its obligations. Either of the other options would put Snap at a disadvantage, especially if it continues to burn through its cash reserves rapidly.

 

Snap will likely mount a comeback from the extremely low prices it currently trades at, but the process could be a long one. Some of its problems, particularly with regard to free cash flow, could take a year or more to resolve.

 

Investors would also be wise not to bank on an appreciable recovery this year since even a minor piece of bad news could send the stock lower and negate the projected chances for upside.

 

Risk-tolerant investors who don’t mind buying and holding through volatile conditions, however, could see strong returns over the next few years.

 

Snap still has real chances for growth, though it will need to address its current problems before it can begin a serious recovery. If it can ride out current market conditions and continue building out features that make it more competitive, Snap could eventually reverse its losses.

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