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Snap Valuation analysis post Q1 earnings

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Snap Valuation analysis post Q1 earnings

Methodology

One way to create a valuation analysis for Snap is to use a discounted cash flow (DCF) model, which estimates the present value of future cash flows generated by the company. To do this, we need to make some assumptions about Snap's future growth rate, operating margin, discount rate and terminal value.

- Growth rate: This is the annual percentage change in revenue for Snap over the next five years. We can use historical data and analyst estimates to project this. For example, according to ¹, Snap's revenue grew by 57% in 2022 and is expected to grow by 35% in 2023. We can assume a declining growth rate over time as Snap matures and faces more competition. - Operating margin: This is the ratio of operating income (or EBIT) to revenue for Snap. This measures how profitable Snap is before interest and taxes. We can use historical data and analyst estimates to project this as well. For example, according to ¹, Snap's operating margin was -22% in 2022 and is expected to improve to -10% in 2023. We can assume an improving margin over time as Snap scales its business and reduces its costs. - Discount rate: This is the rate used to discount future cash flows back to their present value. It reflects the riskiness and opportunity cost of investing in Snap. We can use the weighted average cost of capital (WACC) as a proxy for this rate. The WACC is calculated as follows:

WACC = E / (E + D) * Re + D / (E + D) * Rd * (1 - T)

where E is the market value of equity, D is the market value of debt, Re is the cost of equity, Rd is the cost of debt and T is the corporate tax rate.

We can estimate these parameters using market data and financial statements for Snap.

- Terminal value: This is the present value of all cash flows beyond the forecast period (five years). It assumes that Snap will grow at a constant rate forever after that point. We can use two methods to estimate this: perpetual growth or exit multiple.

Perpetual growth: This method assumes that Snap will grow at a constant rate equal to or lower than the long-term growth rate of the economy (usually around 2-3%). The formula for this method is:

Terminal value = FCF * (1 + g) / (r - g), where FCF is the free cash flow in year five, g is the perpetual growth rate, and r is the discount rate.

Exit multiple: This method assumes that Snap will be sold or valued at a multiple of its earnings or revenue at the end of year five. The formula for this method is: Terminal value = Multiple * Metric, where Multiple is an appropriate valuation multiple based on comparable companies or industry averages, and Metric is an earnings or revenue metric such as EBITDA or sales.

Once we have estimated all these parameters, we can calculate the DCF valuation for Snap as follows: DCF valuation = PV(FCF1) + PV(FCF2) + ... + PV(FCF5) + PV(Terminal value), where PV(FCF) is the present value of free cash flow in each year, calculated by dividing FCF by (1 + r)^n, where n is the number of years from now.

This would give us an estimate of what Snap's intrinsic value per share should be, based on its future cash flows. We can compare this with its current market price per share to see if it is overvalued or undervalued.

Data

I will use the financial statements and market data to make the estimate with my proposed methodology. Here are some of the parameters I will use:

⁠

Growth rate: Based on ⁠

⁠

1⁠

, Snap’s revenue grew by 57% in 2022 and is expected to grow by 35% in 2023. I will assume a declining growth rate of 30%, 25%, 20% and 15% for the next four years respectively. This gives me a projected revenue of $1.36 billion, $1.77 billion, $2.12 billion, $2.54 billion and $2.92 billion for 2023 to 2027 respectively.

⁠

Operating margin: Based on ⁠

⁠

1⁠

, Snap’s operating margin was -22% in 2022 and is expected to improve to -10% in 2023. I will assume an improving margin of -5%, 0%, 5% and 10% for the next four years respectively. This gives me a projected operating income (or EBIT) of -$136 million, -$89 million, -$11 million, $127 million and $292 million for 2023 to 2027 respectively.

⁠

Discount rate: Based on ⁠

⁠

1⁠

, Snap’s market value of equity (or market cap) was $16.84 billion as of March 5th, 2023.

Based on ⁠

⁠

2⁠

, Snap’s total debt was $1.9 billion as of December 31st, 2022. I will assume that this remains constant for simplicity.

Based on ⁠

⁠

2⁠

, Snap’s cost of debt was 6% as of December 31st,

⁠

I will assume that this also remains constant for simplicity. Based on ⁠

⁠

3⁠

, Snap’s beta was 1.32 as of March 5th, 2023. I will use this to estimate its cost of equity using the capital asset pricing model (CAPM), which is:

Re = Rf + beta * (Rm - Rf), where Rf is the risk-free rate, Rm is the market return, and beta is the systematic risk.

I will use a risk-free rate of 2% and a market return of 10% as proxies for these parameters.

This gives me a cost of equity of Re = 0.02 + 1.32 * (0.1 - 0.02) = 0.1256 or 12.56%.

