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Over the last six to nine months, we decided to take a step back on covering Pinterest (NYSE:PINS) and let the volatility play out in the stock. In returning to coverage, our conclusion is that while the dust hasn’t settled yet, and the stock likely hasn’t bottomed yet, we would be happy to be long-term shareholders.
In the short term, there are quite a few headwinds afflicting the business that leave us believing you have serious downside risk to estimates (on both the top-line and bottom line). These risks include:
In spite of all these headwinds, which we think the Street is actually underpricing, the reality remains that in our opinion, Pinterest is likely a stock detached from good business fundamentals. As such, we’re restarting coverage at Buy.
To start, let’s go over the numbers and commentary from Pinterest’s 4Q report and forward outlook.
In spite of recent churn in engagement, management at Pinterest has built out a pretty good ability to lead the Street into a trend of positive estimate revision since the IPO, especially on top-line numbers.
They’ve beat earnings expectations every quarter for the last six quarters, and have beat revenue expectations every quarter for the last nine.
Pinterest Revenue Surprises (Seeking Alpha Premium)
Pinterest Earnings Surprises (Seeking Alpha Premium)
That’s impressive, and shows that for all one can say about the work culture at Pinterest, they continued to exceed expectations. Additionally, we like seeing management conservatism, something CEO Ben Silbermann and CFO Todd Morgenfeld have begun to showcase.
For example, they guided 4Q revenue growth in the ‘high-teens’ after reporting 3Q numbers. Subsequently, in spite of the pressures they faced during the quarter (both macro and company-specific), they delivered 20% revenue growth, a beat relative to the guide. When management does this, underpromising and overdelivering, it sets a tempo for Wall Street, and, more importantly, establishes a trusting and credible relationship between the two.
While we don’t think this repeats in 1H’22, we think it’s important to note that to this point, management has been pretty solid about delivering strong, above-consensus numbers. Now, onto the numbers for 4Q’21:
Overall, the numbers were relatively solid. Keep in mind, at the time Pinterest reported, the bar had already been set incredibly low (especially on the buyside) because of other, incredibly weak prints from larger internet advertising firms. This set up an even more pronounced gap between expectations and the reality of the results that enabled a large, if temporary, squeeze in the stock price. This squeeze was also likely exacerbated by large short interest expansion heading into the quarter, predicting a drop in the stock. The actual headline numbers weren’t bad, except for the user numbers, which were really weak. These numbers are very surface level, so in order to understand in better detail, we should jump into the conference call.
Our notes on the call are obviously not everything management said, or even everything important management said. We’re just giving commentary on what was both important and new information from this call. Feel free to read the transcript or listen to the call for yourselves.
In 2021, we made our publishing tools available in 37 markets and launched 150 new features, many of which were released in October. So it’s still very early, but we’re already seeing signs of promise specifically a rise in session frequency and time spent from people who followed multiple creators.
This supports our hypothesis that our investments in native content can be engagement accretive over time. We believe that with sustained investment will see these trends grow as more and more Pinners find and follow creators they love. – Ben Silbermann, CEO
This is a promising early sign, as it indicates that users that have already started engaging with native content creators are also spending more time and are more frequently logging in to the platform. It is also encouraging to see that in spite of critiques of Pinterest’s slower than normal tech culture, they launched 150 features this year. The important point is scalability, making sure that almost every Pinner has that creator(/s) that they can engage with in addition to engaging the core experience.
We know we’re building this new platform in a challenging environment. In Q4, we saw monthly active users decreased 6% year-over-year to 431 million. This was primarily due to the continued unwinding of the pandemic, lower traffic coming from search and increasing competition for user attention. – Ben Silbermann, CEO
So these are the headwinds impacting user numbers: pandemic engagement unwind as lockdowns have eased, competition for user time (think TikTok and Instagram particularly), and lower top-of-funnel, low conversion desktop traffic as a result of Google (GOOG, GOOGL) Image Search SEO changes. Keep these headwinds in mind, and think about how structural vs. transitory they really are.
