One of my 2017 tech predictions was that Snapchat parent Snap Inc. would deliver a solid IPO, but then stall as worries about Facebook (FB - Get Report) and the company's ad scale grew. After going through its IPO filing, though, I'm not sure the company will be granted such a honeymoon period, at least unless it tempers its valuation expectations some.
Snap's filing Thursday does show that the company made a lot of headway last year in monetizing its core ephemeral photo/video-sharing app: Revenue soared to $404.5 million from just $58.7 million in 2015, topping a reported target range of $300 million to $350 million. That helped Snap's quarterly average revenue per user (ARPU) grow to $1.05 in the fourth quarter from just $0.31 a year earlier.
But as fund manager Conor Sen points out, Snap's sequential sales growth slowed meaningfully towards the end of the year. During the December quarter, when many advertisers dial up their spending due to the holiday season, Snap's revenue rose 29% sequentially to $165.7 million. Facebook grew nearly as fast in spite of being exponentially larger: Its sales rose 26% sequentially to $8.81 billion.
Likely an issue: While many advertisers and agencies clearly warmed to Snapchat last year,the company is still in the "experimental" part of many ad budgets, as one industry exec talking to BuzzFeed put it. In online ads, Facebook and Alphabet (GOOGL - Get Report) remain in a league of their own thanks to their massive scale, numerous ad products and powerful targeting and measurement abilities. Some major brand advertisers have signaled they want to focus their spending on Facebook and Google out of a wish to reach as many people as possible with their campaigns; that's been a problem for Twitter (TWTR - Get Report) , and could be emerging as one for Snap.
Meanwhile, Snap is still losing money hand-over-fist: Its net loss totaled $514.6 million in 2016, up from $373 million a year earlier. Free cash flow, at negative $678 million, was even worse. Notably, Snap's cost of revenue ($451.7 million) single-handedly exceeded its full-year sales, and its Q4 cost of revenue ($153.4 million) almost matched its Q4 sales.
Cost-effectively monetizing tons of user-shared online video traffic isn't easy. Just ask Facebook, which this week set a $7 billion to $7.5 billion 2017 capital spending budget (compares with 2016 capex of $4.5 billion) as it pushes ahead with its "video-first" app development strategy. Or Google, which has struggled to turn a profit on YouTube even as the video giant's revenue has reportedly surged past $4 billion.
Snap Inc. says it's more than just an app-maker
Snapchat, which was reportedly seeing over 10 billion daily video views as of last spring, faces the same challenge while having much less user/ad scale. And an IPO filing disclosure indicates Snap's infrastructure spending will remain elevated: A few days ago, the company struck a deal with cloud infrastructure provider Google through which it promises to pay Google at least $400 million per year for the next 5 years. Snap likely got some discounts from Google in exchange for such a giant commitment, but the deal still adds to the pressure faced by the company to ramp ad sales.
Snap's spending in other areas is also heavy for a company of its size. R&D and G&A spend equaled 45% and 41% of 2016 revenue, respectively, while sales/marketing spend was 31%. And stock compensation expenses are due to surge after the IPO: Snap says that if it had gone public on Dec. 31, it would have recognized $1.1 billion in stock expenses for vested restricted stock units (RSUs), and $1.5 billion in "unrecognized compensation cost" for RSUs that hadn't yet vested. Moreover, with only 1 in 4 RSUs vested as of Dec. 31, Snap's share count could grow significantly over the next couple of years.
Then there's the matter of slowing user growth amid Facebook's suddenly-aggressive efforts to take on Snapchat -- particularly via Instagram. After rising by 36 million over the first half of 2016, Snapchat's daily active user (DAU) count only rose by 15 million over the second half to 158 million. Moreover, DAUs rose by just 3 million during the second half outside of North America and Europe, to a fairly modest 39 million.
Instagram, though much larger, appears to be growing faster: Mark Zuckerberg disclosed this week Instagram now has over 400 million DAUs, up from about 330 million as of June. And its Stories feature, which launched in August, appears immediately when Instagram's app is loaded and bears a strong resemblance to Snapchat's feature by the same name, topped 150 million DAUs last month.
In the fall, Instagram updated Stories to support live video streams, and also added support for disappearing direct messages (another Snapchat feature). And Facebook proper, both via its core app and Messenger, has begun integrating Snapchat-like tools such as photo/video filters, stickers and goofy face "masks."
Snap partly blamed its user growth slowdown on technical issues related to app updates -- particularly for its Android app, which is used more overseas -- but also admitted tougher competition is a factor. Four days ago, TechCrunch (citing a dozen sources) reported popular Snapchat Stories accounts have seen view count declines of between 15% and 40% since Instagram Stories launched. Sources state many teen Snapchat users are now also using Instagram Stories, and that "influencers" who were late to build Snapchat audiences are now opting for Instagram due to its greater scale.
Amid all the negative info, there are some positives in Snap's filing. At $1.05 per DAU, the company's Q4 ARPU is still well below the $4.83 Facebook obtained per MAU in the fourth quarter. And this is in spite of the fact Snap's user base skews far more towards the lucrative North American market.
Snap Inc.'s Spectacles
Even if one accounts for the ARPU benefits Facebook gets from its superior scale and the fact the average user spends over 50 minutes per day on its properties (excluding WhatsApp), there should be a fair amount of room for Snap to better monetize its app. For now, Snap only has a couple of ad products: "Sponsored Creative Tools" that let users deploy photo lenses and filters supplied by ad partners, and full-screen video ads that appear within Stories.
Moreover, both Snap''s prospectus commentary and its recent feature launches show that it has a good understanding of what has made its app so popular with its core user base. Notably, Snap calls itself a camera company in its filing -- launching its app immediately take a user to a camera view, rather than to a list of Stories or messaging threads -- and argues that "reinventing the camera represents our greatest opportunity to improve the way that people live and communicate." With AI and augmented reality beginning to let phone cameras understand the people and objects they're seeing, one can understand's Snap's thinking.
Snap also discussed how its app has been optimized to support the rapid and constant sharing of photo/video content -- including things users might not want all of their family members to see, or be permanently attached to a user profile -- and explained the logic that went behind decisions such as not providing a traditional profile page or content feed, or to encourage usage of "creative tools" such as face masks and bitmojis, or to not include an option for sending a photo or video "snap" to all of a user's friends (Snap is worried about accounts being spammed).
The trouble with some of these product decisions is that they can bewilder and push away many social media users-- particularly older and international users -- even as they endear Snapchat to its die-hard fans. Complaints about Snapchat's interface being messy and confusing are easy to find. And compared with Instagram, Snapchat makes it harder to discover content from accounts that aren't on one's contact list.
And though its app doesn't show a camera view when it loads, it's not hard to record and share material via Instagram either. In addition, by providing good content and user-discovery tools, as well as offering both disappearing Stories and permanently-shared photos/videos that appear on a content and immediately providing access to the feed and Stories when its app loads, Instagram arguably strikes a better balance between content creation and consumption. One that appeals to a broader set of social media users.
Throw in Facebook's other efforts to take on Snapchat, and the DAU, revenue growth and spending issues raised by the IPO filing, and suddenly it's not guaranteed that Snap's IPO valuation will be around the $25 billion figure that has been thrown around in reports. Snap isn't Twitter 2.0 -- overall, the company is more focused and executing better. But in its own way, Snap is accompanied by many of the same question marks that have plagued Twitter over the last couple of years.
As the saying goes, history doesn't repeat, but it often rhymes.