If you’re under 35, chances are Snapchat played a starring role in at least one chapter of your life.

For me, it was high school and college. Snapchat was where you’d send goofy selfies, keep a streak alive with your best friend, and play with funny face-distorting filters, but also where you’d quietly track the social scene around you through your “Best Friends” list and the Snap Map (which shows the location of where all your friends have last sent a snap from).

It’s hard to overstate how much the app defined the social lives of an entire generation...

So when I sat down to study Snap Inc. as a potential addition to The Intrinsic Value Portfolio, the story seemed straightforward: nearly a billion monthly active users, 75% penetration among 13–34 year olds in 25 different countries, and less than 2% share of the U.S. digital ad market.

How, then, could this be a stock trading with a market cap sub $13b?

The deeper Daniel and I went, the more that promising surface narrative broke down. Instead of a misunderstood compounder hiding in plain sight, Snapchat ended up being one of the clearest case studies we’ve come across in what to avoid as long-term investors.

As such, this is our first true “anti-pitch” — not because we’re suddenly endeavoring in short-selling, but because studying failed or flimsy business models can sharpen your BS detector just as much as studying great ones.

Snapchat is arguably the perfect case study for that.

— Shawn

Incredibly, Snapchat today reaches close to a billion people — roughly one out of every eight humans on earth opens Snapchat at least once a month.

Despite that cultural reach, the business is small. Meta is worth roughly 100 times more than Snap, even though Snap’s monthly active user base is 1/3 of Facebook’s (and 1/6 of Facebook & Instagram combined). The problem is that Snap’s share of the U.S. digital ad market is still under 2%, which is shockingly low for a platform that has saturated the phones of teenagers and young adults (a very valuable demographic!) for a decade.

A bull case would begin by looking at the runway for further global penetration. In North America, Snapchat has penetrated about 22% of smartphone users; in Europe, 17%; but just 9% in the rest of the world. If that 9% grows toward 12–15%, you’re talking tens or even hundreds of millions of additional users.

And, of course, there’s an AI angle here, too. Snap’s “My AI” chatbot has been used by more than 200 million people, who’ve sent over 20 billion messages — making it, by their telling, one of the most used AI chatbots on the planet.

Thirdly, the quality of the company’s earnings is fast improving thanks to having more recurring revenues. Snapchat+, their paid subscription, has 17 million subscribers and a run rate of about $700 million in annual recurring revenue.

Add all of that together, and you can see why someone, such as myself, might look at the stock (now trading at roughly a third of its IPO price after briefly touching a $100 billion valuation in 2021) and think there’s a promising opportunity to be had. The company has 13x’d revenues, and 2.5x’d its daily active users since the IPO, yet the shares are down nearly 70% all-time (!)

For as intriguing as the setup sounds to us value investors, Daniel and I quickly concluded that the market isn’t missing something big. If anything, we think investors may still be underestimating just how structurally challenged this business is.

Why are we spoiling the conclusion so early in today’s newsletter? Well, because we want to show how gripping some investment stories can look, and why people get sucked into them, only for the bet to fall apart. Knowing how to diligently sift through the signal from the noise is critical to finding 100-bagger compounders in the long term and avoiding traps along the way.

I soon realized that Snapchat was singing a siren’s song to me, and the rest of today’s newsletter explains why…

The frustrating thing about Snapchat is that, as a product, it really was incredibly innovative.

Back in 2011, Reggie Brown came up with the idea of sending photos that disappear after a short time and shared it with his friend Evan Spiegel as a design class project called “Picaboo.” Bobby Murphy joined to build the code, and by that summer, the first prototype launched. Shortly thereafter, a cease-and-desist from a photo-book company forced the name change to Snapchat, which, honestly, rolls off the tongue better anyway.

The founding story quickly turned messy, though. Brown was pushed out, but later won a $157.5 million settlement, which sounds a lot like Facebook’s controversial early days, as profiled in the movie The Social Network, but the comparisons between the two largely end there.