We’re also continuing to improve the core experience to help surface the most relevant content at the right time. With shopping, we’re building a more dedicated experience to help people discover and buy what they love as well as expanding our test of seamless checkout. – Ben Silbermann, CEO
In addition to the creator push, management is trying to build tools to surface the best and most relevant content to users at the right time, likely through organic content recommendation algorithms. These are the types of algorithms that have made TikTok and YouTube Shorts content so hyper-targeted and addictive. This will help with user retention and more un-interrupted scrolling through the core product. Additionally, the team at Pinterest continues to work on testing seamless checkout, basically a full-funnel transactional experience that takes users from ad impression to checkout while never leaving the platform.
Strength in the quarter came from large retailers, midsized and managed small advertisers and international markets. This was offset by muted demand from CPG advertisers who continue to face pressure from supply chain issues. – Todd Morgenfeld, CFO
If you’ve been following macroeconomic developments, you are no doubt aware of crippling global supply shortages. CPG products, and goods more generally, have been greatly affected by these shortages, and it is causing advertisers to pull back on spending that would ordinarily increase incremental demand. The reason for this is that there is no need to spend money to create incremental demand they can’t fulfill. Smaller advertisers, international advertisers and retail partners are continuing to drive strength in the advertising mix, while macro issues weigh on the CPG vertical.
Furthermore, with the continued distribution and placement of Idea Pins during the quarter, we estimate that the negative impact to our fourth quarter year-over-year revenue growth was in the mid-single digits, similar to the third quarter. – Todd Morgenfeld, CFO
Idea Pins is more of a medium-term revenue growth headwind. Assuming Pinterest wasn’t making the creator push and sacrificing ad inventory for space on platform for creators, revenues are up mid 20s on a y/y. This is a good number to have in mind, and it helps us quantify the negative impact that the creator push is directly having on the business short-term. In essence, management is intentionally stifling short-term revenue growth trends to build what they believe will be a structurally stronger business with the video/creator push.
Furthermore, our monthly active users were negatively impacted from lower search traffic due to Google’s November algorithm updates. In fact, more than half of the Q3 to Q4 sequential decline in U.S. monthly active users was attributable to Google’s algorithm update starting in mid-November. – Todd Morgenfeld, CFO
This is important to note, because the users Todd is talking about here are generally more top-of-funnel, lower value users that aren’t going to meaningfully contribute to ad impressions and revenue, but do contribute to the user number nonetheless. Sequentially, US MAUs declined by ~3mn, meaning >1.5mn of this decline was in these low value web users. This is just context that is necessary for understanding the dynamics of Pinterest’s user mix. Generally, mobile app users log in more frequently, engage with more surfaces (especially monetized ones), and have higher ad impressions. We’d be more concerned if mobile engagement was off-track.
We’re examining the overall impact from recent search algorithm changes as it appears to be more persistent than we’ve seen historically. Our teams are working diligently to understand this, but it may take some time. – Todd Morgenfeld, CFO
SEO (search engine optimization) changes are having a bigger, and more pronounced drag than normal, and it’s worth monitoring for investors, but it isn’t going to be a business-wrecker. Nonetheless, these changes are continuing to weigh on user numbers, and investors should understand that fixing Pinterest’s manipulation of Google’s SEO algorithm might take time (if it ever comes to fruition).
Looking at users by platform, U.S. monthly active users coming to Pinterest from the web, desktop and mobile web declined around 30% year-over-year while U.S. monthly active users coming to Pinterest from mobile apps who account for a significant majority of our impressions and our revenue declined around 6% year-over-year. – Todd Morgenfeld, CFO
The parity in the mix is staggering. Yes, 30% cut in web traffic versus the Covid-loaded comp of 4Q’20 is staggering, but what’s even more staggering is that mobile was only down 6%. This is why you can see users tank on a y/y basis as a monolith, but have revenues grow 20%. When your core, revenue generating users are by-and-large sticking with your product, that is going to bode well for your business. This is something to really underscore, as it shows that the ‘fluff’ being cut off Pinterest is lower value ‘fat’ for the most part that does little more than juice user numbers. In contrast, the underlying muscle (mobile app, impression generating users) is mostly still there.
