Equity research note on Snap's upcoming earnings and DAU outlook

Snap (Neutral, $25 PO) Stock view: Long-term potential, but near-term could be lumpy Snap will report its first earnings as a public company and expectations have a wide range. The 2H16 DAU slowdown has raised concerns in terms of both competitive risk and execution, so user trends could be the most important metric in the quarter. At this point, it’s difficult to gauge relative impact of Facebook / Instagram competition, Android technical issues, product cycle lumpiness, and seasonality to the recent slowdown. Nonetheless, our sense is that DAU expectations are around 164-166mn, and we'd expect variability (higher or lower) to have a meaningful impact on stock sentiment. In terms of the P&L, we expect a slight q/q decline in revenue per normal seasonality and are modeling down 1% q/q (consistent with comments in the prospectus filing}. While we can appreciate the momentum of the API roll-out with several new partnerships announced in January, our checks suggest most programs are early stage with limited volume to date. Considering the rest of the P&L, we expect a fairly messy quarter between deal costs, the CEO stock award, and a catch-up RSU stock comp expense. As we do not anticipate non-GAAP profitability until 2H19, we expect traditional P&L metrics will be less of a focus in the coming quarters. We recently initiated coverage with a Neutral and $25 price target (please see User overhang unlikely to be resolved in a Snap — Initiate at Neutral with $25 PQ). Social media sector history suggests a wide range of possible outcomes for Snap and, as such, near-term lumpiness in metrics could result in high volatility for the stock. We also note that lock-up overhang could drag on near-term performance into the first lock-up expiration on 7/29. Key theme/metric(s) for 1Q: DAUs, ARPU, and competition We believe the key metric for the quarter will be the DAU number, which we model at 166mn (up 8mn q/q, 36% y/y). We believe DAU headwinds may peak 1H17 as the company is facing an onslaught of competitive products (see More Stories in the Snap competitive saga), technical challenges with Android (from Memories), and seasonality entering the summer. We model ARPU at $1.01 (down 5% q/q), with North America ARPU at $2.03 (down 7% q/q). We won't be surprised to see upside in ARPU driven by ad load growth and higher user engagement, though competitive pricing could potentially offset. Biggest 1Q issues/risks: ¢ DAU deceleration on share loss: Anything short of 164mn will likely be met with skepticism as investors extrapolate recent trends in considering competitive resilience vs Instagram, Facebook, and others. Management will likely address the Android technical issues impact on DAUs. + Aggressive pricing could drive short term growth but have mixed perception: Twitter noted elevated competition and potentially aggressive pricing surfacing in mid-January, which aligns well with Snap’s API update. ¢ Lack of visibility into pipeline: While we don’t necessarily expect new product announcements, lack of color/visibility on the product pipeline could disappoint. ¢ Results could leave investors looking for more disclosure: We are not sure what disclosure Snap will provide on results, and important trending info (like average minutes per user) could be lacking. Top 1Q data points: comScore suggests some gains for Instagram While comScore data is not consistent with reported minutes, it is useful for relative comparisons. The data puts Snapchat minutes per user well above Twitter, but still . Bankof America 34 Internet/e-Commerce | 06 April 2017 Merrill Lynch HOUSE_OVERSIGHT_014920