Still, the early product decisions were genuinely impressive:

— Snapchat figured out how to send images almost instantly at a time when photos could take a minute or more to go through, which was crucial for a chat-first, image-based app like Snapchat to even be viable

— The interface was beautifully simple, too: tap once for a picture, hold to record video

— Teens discovered that they could use Snapchat’s disappearing messages as a way to communicate during class in schools where Facebook and other social media were banned. From this little loophole, adoption exploded across the U.S. in 2012 and 2013.

Over time, Snap layered on all kinds of effective engagement mechanics, from streaks that turn daily interactions into a game, “Best Friends” lists for those you message most, and Snap Map, which, as mentioned, lets you see where your friends are in real time. (Sort of like Find My Friends on iPhone, but with Snapchat, anyone you know’s location can be seen, whereas on Find My Friends, people have to explicitly opt into sharing their location with you. One is very clearly more privacy-minded than the other!)

Objectively, a lot of what Snapchat does is deeply juvenile. Subjectively, though, it worked, and Daniel and I can attest to it. It defined middle school, high school, and college social life for entire cohorts of Gen Z, like ourselves. I know people who barely use Snapchat anymore but still log in just to keep their thousand-day+ streaks alive; breaking the streak would feel like breaking the friendship.

From an investor standpoint, that kind of engagement — an app you might open 20+ times a day and can’t give up, socially speaking — feels like solid gold. So, you really could say Snapchat did many of the “right” things in terms of building a sticky app.

The problem has been that none of their innovations can be patented in a way that their bigger peers can’t copy. Snapchat pioneered Stories, for example, and that has since been cloned by Facebook and Instagram, and now may even be more associated with Instagram than Snapchat.

As funny as it is that Snapchat’s co-founder and CEO, Evan Spiegel, changed his LinkedIn to describe himself as the VP of Product at Meta, it has done little to ease investors’ concerns that the company can’t generate shareholder value from its most popular features.

Underlying this monetization challenge is that Snapchat’s core use case is what you’d call synchronous communication, where you open the app, send a disappearing message or photo to a specific person, they respond, and you’re out. It’s much closer to iMessage or WhatsApp than to an infinitely scrollable feed of posts.

That’s incredibly useful for users, but a nightmare to monetize.

As we talked about on our podcast, there’s really no way to inject ads into intimate back-and-forth messaging without it feeling creepy or intrusive. Imagine Apple suddenly slotting ads between your texts. It feels like a major privacy violation, and, well, that’s why they don’t do it; users would revolt.

Contrast that with asynchronous communication, as it’s known, via infinitely scrollable feeds such as Instagram Reels, TikTok, and YouTube Shorts.

You’re not having a personal conversation. Instead, you’re zoning out and letting an algorithm spoon-feed you videos, creating an environment that’s tailor-made for advertising with long dwell times, low emotional stakes, and, ultimately, content where an ad break doesn’t feel like an invasion of privacy.

Snap has eventually tried to bolt that kind of feed onto its core messaging-based app. In 2020, it launched Spotlight — an algorithmic short-video feed clearly modeled on TikTok and Instagram Reels. Snapchat has since become a hybrid of messaging plus scrollable content, which was probably strategically necessary.

But it doesn’t change the fact that the app’s primary association, especially with its longest-tenured users, is still “this is where I chat with friends,” not “this is where I go to discover new products or creators.” The latter is critical for advertising purposes.

From day one, Snap leaned into privacy more than Facebook, which initially pushed it toward brand advertising — think Coca-Cola commercials — rather than highly targeted performance ads that directly drive measurable sales for, say, a small-to-medium-sized e-commerce business.

One of the narratives sold by investment bankers at IPO was that Snapchat could siphon ad budgets away from cable TV as viewership eroded, becoming the new home of brand-awareness advertising. Unfortunately for SNAP shareholders, the company has proven far poorer at taking this market share, and cable advertising far stickier, than most would’ve imagined.

To take a step back, though, here’s how I think about the spectrum of advertising monetization potential:

On one end, you have Google and Meta (and Instagram), where advertisers can target individual users in incredibly granular ways and measure conversions, which enables brands to directly see whether their ad spending is profitable.