We’re taking a number of steps to increase engagement on Pinterest. First, we’re investing in native video content in a creator led content ecosystem. In the long run, we believe that this can be engagement and revenue accretive.
As Ben mentioned, the early data make us cautiously optimistic. But bending the curve on overall engagement will require us to scale this effort with sustained execution over several quarters. – Todd Morgenfeld, CFO
Pinterest is pivoting. Not fully, but they are moving from a static pins based model of content consumption (i.e. image-based content) to more video-centered content consumption. Right now, they are very early in their push to enable Pinners to connect on Pinterest with content creators. As mentioned earlier, management is noticing that Pinners that do engage with creators also have higher time spend and session frequency. Early results are promising, but getting content creators in front of an audience of 400m people across multiple geographies, interests, and languages is going to take time and capital. That said, management is optimistic that bending engagement towards video-centric, creator-loyal content consumption will work to broadly increase session frequency and time spend. Generally, we believe that if Pinterest can tie the right creators to the right interest patterns, at scale, this will prove true. We’ll go more in-depth on the creator push later on. Nevertheless, this will take time to scale.
In the near term, we plan to invest in our core discovery and planning engines to provide our users with a richer even more personalized experience across our various surfaces. We plan to apply more data and larger models to our sophisticated machine learning stack to help with content recommendations, home feed personalization and an improved search experience for existing, previous and new users who come to Pinterest. – Todd Morgenfeld, CFO
While the creator push is likely a multi-quarter, if not a multi-year, effort to change broad engagement patterns, Pinterest is addressing engagement another way, via improving content recommendation engines. This is very important. Getting the right Pins aligned with the right interests in front of the right Pinners will increase retention, session frequency and time spend per session. Improving Pinterest’s proprietary machine learning algorithms to personalize users’ feeds and curate content will be critical in increasing engagement and smoothing out the churn we’ve seen in user numbers. In the long run, we actually think that good content recommendation will be far more important than building an engaging creator ecosystem in terms of its impact on increasing user retention and growth. Again, this will take some time, and likely solid technical talent and investment. A declining share price doesn’t help spur excitement for new potential hires, especially in a labor environment as competitive as the one we’re in right now.
As of Tuesday, February 1, U.S. monthly active users were approximately 86.6 million and global monthly active users were approximately 436.8 million. – Todd Morgenfeld, CFO
As of the beginning of February, not even the halfway mark of the quarter, domestic users were up ~600K sequentially, while global totals were up ~5.8m. Keep in mind, this is pre-Russia/Ukraine conflict and some checks have been showing weakness in Europe more broadly. While this probably wouldn’t be too much of a headwind, we’re modeling conservatively because of it. Additionally, from Feb. 1 out, search traffic has appeared to dip on Pinterest, maybe meaning you have some weakness there. Nevertheless, it’s positive to see some improvement in q/q user trends.
On the revenue side, we expect Q1 revenue to grow in the high teens on a percentage basis year-over-year.
Please note that our Q1 revenue guide takes into account a few considerations. First, the macro environment remains challenging for our CPG advertisers who are still dealing with supply chain and other macroeconomic issues. We believe this headwind could persist for a few quarters. – Todd Morgenfeld, CFO
Do note that this is the same guide Pinterest gave for 4Q, while revenues actually slightly exceeded the guide. This guide factors in the headwind that CPG advertisers are facing from tight supply conditions and pronounced inflation. Particularly on the supply side, if supply is tight, the need to create additional incremental demand is reduced until supply conditions loosen. With the Russia-Ukraine conflict and lockdowns in China, it’s likely this is a headwind affecting their CPG partners for the remainder of this year, dragging down revenue growth estimates.
