Snap Q4 2022 & Social Media – Nasty precedent

Twitter sets a nasty precedent for fat companies.

• Rotten results highlight that many social media companies are structurally unable to make money because they are massively overstaffed as the benchmark of Twitter seems to indicate.
• Q4 2022 revenues / EPS were $1.3bn / LOSS $0.18 broadly in line with consensus at $1.3bn / LOSS $0.20.
• The real problem was the outlook for Q1 2023 where the company said that revenue in Q1 2023 was already down 7% YoY and is expected to fall by 2% to 10% YoY in Q1 2023.
• This was an odd admission as the company declined to give any guidance at all in its press release which is just another sign of the haphazard way that this company is run.
• Furthermore, most commentators will point investors to the adjusted EPS which removes the impact of share-based compensation from the calculation.
• While I am no fan of the way in which share-based payments are calculated, these need to be accounted for because while they are non-cash, they lead to share dilution, cost the shareholder value which needs to be reflected in the profitability of the company.
• Snap does generate cash and has $3.9bn of cash on its balance sheet meaning that it is a going concern, but attention should now turn to its chronic lack of profitability given that it is clearly ex-growth.
• The idea for these sorts of companies is that they have to grow very quickly to grab a market position and while they are doing that they burn a lot of cash.
• However, once they become mature, operating leverage allows margins to increase substantially creating a cash machine that more than justifies the investment that initially went into it.
• Companies like Snap, Pinterest, Twitter and so on took the money from investors while they were growing fast but then forgot to generate a return when the market began to mature.
• This is why their valuations have cratered and why they will not be going anywhere until managements decide to act.
• Now we are in a full-blown economic downturn where the revenue profile of these companies will behave in line with the economy rather than the emergence of a new secular trend.
• Consequently, these companies should now be spewing out cash not still losing money and diluting existing shareholders.
• The problem for these companies is the precedent that Twitter has recently set after headcount was purged by Mr Musk.
• Twitter’s headcount is down by 50% – 70% but the service is still functioning and hardly anyone has noticed a difference.
• Twitter proponents will point to the recent outage and the fact that R&D cuts take some time to manifest themselves in weaker products as evidence that the cuts have hurt the functioning of the company.
• However, I think that everyone suffers outages from time to time and it has been a long time since I have seen any new R&D-driven features appear on Twitter.
• At the same time engagement with the service has increased significantly, meaning that with a 70% headcount reduction, Twitter may now be cash positive.
• This raises the question as to whether other social media companies like Meta, Pinterest, Snap and so on are also substantially overstaffed and whether their financial woes could be fixed with large headcount cuts.
• Meta has spent the last few years recruiting content moderators like crazy because its AI has not been good enough to do the work of humans.
• Although revenues are struggling, engagement with Meta’s services continues to be strong and so I suspect that if it was to really take the knife to the fat, a lot of cash could be generated without harming the underlying business materially.
• This would be a much better way to raise money to invest in the Metaverse because, at the moment, it is shareholders who are footing the bill as EPS is likely to decline again this year.
• Meta is still comfortably profitable and generates a lot of cash, but I suspect it could generate far more if Mr Zuckerberg decided to run the company efficiently.
• While there is a lot of upside in these companies should they be run for shareholders rather than the employees, I don’t think the situation is nearly serious enough to shake management teams into action.
• For example, it took Ericsson to be on the verge of bankruptcy before its controlling shareholders were forced to act and I suspect we may see a similar situation here.
• Hence, I do not like the recovery story for social media and would continue to avoid it as large jumps in profitability seem to be very far off.