In the middle, you’ve got something like Reddit — pseudonymous, but interests are grouped into communities (subreddits), which is still very targetable, and the platform is famous for its ability to draw in users seeking questions & answers, product recommendations, shopping/travel advice, etc.

On the other extreme sits Snapchat, where users aren’t there to search, to join interest communities, or to shop; they’re mostly there to talk to friends, play with face filters, and maintain social rituals.

That naturally limits the kinds of advertisers willing to spend heavily and the returns they can earn compared to those other platforms, explaining why, seven years after painting a compelling picture of its ability to profitably expand its ad business, the company has never come close to investors’ expectations.

On top of this, Snapchat’s interface adds another layer of friction for advertisers. Its ad products are full-screen, immersive, visual experiences. That’s fun creatively, but it means marketers can’t just repurpose a text ad or static banner as easily. They have to build bespoke creative for Snapchat — and if Snapchat isn’t where they’re getting the best return on ad spend, that extra effort is tough to justify.

It’s telling that when Evan Spiegel laid out his “we’re the middle child” narrative in a shareholder letter, he acknowledged that Snap controls less than 1% of the global digital ad market and sits squeezed between trillion-dollar giants on one side and leaner upstarts on the other.

Put simply, the nature of how people use Snapchat just doesn’t line up with the most lucrative and scalable slices of the digital ad pie, something the market has realized in recent years after once imagining Snapchat to be the next Instagram during the Pandemic-era’s euphoria.

One of the biggest takeaways from digging into Snapchat is just how fragile the company’s franchise has always been.

Illustrating the point, a single tweet from Kylie Jenner in 2018 — essentially saying she wasn’t using Snapchat anymore — erased more than $1 billion of Snap’s market value in a day. This strikes me as being the opposite of a margin of safety. Margin of danger, perhaps?

Speaking to my fellow Buffett and Munger acolytes here, compare this with the moats around Coca-Cola, American Express, or a railroad. You’d need to stretch your imagination over a hundred-year timeline to begin to picture those disappearing. With Snapchat, it isn’t crazy to wonder if the app will still exist in ten years.

A product can be culturally important, addictive, and wildly innovative, and still be a terrible vehicle for long-term compounding if the business model doesn’t match the behavior it’s built around.

It’s not enough to ask “Do people love this?” You have to ask, “Can this love be monetized in a way that produces durable, growing cash flows for owners?” For Snapchat, thus far, the answer to the latter question has been no.

If the product vs. economics mismatch is the first red flag, the second is governance and incentives. Snap manages to fail that test in almost textbook fashion with the most lopsided voting structure you’ll see.

Every share you and I can buy in the public market carries zero voting rights. Not “some rights but less,” not “1 vote vs. 10 votes for founders.” Literally zero.

Meanwhile, Evan Spiegel and Bobby Murphy control roughly 95% of the voting power through super-voting shares, making it exceedingly unlikely for any trapped value in Snapchat to be realized by acquisition, since Spiegel has made it clear that he isn’t interested in selling after turning down Zuckerberg and Facebook over a decade ago.

In practice, what it means for share classes available to the public to have no votes is that you could buy every single traded share of Snap and still have no ability to force a leadership change, push for a sale, or influence strategy.

Founders are insulated from the normal feedback mechanisms of capital markets. If things go poorly, they can’t be voted out. With truly exceptional, once-in-a-generation leaders, that sort of structure can be great for shareholders. Too often, though, it just means that shareholders, who the CEO ultimately reports to, have no way to hold anyone accountable or enact change.

Most egregiously, Snap has never produced a full year of profit, and cumulatively, the company has racked up about $10.6 billion in losses since going public.

However, over that same period, insiders have been awarded over $9.5 billion in stock-based compensation. Net income and stock-based comp mirror each other almost perfectly over time, as if every dollar of loss for shareholders was offset by a dollar’s worth of equity handed to employees and executives.