Analysis

Using these values, I can calculate Snap’s WACC as follows:

WACC = E / (E + D) * Re + D / (E + D) * Rd * (1 - T), where E is the market value of equity, D is the market value of debt, Re is the cost of equity, Rd is the cost of debt, and T is the corporate tax rate.

I will use a corporate tax rate of 21% as a proxy for this parameter.

This gives me a WACC of WACC = 16840000000 / (16840000000 + 1900000000) * 0.1256 + 1900000000 / (16840000000 + 1900000000) * 0.06 * (1 - 0.21) = 0.1158 or 11.58%.

Terminal value: I will use both methods to estimate Snap’s terminal value and take an average.

Perpetual growth: I will assume a perpetual growth rate equal to the long-term growth rate of the economy, which I will proxy with 3%.

Terminal value = FCF * (1 + g) / (r - g), where FCF is the free cash flow in year five, g is the perpetual growth rate, and r is the discount rate.

To calculate FCF, I need to subtract taxes, capital expenditures, and changes in working capital from EBIT.

Based on 2, Snap’s effective tax rate was 17% in Q4 2022. I will assume that this remains constant for simplicity.

Based on 2, Snap’s capital expenditures were $91 million in Q4 2022. I will assume that this grows at the same rate as revenue for simplicity.

Based on 2, Snap’s change in working capital was $ (18) million in Q4 2022. I will also assume that this grows at the same rate as revenue for simplicity.

FCF = $144 million, $94 million, $16 million, $102 million, and $202 million for 2023 to 2027 respectively.

Using these values, I can calculate Snap's terminal value using the perpetual growth method as follows:

Terminal value = $202 million * (1 + 0.03) / (0.1158 - 0.03) = $3,389 million

Exit multiple: I will use an exit multiple of 10x EBITDA as a proxy for Snap's terminal value.

To calculate EBITDA, I need to add back depreciation and amortization to EBIT.

Based on ⁴, Snap's depreciation and amortization were $49 million in Q4 2022. I will assume that this grows at the same rate as revenue for simplicity.

This gives me a projected EBITDA of $87 million, $40 million, $38 million, $176 million, and $341 million for 2023 to 2027 respectively.

Using these values, I can calculate Snap's terminal value using the exit multiple method as follows:

Terminal value = $341 million * 10 = $3,410 million

Taking an average of both methods,

Terminal value = ($3,389 million + $3,410 million) / 2 = $3,400 million

Enterprise value: I will discount the projected FCFs and terminal value by WACC to get Snap's enterprise value.

Enterprise value = PV (FCFs) + PV (terminal value), where PV is the present value function.

Using Excel or a financial calculator,

PV (FCFs) = $-71 million

PV (terminal value) = $1,509 million

Enterprise value = $-71 million + $1,509 million = $1,438 million

Equity value: I will subtract Snap's net debt from its enterprise value to get its equity value.

Equity value = Enterprise value - Net debt, where Net debt is the difference between total debt and cash and cash equivalents.

Based on ⁴, Snap's cash and cash equivalents were $2.1 billion as of December 31st, 2022. I will assume that this remains constant for simplicity.

Net debt = $1.9 billion - $2.1 billion = -$0.2 billion

Equity value = $1,438 million - (-$0.2 billion) = $1,638 million

Share price: I will divide Snap's equity value by its number of shares outstanding to get its share price.

Share price = Equity value / Shares outstanding, where based on ⁴, Snap's shares outstanding were 1.58 billion as of December 31st, 2022. I will assume that this remains constant for simplicity.

Share price = $1,638 million / 1580000000 = $1.04 per share

References

(0) Bing prompt:

Create a valuation analysis for Snap, given the latest earnings report

Look up the financial statemnts and market data to make the estimate with your proposed methodology

(1) https://bing.com/search?q=Snap+financial+statements Accessed 3/5/2023.

(2) Snap Inc. - Annual Report. https://investor.snap.com/financials/Annual-Report/default.aspx Accessed 3/5/2023.

(3) Snap Inc. - Financials - SEC Filings. https://investor.snap.com/financials/sec-filings/default.aspx Accessed 3/5/2023.

(4) Snap Inc. Announces Fourth Quarter and Full Year 2020 Financial Results. https://investor.snap.com/news/news-details/2021/Snap-Inc.-Announces-Fourth-Quarter-and-Full-Year-2020-Financial-Results/default.aspx Accessed 3/5/2023.

(5) Snap Inc. Announces First Quarter 2022 Financial Results. https://investor.snap.com/news/news-details/2022/Snap-Inc.-Announces-First-Quarter-2022-Financial-Results/default.aspx Accessed 3/5/2023.

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