Second, we continue to monitor the impact that higher CPAs could have on our more price-sensitive advertisers. There are some exogenous factors that appear to be resulting in higher CPAs, including overall demand for digital ads from advertisers. On Pinterest, specifically, if engagement declines continue, we could eventually expect to see some constraints on our monetizable supply and in turn, higher CPAs. This supply constraint is not something that we’re seeing today, but we’re monitoring it carefully. At the same time, we’re investing in a number of opportunities to monetize our existing supply and to help advertisers achieve their goals. – Todd Morgenfeld, CFO
Higher cost-per-action is something that generally, especially in a post-IDFA world, advertisers are noticing on mobile social media apps. Pinterest is no exception. The issue, for Pinterest specifically, is that declining engagement could eventually lead to declining monetizable ad supply. Lower supply, coupled with increasing general demand for digital ad inventory, will drive higher CPAs and price smaller advertisers out of the market, acting as a headwind to revenue growth. It’s not a phenomenon the company is currently seeing at scale, but it’s one that could develop if Pinterest cannot stem declining engagement.
Third, our investment in Idea Pins and native video content will likely be a modest headwind to revenue in future quarters as it was in Q4. However, we believe that Idea Pins will be both engagement and revenue accretive over time. – Todd Morgenfeld, CFO
Idea Pins, at least while they take from valuable static ad inventory, will act as a medium term headwind to top line growth. This is nothing new. They noted this as a mid single-digit revenue growth headwind over the last two quarters. That’s what we would continue to model over the next two to three quarters, with a gradual moderation as the surface slowly becomes monetized with new ad formats.
We expect our first quarter non-GAAP operating expenses to grow around 10% quarter-over-quarter sequentially, as we continue to scale our investments in our native content ecosystem, our core Pinner experience and headcount across research and development and sales and marketing.
For the full year, we expect non-GAAP operating expenses to grow around 40% year-over-year. The sequencing of that spend may change from quarter-to-quarter, but we’d suggest you look at the quarterly growth cadence in 2021 as a likely template. – Todd Morgenfeld, CFO
Management gives us some color on the investment direction with these comments. They’re guiding ~10% q/q growth in non-GAAP opex, which translates roughly to mid-50s y/y growth. For the full-year, they’re guiding 40% y/y. That means you likely get an incremental deceleration in the y/y growth rate as the year progresses. Keep in mind, they’re guiding, in effect, mid 50s opex growth y/y in 1Q, while also guiding high teens revenue growth for the quarter. That’s going to make a big dent in profitability. And while we can probably expect somewhat of a top-line acceleration and an opex growth deceleration as the year progresses, this cost path likely means you have meaningful profit compression in 2022. This is backed up by the idea that many members of senior management (especially CFOs) have been calling out in the internet space: 2022 is a build/investment year after two big years of growth pull forward in 2020 and 2021. We don’t think consensus earnings estimates properly reflect this accelerated cost guide. More on that later.
You asked the question about 2022. In terms of growth, we’re opening up in a couple more countries in Latin America. So Colombia, Chile and Argentina will open this year. So extending the reach within Latin America. And then as you mentioned, we’re really excited to start monetizing in a very deep ad market in APAC in Japan.
So all of that work is on track. And I would expect us to continue to see some contribution from those markets by the end of this year, but it takes time.
And reflecting on your question, we opened Latin America last year. And while we’ve seen some early contribution. We’ve got a long way to go. And I think that’s exciting for the future growth potential of the company. – Ben Silbermann, CEO
One of the key complaints investors have had with Pinterest is slow international monetization traction. Pinterest has built out a pretty sophisticated and solid ad stack out domestically, and even in Western Europe. They’re opening up the app in LatAm markets and beginning to monetize in Japan towards the end of the year. Opening in LatAm can be a tailwind for user growth, and monetizing in Japan towards the end of the year could help drive revenue growth. The bottom line is that Pinterest is not going to rush it. They want to nail the user experience and provide advertisers with the proper tools to fulfill that full-funnel advertising experience that has already proven successful domestically.