Recently, stock-based comp has still been running at more than 17% of revenue, and it was close to 30% just a few years ago. In my opinion, companies relying on that level of dilution, seven years into their public life, aren’t run in the best interest of outside shareholders.

On top of that, Evan Spiegel has sold more than 4.3 million shares over the last year without a single open-market buy. On paper, it looks like he has skin in the game, but if there are no actual profits to share and the founder is steadily lightening his stake, it’s fair to ask who the game is really for.

In his own letter, Spiegel effectively admits that they’ve had to rely heavily on stock as a kind of alternative currency because the business doesn’t generate enough cash to compete for talent. That makes sense for a young company in the early burn phase, but mature, profitable companies fund growth out of operating cash flow and use stock issuance more sparingly.

The fact that Snapchat hasn’t been able to even get to that point, so many years after first hitting the public markets, is damning and indicative of exactly why the business has consistently been a disappointment.

Snap’s gross margin — a measure of what’s left after the direct costs of a good or service — is about 54%. If Kroger sells eggs for $5 that it paid $2.50 for, then that’s a gross profit margin of 50%.

40-50% gross margins are roughly what you’d expect to see at top-tier grocery chains and brick-and-mortar retailers. AutoZone, which runs thousands of physical stores selling auto parts, has almost the exact same gross margin as Snapchat.

By contrast, true software and digital platforms tend to have gross margins north of 80%, sometimes close to 90%. Adobe is around there. Reddit, which we’ve also covered before and is an Intrinisc Value Portfolio holding as well, is above 90%.

In theory, Snap should look more like them, with its costs of goods sold consisting of servers, bandwidth, and revenue-sharing with top creators — standard stuff in running a social media app. The fact that it doesn’t tells you that the underlying economics are structurally worse than the “social media” business label implies.

Why is this the case? In short, juxtapose Snapchat with Reddit, where Reddit is primarily a text-based feed. It does have videos and images, of course, but Snapchat, in its entirety, is about continuously sending images & videos back and forth, as well as storing select saved images & videos as memories. From a bandwidth and tech infrastructure perspective, this is vastly more demanding.

Even in Snap’s S-1 filing for IPO, they recognized that they incurred substantial cloud computing costs to support their app, and there was a legitimate risk that, as the app expands globally, especially into emerging markets with lower average revenues per user (ARPUs), then cloud computing costs could outpace revenue growth. Things haven’t been that bad, but fast-scaling tech infrastructure costs to support growth into less profitable markets have contributed to gross margins remaining roughly flat since 2020:

Again, this isn’t indicative of the trends in operating margins and overall profitability that we’ve seen with other fast growers in our portfolio, from Reddit to Uber and Airbnb, which is concerning for Snapchat bulls.

One other difference with Reddit, as we discussed in our previous coverage of the stock, is that the company benefits from a vast army of unpaid moderators who freely volunteer their time to support the platform; there are no creators to be incentivized and paid for frequently posting content. Both points stand in sharp contrast with Snapchat.

When you put the puzzle pieces together, you get a business with structurally weak gross margins, meaning less room for operating leverage; heavy stock-based comp filling financing gaps at the cost of perpetual dilution, and a zero-vote share class, which means you’re along for the ride regardless of whether you like where the founders are steering.

What about that promising subscription business we mentioned, or Snap’s nearly unrivaled rates of adoption by younger generations?

On the subscription business, well, this was another disappointment. Yes, scaling Snapchat+ to a $700m ARR is solid work, but not enough to materially change the thesis, unfortunately. Less inspiring to us is that Snapchat+’s base offering is priced at about $2.25 per month in the U.S., and less in other markets, and its value-add is shaky, at best. All that comes with it is “early access” to certain features and reduced ads (not even totally ad-free!).

Honestly, I’m not really sure who is paying for this…only die-hard Snapchat users would care about access to early features, and if $2.25 a month is the best they can do to monetize their most engaged users, that’s almost sad in a way. After all, $2 a month or so is not much more than they generate in ad revenue from users in the U.S., so it’s not even clear that this incrementally drives meaningful business growth!

