Snap (SNAP) is on a steady decline, and the culprits are pretty obvious: lower-than-expected revenue growth, disappointing user growth, and a free-fall in advertisement prices. But if you want to understand why the stock is sliding, this is really only part of the story.
The real part of the story is Snap’s refusal to cooperate with Wall Street. CNBC has a very good summary of the issue, with quotes from several Wall Street analysts that all boil down to one point: Snap is not helping investors understand its growth vector, its future revenue potential, and how the stock should be valued. As a result, the stock is now below $12 per share, below its IPO price and about 50% lower than its high. The big hits to the stock have happened at both quarterly earnings results, which were major disappointments.
What does it mean for a stock to “disappoint”? While the word evokes emotions, in finance it actually has a clear quantitative meaning. Analysts create estimates for the company’s quarterly earnings, revenue, and expenses. When the company reports anything below that estimate, it’s a disappointment.
How do analysts create those estimates? There are really three aspects to this. The first is part of an analyst’s “due diligence.” By reading about the company, its competitors, its products, its total addressable markets, its probable expenses, its margins, and so on, analysts can get an idea of how revenue and earnings will grow in the future.
The second is extrapolation. Analysts look at the growth trend in the past and extrapolate what it may look like in the future. Stocks with longer histories of earnings results tend to be easier to predict for this reason; there’s more of a track record. When something new happens to the company, like when AT&T (T) acquired DirecTV, that often throws the extrapolation from historical trends out of whack and can create significant surprises that move stock prices. Analysts try to take this into account, but in most cases the change is so drastic that it’s impossible to account for it with any degree of accuracy.
The third, and arguably most important, inspiration for analysts’ estimates comes from company guidance. Most public companies will announce what they expect revenue and earnings to be for the next quarter (some will announce even more). Analysts can use this as a grounding for their own guesses. Of course, it’s in the company’s best interest to underestimate their guidance, and analysts will try to account for this by assuming a slight pessimistic margin of error to companies’ guidance. It’s a cat-and-mouse game that is arguably one of the funner parts of financial analysis, because of the high level of psychological game-play at hand.
The second part of creating estimates is not easy with Snap because it’s so new. The first part is always difficult with all stocks, because it requires a lot of deep reading, interviewing industry experts, and analysis of things that go beyond the wheelhouse of the average person trained in finance. Many analysts will hire outside industry experts to assist in this, but of course others will cut costs and not splurge for the extra assurance those experts can provide.
With a new stock, guidance is very often the lynchpin of estimates for the future. But Snap has rather contemptuously refused to give guidance, making analysts’ jobs a lot harder. Thus for the past two quarters, analysts have had very ambitious estimates because they’re looking at Facebook (FB), Twitter (TWTR), and other similar companies and trying to apply those growth vectors to Snap.
Of course, that won’t work. When Facebook went public, it had no social media competition. Twitter obviously had competition from Facebook, but was still fundamentally different from FB that it could carve a niche (for a while, at least). Snap, however, is facing a very different landscape in the online media world, and analysts are struggling to understand exactly how it’s different. Snap is also a fundamentally different platform with different management, a different corporate culture, and, most obviously, a different attitude towards Wall Street.
That different attitude is quite possibly one of the biggest factors hitting the stock. Because analysts are very much in the dark when creating their estimates, they’re being too ambitious, making Snap a disappointment and causing the stock to fall.
FB and TWTR were very different. Obviously, FB’s IPO was a disaster; not only was a lawsuit filed, but its growth expectations were very low. Many on Wall Street criticized Zuckerberg’s immaturity and inability to handle himself on earnings calls. Others were aghast that FB hadn’t monetized mobile yet (remember, this was 2012!). Quickly, FB helped Wall Street and Silicon Valley understand its future with a series of seminars, conferences, and so on. Similarly, TWTR worked closely with Wall Street and hired Anthony Noto as its CFO. Noto, a former Goldman Sachs (GS) exec, was highly regarded on Wall Street.
Of course, it’s important to remember that playing Wall Street’s game isn’t enough on its own. Noto’s reputation was hurt severely when TWTR had a number of disappointments, and he was quietly moved out of the CFO spot (replaced by Ned Segal, another Sachs alum). Arguably that wasn’t Noto’s fault—Twitter’s business stumbled because of fundamental reasons related to its business model. And, equally arguably, had Twitter not given guidance and worked with Wall Street, its stock would’ve fallen even further.
The lesson here is pretty clear: when you’re dealing with a new company, you need to think about how well it is going to play along with the game of being a public company. Snap was clearly very reluctant; you only had to look at its IPO of non-voting shares to see that. That was the canary in the coal mine that the firm wouldn’t work with Wall Street, and may possibly see it as an enemy for a long time. But Wall Street is really just a synecdoche for shareholders, so one must also consider the possibility that Snap also sees its shareholders as an enemy, too.