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Evan Spiegel, CEO & Co-Founder of Snap, the company behind social media and messaging app Snapchat, sent out a company memo several months ago outlining his goal for Snap to reach breakeven this year.
We wanted to explore this ambitious goal, and the steps, we think are needed, for it to be remotely achievable in the given timeframe.
A year has passed since going public, meaning we’ve now got meaningful insight, data and metrics to unpack. What are Snap talking about publicly and what challenges are they facing? We look at the revenue drivers, as well as the costs associated with servicing that growth. We touch on current challenges, and our take on their short term strategy.
One thing is for sure, there’s never a dull moment in the Snap story. Billions of dollars are at stake, competition with Instagram is at an all time high, millions of users are upset due to a redesign of the app, as well as the $40m inventory write-off due to Spectacles….
…and these are just some of the headlines.
Added to this Evan has always been a maverick, doing things a little different. And we should remember that Snap really is his. His unique hold on voting rights and product focus means that you’re taking a bet on him when investing in Snap.
As we explore the article, you’ll see that we think he needs to focus on increasing ARPU and top-line revenue growth, rather than cutting costs. The constant layoffs that we’ve seen seem insignificant when compared to hosting costs and RSU servicing.
A little background…
Snap lost $720 million in adjusted EBITDA last year. That’s an increase over 2015 and 2016, when the company lost $293 million and $459 million, respectively. Analysts have forecast losses of up to $912 million this year. In percentage terms this means that in each of the past two years Snap’s losses have increased by 57%. Should analysts’ 2018 expectations hold, the rate of increase will fall to 27%
Snap’s stock has been trading between $11.83 (August ’17) and $27.09 (opening in March ’17). It has been trending downward after a series of disappointing earnings in which Snap reported less revenue and user growth than analysts had expected. That said, February ’18 was a good month, Snap’s stock soared 45% to more than $20 a share following the company’s first positive earnings report since going public. However, since then, it has shed much of those gains, and is currently trading around $16.60 with a market cap of $20.3 billion.
Taking a page out of Twitter’s playbook?
When reading analysts’ commentary on Snap, there are a lot of comparisons between Snap and Twitter. In one camp are the Wall Street analysts that think Snap will be the next Twitter—a social media company that struggles with slow user growth and fights to remain relevant. On the other side are the bulls who point out Snap is growing faster than Twitter and has more active users.
For us, we think the similarities centre around cutting costs in the pursuit of profitability. Many investors, it seems, may seek solace in seeing what Twitter has achieved, hoping that Snap can replicate. We also believe that Evan and his Product team are more innovative than those at Twitter. So, you could say we sit in the bull camp (due to optimism in product).
Cutting the wrong costs
Snap’s costs exploded last year, even after discounting the one-time stock awards related to the IPO. Let’s not forget Evan’s huge one-time stock award, valued at $637m at the end of last year1 – making him the highest-paid US chief executive of 2017.
Snap is taking some steps to rein in costs. Peak headcount may be now – around 3,000 employees.
The company recently let go more than 120 engineers, the fourth round of layoffs since September. Those earlier layoffs didn’t do much to help the bottom line in the fourth quarter — total expenses still soared 93% year over year.
Cutting 120 engineers might save the company $36 million annually ($200,000 average salary plus 50% for benefits = $300,000 * 120) which is 10% of the $400 million it would need to cut. However, that’s to get to a $400 million non-GAAP operating profit. To get to breakeven, it only needs to double revenue and keep expenses at $1.6 billion.
So what we don’t understand, is why Evan is in such a hurry to get to breakeven?
The problem isn’t that the company is losing money, the problem is that it only has 187 million daily active users and $825 million in revenue. He shouldn’t be cutting staff, nor should he be hurting morale by cutting bonuses. After all, what’s the difference between losing $775 million from operations on a non-GAAP basis or $875 million?
The problem centres around the reliance on third-party cloud platforms.
Snap don’t have their own infrastructure. They’ve potentially gone beyond the point of no return, in terms of being able to build it out internally. For them to now undertake the task would have a meaningful impact upon their ability to service users.
Prior to its IPO last year, Snap disclosed two massive cloud-computing deals with Google and Amazon. The company committed to $2 billion of cloud spending with Google over the next five years, and $1 billion with AWS over the same period.
Most of Snap’s cost of revenue consists of payments to these third-party infrastructure partners. Snap’s total cost of revenue in 2017 was $718 million, with hosting costs accounting for about 64% of that total.
The remaining cost of revenue is related to revenue share payments to content partners, content creation costs, and inventory costs for Spectacles.
It’s all about ARPU
Snapchat is first and foremost a chat app; that’s not great for advertising. Looking at the factors that impact ARPU.
As a standalone chat app it’s very difficult, if not impossible, to elegantly integrate adverts. Both from a design perspective and from a user interaction perspective (we’re sure that users would be wary of any adverts that appeared mid-conversation — with fears of spying or reading conversations). With this in mind, Snap have traditionally pushed advertising to other parts of their app. Either in ‘Discover’ or between stories, or through original content. Indeed their whole recent redesign of the app was focused on this very matter. However, as you may know, the release of the redesign was met with a pretty fierce backlash from users, with over 1 million signing a petition to revert back to the old design.