If you go from making ~$3/month from a user in ads (~$36 annual ARPU), and cut their ad load in favor of a ~$2/month subscription, the net effect on the business is seemingly negative! The subscriptions, in other words, might actually be making them less profitable in North America.

More typical in the world of apps is that the top 5-10% of super users drive 80% or more of revenue.

Point being, you’d expect Snapchat to monetize its top users at several times the rate of regular users, which is seemingly not even close to being the case.

While that’s disappointing, it’s not a fundamental concern for the business’s viability. What is a fundamental concern is that Snapchat’s popularity in its most profitable market, North America, is declining.

Even though Snapchat has consistently grown its user base, its earnings power could actually decrease if it’s losing American users and replacing them with users from Latin America, MENA, and South Asia, where ARPUs can easily be 1/3 to 1/5 of American users. In other words, for every 1 North American user lost, they could need to add up to 5 users in developing markets just to keep revenues the same (while incurring greater backend costs to support more users).

Seeing this was the final nail in the coffin for me in deciding whether this would be an interesting pitch for the Portfolio to Daniel, to realizing that this write-up would need to be an anti-pitch; an illustration of how to spot what to avoid.

Oh, and somehow, we didn’t even mention the worst part yet. 8 years ago, the company rolled out augmented-reality (AR) glasses, which was maybe a good marketing stunt at the time, but no, it continues to look like a core part of their business strategy; something I find utterly mind-boggling.

When a business has this many structural headwinds, management usually leans hard on “optionality” to sell the future, showcasing new products, new geographies, and new technologies. It’s a bit annoying, but it’s to be expected.

As I said, I initially assumed Spectacles were a fun PR experiment. But if you listen to their earnings calls, management talks about AR glasses as if they’re the future of the entire company and has for years. It’s not a side project!

Snap is trying to move from being a mostly digital, ad-supported platform into tech hardware, which is historically one of the worst, most competitive, and lowest-margin segments of tech. And they’re doing it in exactly the corner of hardware where multi-trillion-dollar companies like Google (Glass), Meta (the metaverse / Quest), and Apple (Vision Pro) have poured billions and still failed to create mass-market products. I don’t think I’ve ever, in the real world, seen someone wearing an Apple Vision Pro headset or smart glasses.

If Meta and Apple can’t crack augmented-reality hardware profitably at scale, it’s hard for me to imagine Snap doing it while their core business is already struggling. I mean, seriously, if you can’t build a profitable advertising business with almost a billion users, how are you going to make smart glasses work?

It’s so unserious that I’d almost expect analysts to openly mock Evan Spiegel about it on earnings calls. Maybe that sounds harsh, but I really cannot emphasize how terrible the idea sounds with even just a little bit of second-order thinking. The prospects for success are incredibly low for a product with no proven demand from customers, following years of different versions of smart glasses being rolled out by tech giants.

So yeah, clearly, Daniel and I won’t be investing in Snapchat. We hope, though, you enjoyed this change of pace. It goes without saying that a model isn’t needed for us to determine that Snapchat, at almost any price, would seem overvalued to us. If a business can never generate profit, its intrinsic value is, well, zero (or maybe even negative, you might argue.)

Next week, we’ll be back to our usual habit of trying to find powerful compounders and undervalued businesses to invest in, but we couldn’t help ourselves from highlighting this egregious case of shareholder value destruction.

This isn’t to say that it’s guaranteed that Snapchat’s business will never be profitable or that the stock will never rally, but there are many, many other bets in markets we’d prefer to make before wagering on Snapchat’s long-term value to potential shareholders.

In ten years, Snapchat might still be around, or it might be an appendix in a tech history book. The range of outcomes here runs from 100x if everything suddenly goes right to zero if the business doesn’t materially improve, and there’s no durable moat to tilt that distribution in your favor.

That’s not the kind of bet we’re interested in.

Updates below on our Intrinsic Value Portfolio.

"It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”

— Charlie Munger

📺 WATCH: Where Disney is heading in its next century

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