Pando

Turns out no dancing hot dogs were necessary. All that Snap needed was to act like a grown-up

By Kevin Kelleher , written on February 7, 2018

From The Earnings Desk

Snap's stock was surging 45% mid-day Wednesday to $20.36 a share after delivering better than expected earnings for the first time since it went public a little more than a year ago.

Not only did that rally vault the stock above its $17 a share offering price, it put the stock at its highest level in eight months.

That has some wondering whether 2018 could be the year of Snap. The narrative on the company has gone from discouragingly dark to blindingly bright in the space of less than a day. Which feels like a premature call, given that the numbers Snap posted, while encouraging, also show the company has a lot of work to do to become the kind of profitable enterprise beloved by tech investors.

Snap said revenue in the last quarter of 2017 rose 72% to $286 million, above the $253 million analysts had been forecasting. The 187 million daily active users, up 18% year over year, were also above the 184 million forecast. Net loss of $159 million was below the expected $187 million loss.

All good in a relative sense, but let's not forget Snap is still posting nine-figure losses. And it's burning through cash: Free cash flow was negative $197 million, larger than the negative $188 million figure a year ago. Snap's earnings surprised, yes. It did much better than expected, yes. But doing better than low expectations isn't the same thing as doing great.

Investors hadn't just lowered the bar for Snap, they had been actively hammering it down. Short sellers accounted for nearly a quarter of Snap's outstanding shares, having expanded their short positons in the past several weeks. Bears were aggressively betting on another disappointing quarter. When Snap did much better than expected, the rush to close out of short positions accelerated the stock surge. Snap may have quieted the hungry bears, but in doing so has raised the bar of expectations for future quarters. 

But here is what is probably the most encouraging thing about Snap's financial report: Not the revenue growth or the new discipline in spending or even the rise in daily users. It's the sober, serious approach the company has adopted. Evan Spiegel has heard shareholder concerns loud and clear, and is doing something about it.

That shift was clear from the difference between Spiegel in his first earnings call – when he openly dissed Facebook and made comments about puppy dogs – and the Spiegel who spoke to Wall Street this week. The rough edges had been smoothed down. He seems to be mastering the trick of sticking to the bland talking points and, when asked a challenging question, simply reiterating that he feels good about whatever uncomfortable topic an analyst just asked him about.

That approach isn't ideal for open disclosure, but it seems to be what institutional investors expect of a tech CEO. Spiegel is learning to play this game. More importantly, he was able to show progress on several fronts of investor anxiety. Last year's investments in an Android-friendly Snapchat, for example, are beginning to bear fruit. Spiegel said the retention rate of new Android users increased by nearly 20% last quarter. "The people who try Snapchat on Android are much more likely to stick around and become daily active users," he said.

Snap isn't just drawing in more daily users, it's getting better at generating revenue from their attention. Average revenue per user rose 46% to $1.53. That's well below the $26.76 revenue per user that Facebook enjoys from its North American members. Snap is further behind in this race, having switched to programmatic ads in the last year. Ads from automated auctions have gone from 10% of total ads in late 2016 to 90% last quarter.

Still, the shift to automated auctions is drawing in more customers. The number of advertisers using Snap's programmatic ads doubled in last quarter from the previous quarter. While welcome news, the company still has to show these advertisers will stick around and aren't just test driving an alternative to Facebook. In that sense, 2018 may be less the year of Snap than the year that makes or breaks Snap.

This is where the redesign of Snapchat figures in. The bad news dogging Snap has surrounded its stock performance. The bad news dogging Facebook has concerned, well, nearly everything else. Facebook is in the midst of an existential crisis, even as it posts record profits. But the slowdown in user growth and the drop in time spent on the site suggest that people may be longing for an alternative social network.

Facebook has been copying Snapchat's more popular features, but it just may be that in doing so, it's mainstreaming the best of Snapchat, making it more palatable to would-be users confused with how to use the app. At the same time, Spiegel has taken a different approach – building strengths exactly where Facebook is weakest.

The redesign makes Snapchat easier to use, but it also separates news and other content from the conversations a user has with friends. Spiegel drew this distinction using old-school technologies. “There's a really big difference between talking to your friends on the telephone and broadcasting on a TV channel. And I think our society has noticed that difference for a really long time.” The dig at Facebook is, Facebook noticed this too late.

The new Snapchat is rolling out slowly, but the company noted that usage among users over 35 is “disproportionately higher” on the redesigned app. But again, the next few quarters will show whether the turnaround in Snap is a head fake, or the real thing.

Spiegel may be working hard to distinguish Snapchat from the family of Facebook apps, but there is one similarity between the two companies: Both had a terrible first year in the public stock market. Facebook prevailed by addressing its weaknesses. The case Snap is making is it's doing the same, but for now the jury is still out.