They also don’t have as rich a data set as Google or Facebook; thus, targeting can’t be as specific, which reduces how much they can charge advertisers. Looking specifically at the Facebook / Snapchat comparison, we put together some graphs to show how much better Facebook are at monetising their audience. Instagram’s 2017 overall revenue figure was an astounding $5.38 billion compared to Snap’s $825 million for the year. This is particularly worrying for Snap as it not only shows that Instagram are ahead of them but also that they are much more efficient at transferring DAU activity into revenue. Based off these figures, if Snap’s user base was three times its current amount (561 million) and thus closer to Instagram’s 500 million they would still only theoretically be able produce $2.47 billion in annual revenue which would still be dwarfed by the $5.38 billion Instagram boasts.
When looking at it from only the perspective of North American users, the gulf widens. Facebook in the last quarter reported nearly $27 per user, whereas Snap reported only $3. Nearly only one tenth that of Facebook!
One thing worth noting is the lack of web presence for Snapchat. They’ve always been focused on mobile. And whilst they are exploring desktop and browser destinations, they’ll remain focused on mobile. This does put them at a disadvantage against Facebook and Google — who are multi-device. This means they can sell more lucrative adverts to ecommerce players who want to target a certain audience and have the ads follow them around the internet. We’re purposefully keeping this section brief, as we could open up the recent Facebook, Cambridge Analytica scandal and say that Snap are actually positioned quite well to benefit from a scenario whereby customers want more privacy and reduced tracking from ad companies. But in short, at the moment, their single platform focus, will be impacting their ARPU.
Historically poor analytics for influencers and brands. Unlike competing platforms such as Youtube, who very proactively foster positive creator relationships through initiatives like Play Buttons, Super Chat, its annual Rewind video, and YouTube Red, Snapchat has been repeatedly criticised for failing to support influencers. As a result, many have left the platform. 2018 saw them have a change of heart. Snapchat just announced a new analytics tool called Insights. The tool will provide data to influencers, giving them the information they need to grow and thrive on the platform. But is it a matter of too little, too late to lure the large influencers back?
Related to above, their self-serve ads platform lags behind peers. Opening up more targeted API buying was a smart move for Snapchat, but without user growth, it becomes hard to slice audiences down even smaller. Ad buyers seem to reserve Snapchat for the “experimental” portions of their budgets. What they’ve failed to do is to convince brands that they are a must-have platform for campaigns. They are in most cases an add-on or used to reach a niche, usually young audience.
We also have to remember that Snap is still tiny in the advertising world. It accounts for ~1% of a market dominated by Facebook and Google. This brings both opportunity and an uphill struggle against some very smart competitors.
Snap do have innovation in their DNA
With all that said, Snap are incredibly innovative – even with the constraints in terms of being single-device, not holding that much targeting information on users and overall being used mostly as a chat app.
They pioneered tappable stories. A feature that Instagram have brazenly copied, bringing a huge uptick in usage to their platform.
With that the focus on vertical video. They have stood their ground, building a platform that is orientated on vertical video. All original content, hardware accessories, etc. support this mission. We respect them for that — it really does focus the content producers and give the consumers an overall better experience.
They were the company to bring filters to the world. Being able to transform and overlay characters, brands ands scenes in real-time over your face.
They aren’t afraid to make bold bets on hardware. Something that Google couldn’t achieve with their foray into smart eyewear — Snap delivered a pretty cool product for enhancing content capture. Unfortunately they overestimated demand, and perhaps made the device a little too expensive for it to have a fair shot of reaching mass market. But it does give a peak into what we can expect in the coming years. Snap desperately want to get into augmented reality. Specifically, augmented reality delivered through sunglasses and other eyewear. They want to be the first to deliver an immersive ‘alternative reality’ which they can then monetise through innovative advert integration.
Finally, is growth plateauing?
Snap’s user growth is also slowing down, which is something often overlooked considering DAU climbs of 5% quarter over quarter and 18% year over year. In fact, a quarter by quarter analysis of Snap’s growth reveals that DAU growth is well on the way to plateauing and that the 100% DAU growth of 2014, or even the 50% growth of 2015, are best consigned to history.
Getting to zero
A longer than usual article, apologies for that — but lots of ground to cover, and lots to explore. We’ve only touched on a few parts.
Evan realises that if he has any chance of breaking even in 2018, operating expenses must come down significantly — but he’s fighting a losing battle with those hosting contracts hanging over him.
They must also double revenues or they’ve absolutely no chance of meeting his goal. They need to sit-up and pay attention to ARPU. Facebook have paved the way — the data is there. The correlation between Facebook’s ARPU figures on quarterly earnings calls and stock performance is pretty hard to argue. A correlation value of 0.9649, with over 93% of the variation explained.
ARPU for the rest of the world can increase substantially by giving Android users some love. And, ARPU for North America has some easy gains, we saw the huge delta between Snap and Facebook.
So in summary, in Snap’s favour:
Looking at the financials
Q4 revenues grew 72% year-over-year, a figure which was 19% higher than the Reuters consensus. Daily active users (DAU) grew by 18% in the last quarter to 187 million. Average revenue per user rose to $1.53 in Q4, up 46%. EPS coming in at -$0.13, three cents above expectations. Top-line sales of $286 million beating expectations by 13%. Snap is growing, maximising its income streams, and outperforming forecasts
What we think needs to happen:
- Team needs to bed down, lots of changes in leadership and layoffs
- Solid direction with a focused roadmap
- More focus on the users and their ARPU
- Better self-serve ad platform
- Focus on timing for new products
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. This article expresses our own opinions. We are not receiving compensation for it. We have no business relationship with any company whose stock is mentioned in this article.