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== Investment framework == Within our investment framework, we look for companies exposed to the strongest growth drivers, high degrees of leverage in the business model, management focus on innovations that are disrupting a large underlying industry, and, in an industry that offers few of them, real competitive barriers or sustainable advantages in technology, scale, and/or business model. In particular, we look for strong network effects, a high ratio of revenue to customer acquisition costs, and strategies to exploit the growth in internet as a whole and mobile, social, and local in particular. Upon determining attractive and sustainable business models, we layer on valuation to determine our best investment ideas. We look for attractive valuations relative to the growth rates and returns on invested capital that we believe the companies can sustain. Those are the companies we believe investors will be best served owning, particularly when their current growth multiple undervalues those opportunities in our framework. Based on our growth, leverage, innovation, and competition (GLIC) framework analysis and the stock’s current valuation, we believe SNAP warrants a Buy rating. To provide a quantitative guide to this process we rank the companies across our coverage by the four factors of the framework, namely, Growth, Leverage, Innovation, and Competitive Advantage (Exhibit 24). We elaborate how we view Snap on each of the factors below: '''Growth'''. Within our framework, we measure growth using a 2016-2019 sales CAGR. Snap leads our coverage in terms of next three years’ sales CAGR with ~100% expected sales growth, driven by a 16% increase in DAUs and 70% increase in ARPU over the same time period. Snap benefits from a large and expanding addressable market and we expect the revenue growth to come through user growth, and increased monetization efforts through the products that currently exist. '''Leverage'''. We measure leverage as incremental margin, which is calculated as (NTM adjusted EBITDA – LTM adjusted EBITDA) / (NTM sales – LTM sales), using GS estimates. Snap ranks lower in our coverage on operating leverage as its faster sales growth is more than offset by the lack of its profitability given its resource-intensive nature and focus on improving monetization. The company had negative adjusted EBITDA margins in FY16 as it ramped up R&D and marketing investments. The company is not expected to break-even on an adjusted EBITDA basis until 2019 as it would continue to make these investments to drive adoption and improve monetization. '''Innovation/disruption'''. We use a 50%/50% blend of TTM product development expense and TTM product development expense as a percentage of gross profit to quantify the level of innovation at a company. Snap falls into the top quartile of the coverage with rank 7 in terms of innovation. Snap spent $184mn on R&D expenses in 2016, a growth of 123% yoy. We expect Snap to almost double R&D investment in 2017 and grow it to $1.8bn by 2021. Snap ranks second, just behind Zynga in terms of product development expense as a percentage of gross profit, reflecting the investments required for an early stage company to stay relevant in a highly competitive environment. We believe Snap has the potential to reach 70-80% gross margins as a mature business with higher monetization. Therefore, for comparison with our coverage, we have assumed a gross margin of 75% for our calculations despite the company’s negative gross margins in 2016. Competitive advantage. We measure competitive advantage using a 50%/50% blend of (i) a qualitative (1-4) rank where 4 represents high levels of competitive advantage and (ii) LTM market share for the respective addressable markets. Snap ranks 22nd in our coverage in terms of competitive advantage given the company is in early growth stage. We rank Snap as 3 on a scale of 4 based on the pace of new features and products introduced by the company, higher engagement compared to most of its competitors. We calculate Snap’s market share using FY16 revenue as a percentage of total global ad spend. Though there are other ways to look at Snap’s market share including share of time spent on platform, unique visitor traffic, we believe total global ad spend is a better metric for comparison with other online advertising companies in our coverage.
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