We, from Q3 to Q4, did see a large impact globally and in the U.S. from the search algorithm changes from Google. And so sequential growth, the bulk of that decline Q3 to Q4 was not pandemic related. It was more related to search algorithm changes that drove less search-related traffic to Pinterest. – Todd Morgenfeld, CFO
Management is outright telling us here that the majority of the decline in engagement isn’t even an unwind of the pandemic on a quarter-to-quarter basis. The decline was driven by reduced search traffic to Pinterest. So, yes, users are declining, but what’s driving it? People no longer finding core use cases compelling? We sure don’t believe so. They break out this divergence between high-value and low-value users out more…
If you stripped out the impact of that, we were actually up in terms of direct mobile app users globally in the high single digits year-over-year. Internationally, we were up 11%. In the U.S., we were down around 6%. So much more resilient engagement with respect to the users who are the deepest, most dedicated resilient users who drive the bulk of our impressions, time spent and revenue. – Todd Morgenfeld, CFO
Engagement in the demographic that matters most, mobile app users, grew high single-digits y/y globally in spite of lapping the 4Q’20 COVID comp. That’s actually very resilient, and underscores the fact that the majority of the drop-off in engagement really is web-based. So what you’re seeing is that the customers that actually drive business are quite resilient.
So in the past, you heard us talking about bidding automation. But this year, our investments are really directly linked to providing more value to midsized and small advertisers that are natural fit for Pinterest. And so that should result in increasing the efficiency of our ad marketplace and delivering greater value. – Ben Silbermann, CEO
This is an important step for Pinterest, as it signifies management’s desire to capture a large swath of the digital ad market: SMBs. Granular and focused ad targeting and relevance has led to the explosion of internet-based advertising for small business. While Facebook (NASDAQ:FB) and Google have become the default places to advertise, Pinterest is trying to carve out its own presence. We think this is where Pinterest has the most upside: direct response SMBs. These are small businesses that have struggled with Facebook in the post-IDFA world, and are looking for new places to experiment with budget. Creating value for these SMBs will lead to great long-term expansion in the business. We’ll go into why Pinterest is compelling for SMBs over the long term later.
Second is relevance. This is sort of this thing that never stops, but we really believe we have room to improve our relevance engines which should further improve the efficiency of our ads. Again, underlying that is leveraging our taste graph and leveraging machine learning. So when people see ads, they feel just like content. – Ben Silbermann, CEO
Pinterest has more upside in terms of improving ad relevance. We would expect that as organic content recommendation improves, so will ad relevance. Leveraging machine learning to gain insights into user interests and behavior will be crucial to understanding what ads to target and when/where to target them.
Third, we talked a little bit about international. Like I said, Todd did a great job of covering that we’re expanding to new markets. And I’m really excited that the team that we built there and the playbook that we’ve developed over the last few years, we’re kind of learning with each subsequent market how to get off our feet a little bit quicker. – Ben Silbermann, CEO
Management has talked about go to market strategy and pacing when it comes to both opening up the app internationally as well as monetizing in international markets. Especially, in Western Europe, as they learn more about how to roll-up value-add products on the ad stack side, as well as giving users the features they care about, execution will accelerate. International is a key part of management’s playbook for growing the business over the long term.
We know that the shopping surface in particular, the surface with the highest commercial intent still has huge headroom for monetization. So we’re investing in building that great consumer experience first. But we see year-over-year increases in the number of people doing product searches, the amount of time that they’re spending on shopping surfaces. And we’re also simplifying our shopping ad formats so brands can just more easily promote their products. – Ben Silbermann, CEO
Shopping, likely the greatest driver of long-term platform monetization, has a long way to go and the team is investing in the customer experience first before layering in monetization accretive tools. Nonetheless, consumer demand for Pinterest’s shopping surfaces is clearly increasing, and so are the number of tools Pinterest is giving advertisers to utilize the platform for direct commerce.
