Every 5 or 10 years, the internet industry gets a painful reminder. Rather than saving the world, or changing the future through technology, most of the sector sells ads -- a business that relies on the fickle whims and fluctuating financial health of consumers.
This time, Snap CEO Evan Spiegel delivered the reality check. Late on Tuesday, he wrote a memo to staff saying "the macro environment has deteriorated further and faster than we anticipated," denting revenue growth.
The warning was a shock because just over a month earlier, when Snap reported quarterly results, the CEO was a lot more upbeat. Snap shares collapsed 43% on Tuesday to the lowest level since its IPO in 2017.
Some industry observers grasped at straws initially, with a few suggesting that Snap didn't have a good grasp of its business and isn't good at forecasting. However, most experts settled on the obvious but uncomfortable explanation: There's been a sudden economic downturn, consumers are in retreat, and digital advertising spending is rapidly adjusting in ways that will hurt many internet companies.
"Advertising is highly cyclical and driven by/dependent upon the health of the economy and consumer spending," Morgan Stanley analysts wrote in a sobering note following Snap's warning. "We expect all online ad platforms to feel some impact of a significant consumer pullback."
Consumer transactions are a major driver of ad spending, so when the economy slows, marketing budgets often contract. Consumer packaged goods, video streaming, financial services, and travel are all important advertising segments for Snap's business, and the analysts noted that "the weakness they are seeing is broad based across verticals and geographies."
Shares of other internet companies, including Facebook, Google, and Twitter, also dropped on Tuesday. Pinterest plunged 24%. Earlier this month, Facebook implemented a hiring freeze and warned of tougher times, as Insider was first to report.
"We see no real reason to not take Snap's negative pre-release at face value," Mark Mahaney, senior managing director at Evercore ISI, said. "Digital advertising is cyclical, like all advertising, and macro headwinds are very likely getting much harder."
Snap had already given a "more conservative outlook" when it reported quarterly results in late April. The fact that the company needed to disclose more bad news so soon after, shows its ad-reliant business has "in just a month…aggressively deteriorated," Mahaney added.
"We view Snap's negative pre-release as a negative for the rest of the internet advertising sector," the analyst wrote in a note to investors. "Snap accounts for only a small percent of total digital advertising, but the macro factors cited should be relevant for all companies."
Twitter is particularly exposed to Europe, where a pull back in advertising has been most significant so far, Mahaney said. Next is Facebook and Google, with an estimated 25% of ad revenue coming from Europe for both companies, according to the analyst.
Ali Mogharabi, a senior equity analyst at Morningstar, agreed the abrupt hit to advertising at Snap is likely to to be felt by other ad-reliant companies. However, Facebook, now Meta, and Google are seen as pulling through faster given their positions as the two top platforms for direct response advertising, compared to brand advertising. Direct response ads are those aimed at getting a person to click through to a site and make a purchase, for example, while brand advertising is about building awareness.
"During economic slowdowns advertisers prioritize purchasing ad inventory from the likes of Meta's Facebook and Instagram, TikTok, and YouTube over others in the space, including Snap and Pinterest," Mogharabi said.
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