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Does Snap Deserve Its First "Buy" Rating?

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Finally, Snap Inc. (SNAP - Free Report) is being recommended to investors. On Monday, James Cakmak, an analyst from boutique equity research firm Monness, differed themselves from the rest of the tech analysts and gave Snap its first “buy” rating.

Snap raised $3.4 billion in the biggest tech IPO in the last two years. Since then, Snap’s stock has not been able to recreate the momentum that once convinced investors and analysts. It ended with a post-IPO low of $19.54 per share last week, falling more than 20% on Friday compared to its IPO price. Several analysts have been giving either a “hold” or “sell” rating to the company after its IPO on March 3.

“There is substantial execution risk, but we’re prepared to give the benefit of the doubt at this stage knowing what we know about Snap, and knowing what we know about the efforts of competitors,” Cakmak wrote in a note on Monday.

Why Buy?

Despite having less users than its competitors like Facebook Inc. (FB - Free Report) and Twitter Inc. (TWTR - Free Report) , a Monness analyst argued that Snap’s decision to brand itself as a “camera company,” and the chance to avoid the ending up like Twitter are the reasons for the “buy” rating.

The hardware of a phone’s camera constantly sees improvement but the camera app has seen little innovation. The analyst says “Snap takes users to a decision tree on what to make of the captured memory.” It engages users and challenges them to create and share content.

If the disappearing photo-sharing app can harness enough creative firepower to avoid becoming just another social media platform, Cakmak sees potential for the company to grow its revenues seven times faster than its competitors, as its competitors’ margins have also likely peaked.

Why Not Buy?

Snap is fairly new to the game of social media advertising, as it only started selling ads at the beginning of 2015 but it has introduced several innovative ways to insert ads. However, these factors can only get Snap so far until it can produce results for marketers. Here are two major obstacles that Snap needs to overcome to attract more marketers.

First, Snap needs to provide detailed measurement statistics that allow marketers to optimize their ad spend. Both Twitter and Facebook allow marketers to run different ads at the same time and provide tools to see which one performs better. With more platforms to introduce ads through, the detailed measurements from Snap become increasingly important for smaller brand companies, as they don’t have the budget like big brand companies to campaign on multiple platforms. This could be a big revenue source for Snap if it can satisfy the needs of small business markets.

Second, Snap’s ad engagement is declining. One of the biggest selling point for Snap before its IPO was that the average user spends 25 to 30 minutes per day on Snapchat. However, app engagement doesn’t equal ad engagement. The customer acquisition firm Fluent said that 69% of the surveyed users “often” or “always” skip ads on Snapchat and the percentage climbed up to 80% among 18-to 24-year-olds users.

Though the sponsored lenses and location overlay are still very engaging, it is hard to solely rely on that. There is limited inventory for the original ads format and also the ads are both expensive to buy and produce.

Bottom Line

Snap holds a bright future if the company can navigate past these obstacles. Monness analysts put a price target of $25 per share on Snap’s stock. The company is trading up almost 2% to $19.90 per share after the “buy” rating was released on Monday. Reuters reported five analysts have recommended selling while four other analysts have neutral ratings for Snap.

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