SNAP: Don't Miss the Inflection Point -- Pivotal Research Group

User growth has prospectively turned the corner and estimates seem too low– We are confident the Android launch at the end of Q1 is doing well, but likely anticipated by the buyside based on third party data. Less appreciated based on our industry checks, we think the latest launch of lenses is among some of the most impressive product innovation we have seen in some time from the company. This in our opinion constitutes real innovation in Augmented reality

Advertising we think is moving in the right direction –we continue to hear glowing things about the organization under Jeremi Gorman and suspect that quarter at 2h19 are shaping up well. As we framed in our initiation, based on our experience, there is an important dynamic in online advertising that is under appreciated by the street. When there is a change in senior sales leadership, you have a 3-4 quarter window to make amends for mistakes/mis-execution under the prior regime. Particularly true when you have strong relationships to leverage. That we are already seeing better focus on ad agency relationships and a category-focused sales team – exceptionally low-hanging fruit, suggests alignment is moving in the right direction. Our checks have been more around the large brands/agency part of the business and positive, but self-serve both domestic and internationally should be incremental as well.

Media buyers – for right or wrong - can be fickle, and SNAP is underpenetrated on media plans.We actually think the negative narrative that happened post IPO - coinciding with FB competition, the slow-down in user growth, and multiple quarters of missing estimates likely lead to some potential advertising buyers concluding that they didn't need to add SNAP to a marketing plan – it was no longer the shiny new toy. In our view, that dynamic flows in both directions, and we suspect that it will hold true on the upside as well – particularly heading into the seasonally stronger 2H of the year. To the extent there has been a tenor change in the business, this can serve as a catalyst underappreciated by investors.

If we are right on the our topline and user conclusions, it will be happening on the backdrop of a much more rationalized cost-structure –We think a more important part of the argument of the bull case will be around topline and user metrics, but the prospective incremental profitability will be impressive. We are at 55% gross margins for 2020 vs the street at ~53%. We have total costs accelerating next year, as we suspect the company will lean into Sales and Marketing in particular

Call options in both gaming and an off-network strategy– we are in early innings with regards to both of these initiatives announced at partner day. Social gaming is likely a good fit given the younger user base, and we like the interactive element of it. We are a little less convinced on the off-network strategy, as it can trade off zero-TAC dollars for those laden TAC – maybe premature given they likely are under-monetized on O&O, but it could still be incremental. If the core business is performing well, having call options will serve as another reason for the business to rerate higher.

Where we could be wrong: 1) 2H18 turn was a false positive and momentum tapers out on tough comps, 2) mis-execution from the sales re-org, 3) Android and other recent initiatives are a flop, 4) a bigger than expected investment cycle.

RISKS:1) Over saturation of online marketing within overall ad budgets, 2) macro-economic deceleration causes greater than expected declines in advertising, 3) user growth slows faster than the street expects, 4) limited user growth limits the amount of real upside prospective pricing pressure.

FULL REPORT INCLUDING RISKS AND DISCLOSURES CAN BE FOUND HERE: SNAP 6-6-19.pdf

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