We’ll be experimenting with Idea Pins monetization. We expect that to lag. We’re going to wait for that creative economy to sort of get off speed. But we think there are some pretty significant drivers of future revenue growth that we’re still in the early innings of pursuing. – Ben Silbermann, CEO
Idea Pins monetization is early. Management, obviously, is expecting this to lag behind until engagement scales. But keep in mind that this headwind will reverse into a tailwind in due time as Pinterest opens up the surface for monetization. This will enable further acceleration of long-term revenue growth. So yeah, it’s weighing right now but, long-term, the business is going to turn.
On the second, we just started piloting and testing native checkout. And we look forward to continuing to scale and broaden those efforts over the course of the year. So it’s still pretty early days. – Todd Morgenfeld, CFO
Native checkout is something that remains early stages and they’re going to scale it over the course of the year. This is another long-term revenue tailwind.
Search-driven traffic is kind of a way of getting word of mouth but it’s automated. You’re looking for a new idea, you have content that’s recommended to you and you discover Pinterest. So it’s an important top of funnel growth driver and it’s also an important revisitation driver.
For those reasons, we think it’s an important part of our engagement because it’s a source of revisitation and therefore, reducing churn. Ultimately, our MAUs are a byproduct of that. And it introduces people to Pinterest potentially for the first time to solve new problems in their life.
I wanted to give the color on the mobile app uses because that is where people spend the bulk of their time impressions and revenue opportunity. But the two are very important when considered together. So that’s why we’ve broken it out the way we did. – Todd Morgenfeld, CFO
This is management’s philosophy when it comes to the two core engagement drivers on platform: web and mobile app. They overlap, and feed each other. That said, web engagement appears to be much more superficial for the actual business and acts more as a bait to get users onto the app. The idea of building a flywheel at the top of the funnel via conquering Google’s SEO algorithm is smart to continue bringing in users and reducing churn. So while web users are important to driving engagement, they aren’t the end-all-be-all.
We’re not at the point yet today where that experience is as fully instrumented as we would like it to be to have an unmanaged long-tail advertiser base on the platform. And so we’ve been focusing on the managed go-to-market model until we get that up and running. And we’ve been making all the right investments, seeing all the right returns. With respect to building that ad stack, it will just take some time before we get there. – Todd Morgenfeld, CFO
This is an interesting passage, as it highlights Pinterest’s lack of sophistication in providing advertisers with key tools in terms of measurement, performance, etc. that a sophisticated full-funnel platform should have. Instead, they’re investing in their managed-client sales team to broaden coverage across verticals while also scaling their tools for automated campaigns. Once Pinterest can scale an automated campaigns platform, you will likely see that flood of unmanaged, SMB budgets (the long tail Todd is describing here) drive business going forward. It just takes time and technical product execution.
Over the short to medium term, we’re bearish on Pinterest. While we’re certainly net long, there are some serious problems with the story right now:
We think these three headwinds weigh on the business and the stock for at least the next two quarterly reports. For 1Q specifically, we’re modeling ~16% revenue growth on a y/y basis versus consensus at ~18.4%. So on the headline number, we think you get a miss. We also think earnings could miss as you have higher investments from returning corporate travel and the creator move.
On the top-line, management has been calling out continued supply chain headwinds, which have weighed most directly on their CPG advertiser base. We don’t think these headwinds, especially in big ticket items like auto, have abated much at all since the start of the year. In Europe, you have the disruptions of the Russia-Ukraine situation, and in China you have the Zero COVID lockdown extension. Supply remains tight, and it seems like the global supply chain has struggled mightily to decongest. This will weigh on incremental ad buying from affected verticals within CPG, likely catalyzing a further decel in revenue growth.
We touched on this above, but continued volatility in Europe both on the user growth side and on the advertiser base side are concerning. For users, it’s quite simple: the value prop for Pinterest is not there in Ukraine and Russia. It feels sickening to even write about business in these markets when the human toll is as it is. The reality is, who cares about an app on your phone when war is going on in your country? Bringing it back to the stock, that’s a potential drag.
