Social Networks Can't Afford to Lose Too Many Friends

0

Facebook, Twitter and Snapchat-parent Snap Inc. all posted declines in key user bases for the second quarter.

Facebook, Twitter and Snapchat-parent Snap Inc. all posted declines in key user bases for the second quarter.


Photo:

arun sankar/Agence France-Presse/Getty Images

The big social media companies have become highly valuable by effectively selling access to their fast-growing user bases. That makes weak user growth numbers especially dangerous for their valuations.

Facebook, Twitter and Snapchat-parent Snap Inc. all posted declines in key user bases for the second quarter. Facebook reported its first slip ever in the combined number of daily active users in the U.S. and Europe—markets that drive a majority of the company’s advertising business. Snapchat’s daily active users fell for the first time in the young company’s operating history. Twitter has seen drops before, but this time investors were expecting the company to add 2.5 million to its monthly active user base for the June quarter. Twitter instead lost one million.

Investors have driven down their stocks by an average of 16% following their respective second-quarter reports. But all three remain relatively richly valued compared with others in the internet sector. Snap trades at nearly 11 times forward sales following its selloff, while Facebook and Twitter are around eight times. The Nasdaq internet Index currently averages about 4.3 times forward sales, according to FactSet.

The high valuations indicate that investors seem to view the recent bouts of user declines as a temporary blip—rather than a long-term problem. Facebook and Twitter both cited changes they are making to improve the health and security of their networks as reasons for their recent user declines. Snap, meanwhile, blamed a recent—and highly controversial—redesign of its app.

Wall Street analysts are also looking past the recent reports and still expect all three companies to grow their respective user bases. According to analyst projections tabulated by Visible Alpha, the number of Facebook’s monthly active users is expected to top three billion by 2022, up from about 2.2 billion today.

Large advertisers likely aren’t going to shift their budgets based on a bad quarter, especially after having made major pivots toward social media in recent years. In the second quarter, Facebook’s daily active users grew just 1.5%, its slowest pace on record, but advertising was up 42%.

But the risk is that if users continue to bail, social networks will need to earn more cash from those who remain. Admittedly all three have proven adept at that in the past. Facebook for instance made about $22 in ad revenue per average monthly user over the past 12 months—roughly double that of three years ago. But this strategy is limited by the amount of ads that can be crammed into users feeds without damaging their experience. Even the best of friends can only take so much.

Write to Dan Gallagher at dan.gallagher@wsj.com