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Alex Cho

Morgan Stanley Initiates $28 Price Target on Snap Inc.

Morgan Stanley, Brian Nowak analyst initiated Snapchat at Overweight, today. The analysis on forward sales/earnings seemed fairly conservative with price target initiation set at $28. The stock is moving higher today on renewed positive sentiment from other members of the analyst consensus.

Here were the key highlights from the research report:

We initiate coverage with an Overweight (OW) rating and $28 PT following the completion of the March 1, 2017 IPO at $17 per share. Our $28 DCF-driven PT implies Snap will trade at a 19X '18 EV/revenue multiple, slightly above the regression-implied multiple for its comp group. We believe this multiple is appropriate as Snap is expected to be the fastest growing company in the sector over the next three years (~100% '16-'19 revenue CAGR) and our ad load and DAU sensitivities speak to optionality of materially higher earnings power. We also support our PT with 4 additional valuation methodologies (including EV/EBITDA and P/FCF analyses comped against Facebook).

The analyst, Nowak also notes that the service will reach profitability by FY’20. Though, he also acknowledges that monetization ramp may happen quicker, or DAU (daily active user) growth may trend even higher than what his estimates suggest.

Furthermore, he goes onto mention that Snapchat has yet to optimize ad-load and pricing, which creates significant opportunities to ramp revenue growth.

Here’s what he mentioned in his report:

Snap’s ad load is still very low as, by our math, Snap’s 2016 ad load was 0.6 ads/DAU/hour, vs. ~50 at core Facebook, ~100 at Twitter, and ~7 at Instagram. Our Base case calls for Snap’s ad load to increase to ~8 per hour by 2020…which (when combined with 11% '16-'20 CAGR DAU growth, partially offset by ad unit pricing compression) leads to 87% '16-'20 CAGR advertising revenue growth.

Generally speaking, Snapchat’s monetization efforts have been slow in response to potential DAU churn, which is why investors have been overly discounting the potential of further optimization in ad-inventory, as opposed to user growth.

Nowak goes onto describe his valuation method:

Our PT is derived from a 10-year DCF, implying a value of $28/share or a 19X '18 EV/Revenue multiple. In our DCF, we assume Snap grows revenue at a 51% CAGR from 2016-2025 and its adj. EBITDA margins expand to 40% by 2025, from approximately 0% in 2016. Higher long-term profitability would lead to an even higher market value and enterprise value per share. We assume a ~10% WACC and a terminal growth rate of 3.5% (in line with other growth-oriented companies with limited debt).

Overall, the analysis from Nowak felt reasonable, though I have yet to assign a recommendation or price target on the stock. Furthermore, I felt the commentary coming out of the Snapchat IPO among members of the consensus wasn’t all that balanced.

Hence, I believe shares will continue to move higher in response to bullish analyst commentary. Though, I continue to maintain my hold rating until I model earnings/sales ramp.

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