Additionally, you have potential weakness from European advertisers as inflation and supply chain issues could end up dinging consumer confidence overseas more so than in America, where the consumer is the economy’s core driver. So we’d look for potential weakness in both MAUs and revenue from Europe.
And finally, we’d think that you can get some operating margin pressure and EPS estimate pressure as both (a.) revenue growth decelerates below expectations, and (b.) management invests in the future. These two issues compound on each other, and could reverse the strong operating leverage trend we’ve gotten from Pinterest over the last year plus.
As a result, when we look at the stock here at ~$23.50 and change, you’re looking at a name that’s trading at 23x consensus ’22E EPS. That’s a cheap multiple, but we don’t think it’s a multiple that the stock bottoms on. If EPS estimates get cut down 10-15% after the print, then that multiple is closer to 27x. Then the question becomes: do I buy a company with decelerating revenue growth, compressing margins, in a turbulent macro environment for 27x this year’s earnings? Is the stock cheap long-term? Most likely, yes. Over the short term, have we found a sturdy valuation floor if the bear case is right? Probably not.
We think that if our checks are right, and if they miss numbers, the stock can rerate to the teens, where you start moving towards a conviction long-term position. The mid to high teens is likely where you start looking at a valuation floor. We’re just not convinced that this is a floor if the story falls apart short-term.
While the dynamics of the business and macro environment are pointed decidedly against Pinterest right now, we think there is a lot to be optimistic about in the long term. The value prop is still there.
Within the social media landscape, it’s well established that Pinterest has among the highest purchase intents out of any platform. You have 430m+ people using this app once a month at least, with 250m+ using it weekly. That’s a massive audience, and a lot of it wants to purchase products based on what they see.
What it’s going to take is building out the tech stack on the ad product side to open the platform up to as many budgets, objectives, and geographies as possible. That said, the underlying platform’s value to advertisers is likely there long-term.
Pinterest has a unique value proposition for users and advertisers within the large and fast growing social media advertising universe sized at $177 billion for 2022. Pinterest can, with higher session frequency from users and an increasingly sophisticated ad platform (formats, measurement tools, campaign optimization etc.) start to meaningfully grab budget share. That’s the bull thesis. The bull thesis is that management can take the abstract of the value proposition and bring it to life via execution.
As mentioned earlier, we think there is meaningful estimate risk to the stock right now. You have a devolving macro picture, combined with management guiding for an investment year, with some company-specific risk (Idea Pins & SEO adjustments namely).
Our base case model implies a gradual reacceleration in sequential net adds to the MAU side of things, while also modeling a large drop-off in ARPU as the year progresses. This means we expect high teens revenue growth for the full year. We’re also modeling improving gross margins, as we’re booking creator costs under the opex line. We see Pinterest’s management reducing spend as the year goes on. This is simply because we see revenue growth decelerating sustainably below what is likely internal expectations. We model this as a broad-based trend in internet, leading to big firms cutting back on excess investing as the year progresses. So yeah, we think opex growth is ~75bps below guide. You’re still going to get massive growth this year.
With regards to our core operating assumptions (i.e. revenue and user numbers), we see two core things happening. On the user side, we think you’re probably going to get ~3-4m net adds per quarter heading into the holiday season. By this time, we think there’ll be a degree of creator on-ramp and improved personalization. Additionally, we’re expecting gradual top-of-funnel progress on the search side, getting us a couple million more net adds in the holiday quarter. Keep in mind that if Pinterest maintained its Feb. 1 pace on a quarterly basis, you’re looking at closer to ~454m by year end.
On the revenue side, our model goes something like this: +16.5, +11.5, +15.5, +25.1. These are all y/y percentages. In essence, we think that y/y growth rates bottom in 1H’22, before reaccelerating into the back half. The weight on 1H numbers will likely come from comps, CPG headwinds, Idea Pins, and European murkiness. In the back half, we would look to tailwinds in comps (both supply chain and IDFA related), increasing shopping engagement, normalizing engagement patterns, higher impressions (driven by higher session frequency from creator and content personalization initiatives), and improving the ad stack to diversify across objectives. Generally, we think the stock will underperform in the next 3-4 months as investors digest decelerating growth until July/August when they guide a 3Q reacceleration in revenue. Thus is our pitch:
A weak 1H for the business and the stock until expectations recalibrate, followed by a strong 2H when the business (and the shares) can really shine.
