Pinterest: changed my mind, this stock is falling less likely
Summary
More headwinds for Pinterest in 2020, as advertising sector gets hit hard.
Pinterest pulls its guidance for 2020.
This stock is still too expensive but it may start to look more attractive in 2021.
Investment Thesis
Pinterest's (PINS) stock had fallen on hard times through a combination of starting out with an overpriced valuation and facing consistent decelerating growth rates.
COVID-19 will meaningfully impact Pinterest's advertising revenues in the near-term. For now, investors are pricing the stock at 6x times trailing revenues, thus reflecting too much optimism. But once we get into 2021, its larger and more engaged audience could be very positive for the company.
Here's why:
I have been consistently bearish this investment even before COVID-19. Now, with this new dynamic, I see two sides to its story.
Update: Q1 2020 Shows Promise Before COVID-19
Highlighted below is Pinterest's revenue growth trajectory including its recently updated preliminary guidance for Q1 2020.
Some aspects are worth discussing. There is an unquestionable truth that Pinterest's revenue growth rates are declining at a rapid clip. We can football that around and avoid it, but it's important to be candid with each other.
The next aspect that we have to be realistic about, is that while Q1 2020 points towards 35% for Q1 2020, the same period a year ago, Pinterest was reporting 54%. The difference is approximately a 20 percent decline in its growth rate within twelve months, which for a rapidly growing company is too dramatic.
Not All Bad For Pinterest
There are some positive aspects that I believe could be attractive. Firstly, let's face it, this guide is for Q1 2020 and before any serious impact of COVID-19 was felt, particularly amongst travel, automotive, and restaurants. This is akin to stating that 'we have not been affected by any impact that happened before the impact happened'.
Indeed, Pinterest does acknowledge that post the middle of March it noted a 'sharp deceleration' in revenues.
However, this is what I believe is interesting. Even though practically the whole advertising sector has been weak, there is some underlying theme that is highly beneficial to Pinterest's long-term business prospects: brand awareness.
As we adapt to the new normal of working from home, Pinterest has seen an increase in its MAUs:
1) MAUs - United States up 2.2% sequentially;
2) MAUs - International up 12% sequentially.
Revenues Will Fall, But Does It Matter?
According to the very carefully curated press statement, which is designed to reflect reality, but not to spook investors, it states that there's a sharp deceleration after March.
Assuming that Pinterest, Alphabet (GOOG)(GOOG), and Facebook (FB) have some similar advertising dynamics, given that the market has turned very sour on these advertising giants that derive the majority of their advertising per user from their U.S. users, we can assume a similar motion to transpire for Pinterest. Consequently, please note Pinterest's pricing in Q4 2019:
1) ARPU - United States $4.00
2) ARPU - International $0.21
Accordingly, we know that each U.S. user is worth 19 times more than an International user. Hence, if the U.S. advertising sector was to face material weakness, which it has, then Pinterest's revenues in 2020 will be significantly affected.
However, there is a silver lining. Even if advertising and similarly Pinterest's revenues were to rapidly decline in 2020, Pinterest's will benefit from a strong surge in audience numbers and engagement throughout 2020. This will not be strong enough to offset the huge expected decline in pricing for 2020 but will be beneficial in 2021.
Thus, putting aside the impact of COVID-19 to its revenues in 2020, assuming that Pinterest can get past 2020, once we get to 2021 and normality ensues and the economy starts to recover, Pinterest should be able to recoup momentum and its revenues should be able to recover, but this time with a larger audience.
Valuation - Uncertain Margin of Safety
During 2018 and 2019 no investor had any interest in looking at companies' balance sheets.
Only one aspect mattered, revenue growth rate. But now that we are facing a global recession with advertising being hit hard, balance sheets once again start to matter, and to this effect, Pinterest's balance sheet is impressively strong ($1.7 billion in cash and no debt).
The only problem for Pinterest is that at the bottom of 2009, during the previous global recession, investors were picking up companies in the bargain-basement.
On this note, objectively, I do not believe that even the more bullish shareholders would argue that Pinterest today is in the bargain basement?
Pinterest was struggling to breakeven (on a GAAP-basis) despite strong revenue growth rates seen during 2019 when the economy was strong, but now, as economy contracts meaningfully in 2020, shareholders should brace themselves for steep losses again.
Having said that, I believe that once investors get into 2021, investors are likely to see some improvement to Pinterest's revenues. But will it be enough for Pinterest to regain the title of a fast-growing social media network? Will investors be willing to once again reward Pinterest's stock with a high multiple?
Presently, investors are still willing to pay approximately 6x times trailing revenues for Pinterest. Will investors still be willing to pay this sort of multiple once Pinterest gets into 2021? Or will investors be waiting for Pinterest to deliver a 'show me story'?
If the narrative facing Pinterest is that of consistently declining revenues, then this barely profitable social media network is likely to be rewarded with a lower P/Sales multiple than 6x times. However, if its newly found audience is able to remain engaged and interested in the brand into 2021, investors could at that point find this investment opportunity to be a bargain investment.
The Bottom Line
For now, with COVID-19 having a significant impact on the whole advertising industry, I remain bearish. But once we get out into 2021, I believe that Pinterest's highly engaged and increasing MAU audience could make for a compelling investment opportunity.
For now, I believe it's prudent to avoid this stock as its revenues will significantly decline in 2020 and this stock still remains overpriced.
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