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Best Stocks to Short: Ohhhhh... $SNAP

Best Stocks to Short: Ohhhhh... $SNAP

My reasoning behind shorting Snapchat stock

Although I am a huge believer in long term investing, I also occasionally ponder short term trades. I hardly every make them, and if I do it's with a small amount of money, but I believe it's good to keep a lookout for opportunities, wherever they may be. On occasion, I find a short that is really hard for me to NOT trade. For the next two weeks, I am going to spotlight two of my favorites. This week, I'll be taking a close look at Snap, the parent company of Snapchat. Note that I am not short Snapchat stock, and do not advise anyone to... this is simply an exercise in evaluating the business.

Snapchat: The business

Snapchat is a social network. Users can message friends with video and still images, which they can easily edit and augment with text or filters. Pretty simple, right?

Snapchat makes money the same way that Facebook and Twitter and every other social network does: ads. Since they went public last year, Snapchat has grown revenue from $150m a quarter (Q1 2017) to nearly $300m (Q4 2017). Looks pretty good, right? Well... that's just one metric. 

As is common with tech companies that are newly public, losses have ballooned along with the growth in revenue. Snap is losing more money than they are taking in in REVENUE each quarter (and I am being generous by excluding some murderous special items). Yes, you read that right, although Snap took in close to $300m in revenue in Q4 2017, they lost $360m. The first quarter this year wasn't any more impressive. Long story short, they would have to double their revenue without raising costs at all, just to have a -20% margin. 

Absolutely. Fucking. Nuts. Apologies for the profanity. 

Snapchat: The Valuation

Despite the fact that the business is hemorrhaging money, it continues to survive and retain a lofty ~$12b market cap (as of 5/2/2018). To be fair, they have enough money in the bank to weather another year or so without significant fundraising. But, the success of the business is predicated on one single metric that I believe is about to turn dangerously south: monthly average users. See the visualization below for that figure over time.

Screen Shot 2018-04-28 at 1.24.02 PM.png

Like all social media giants, the high valuation of the business is justified by continued and accelerating growth. As we can see from the image below, although MAU is growing, the pace of growth is not anywhere near as impressive as it once was. The moment that number turns flat or negative is the moment Snap loses 50% of its value in a single day. On 5/1 when they reported Q1 numbers that were lower than expected (but still positive), the stock dropped 20% in a day. I think that (significant) blip is a sign of things to come.

Snapchat: The competition

I wouldn't be so bearish on Snap if it weren't for the robust competition in the market. Instagram is eating their lunch, copying every single feature they release month to month. With the far greater reach of Instagram, there's no reason or incentive for users to download Snapchat. Anecdotally, people I have known who LOVED Snapchat and used it every day have now completely abandoned the platform for Instagram. 

You heard it here: Snapchat is going the way of MySpace. 

Conclusion: Shorting Snapchat is a risk, but it could pay off big

I don't know when Snapchats house of cards will come crumbling down, which is why I am not short Snapchat stock. But... I know that it will sometime if current trends continue. Congrats, Snap, you are the first installment in Best Stocks to Short!

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