In terms of multiple, our multiple is really a placeholder multiple for the valuation from our DCF against our ’22E revenue. It comes out to around 9x ’22 sales. The way we’re looking at this is twofold:
On the DCF side, we’re modeling a decade out to ’31E unlevered FCF at ~$2.88b and revenues of ~$10.287b. We won’t be publishing the in-depth model at this time, but these are two of our key output metrics. Additionally, we model improving gross margins, use an 11.5% cost of capital, and an 18x terminal FCF multiple. That gets us to a ~$39 price target which translates to ~9x ’22E sales.
From the other perspective, when we look a year out, to April of 2023, we think that the stock trading at 9x trailing sales isn’t unreasonable at all if you’re seeing growth reaccelerate into the mid to high 20s. So there’s the fundamental value perspective, and there’s the market perception perspective for a year out.
Our bear case target assumes low levels of forward user growth as the year progresses, averaging out at ~3m net adds per quarter globally. It also assumes Pinterest hits a monetization slump because of macro and company specific factors. Idea Pins weighing on monetizable ad supply and rising CPAs from declining engagement on core use cases act as headwinds to ARPU growth. The bear case models higher headwinds to gross margins as a result of higher infrastructure tax from building new surfaces on platform, namely Idea Pins and more sophisticated content rec. spend. The bear case assumes opex comes in slightly above management’s guidance for 40% y/y growth.
In terms of valuation multiple, we’re using a trough multiple on sales of ~3.5x. This is where we’ve seen many other internet companies bottom multiple-wise, and it’s towards the low-end of historical multiples. It prices in the idea of an ex-growth Pinterest with slowing engagement and waning advertiser demand in the face of competing platforms. This multiple is also reflective of a tighter macroeconomic environment and a worsening picture for risk assets.
This is where we would look for a valuation floor if the bear case pulls through over the next couple quarters.
Our bull case assumes a reacceleration in sequential user growth and a reacceleration in ARPU growth as the business branches out internationally. This gets us mid 20s revenue growth with expansion in margins if the infrastructure team can find ways to reduce expenses in spite of opening new surfaces. Additionally, it assumes that management pulls back on spend as the year progresses.
The real meat of this valuation is the sales multiple. We’re at 12x in the bull case. If by year-end, in the bull case they can get to 30s+ revenue growth, and then macro environment plays out okay, we don’t think it’s unreasonable for growth companies to come back to scoring low double-digit multiples.
Again, we would look at it like this: in a scenario where the story is mostly de-risked in a year’s time when growth is re-accelerating and the business has strong cash flows and operating profits, the valuation can rerate. Is 12x unreasonable if risk becomes an on-trade and Pinterest can see revenue growth re-accelerate? We don’t think so.
As everyone knows, M&A potential certainly is there. While everyone looks at Twitter (NYSE:TWTR) and Silver Lake/Elon Musk, Pinterest remains a serious M&A target. They have a unique platform, a unique business model, a low multiple, and a massive platform. We have seen interest, in the past, from both PayPal (NASDAQ:PYPL) and Microsoft (NASDAQ:MSFT) at far higher prices.
Much like Snap (NYSE:SNAP) management in the past, it seems Pinterest has been unwilling to sell, even at a massive valuation. Even still, this is a business that always has that looming buyout hanging over its head. That’s a bull case there, even if the current management can’t pull it together.
While Pinterest has an uncertain next few quarters because of CPG ad exposure, macro worries, European exposure, and more. In spite of this, you’re looking at a very strong business with great potential. Combined with the low multiple, we would still be long-term buyers even if we’re not at full position right now.
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