Snap’s Terrible IPO Timing

Digesting Snap’s S-1 filing and what it means

Snap Inc (maker of Snapchat) finally made its long-awaited S-1 filing public on Thursday evening. I’ve been dying to get my hands on this filing for months, and spent some time diving into it last night and digesting some of the numbers and other information in it. Here’s a quick summary of what I’ve found and some of my conclusions about Snap’s prospects going forward. Below, I’ve embedded a slide deck which shares many of the individual charts in this post and several more — it’s part of the Jackdaw Research Quarterly Decks Service, which offers similar decks on the most important consumer tech companies each quarter to subscribers.

Snap Slide Deck from the Jackdaw Research Quarterly Decks Service

Massive revenue growth

The first thing to note is that Snap is growing extremely fast from a revenue perspective. It showed its first ad in late 2014, and had its first meaningful revenue in 2015 (totaling $59 million), and then passed $400 million in revenue in 2016. The quarterly revenue picture is shown in the chart below.

Snap’s Quarterly Revenues

That’s a very fast ramp, enabled by the fact that Snap held back on monetizing its base for several years following its founding in 2011. Facebook, by contrast, started to monetize the year it launched, and generated $382,000 in revenue in 2004. Its revenue ramp was slower ($9 million in 2005, $48 million in 2006, $153 million in 2007, $272 million in 2008, and $777 million in 2009), but it didn’t hit Snap’s current user scale until 2009. When Facebook turned on revenue generation, it had under 1 million MAUs, whereas when Snap showed its first ad it had 71 million daily active users.

ARPU growth a major enabler

The major driver of this ramp in revenues is rapid growth in average revenue per user (ARPU), as shown in the next chart:

Snap Quarterly ARPU

Global ARPU has risen from 5 cents in Q1 2015 to $1.05 in Q4 2016, but the main driver has been revenue from North America, where ARPU was already $2.15 last quarter. The ARPU ramp in other regions has been much slower, with Europe generating just 28 cents per user per quarter in Q4, and the rest of world region just 15 cents. The one dollar ARPU isn’t far off Facebook’s global ARPU in Q1 2012, the last quarter it reported before its IPO, which was $1.21 globally. But its US & Canada ARPU was already up to $2.90 and its European ARPU at $1.40.

Still a very US-centric financial picture

The reality is that Snap’s business is still very US-centric when it comes to generating revenue. North America had 43% of its users, but generated 88% of its revenues in Q4 2016 (over 98% of that coming from the US). That could be seen as an opportunity for Snap to broaden its horizons and put more effort into monetizing Snapchat in other regions, driving up ARPU, but this may also be a sign that Snap simply hasn’t gained the same traction in other regions yet. It increased its sales and marketing headcount by 340% in 2016, so there’s a good chance it’s hiring in these other markets to drive higher ad sales there.

Profits are another story entirely

While Snap’s revenue picture is fairly clear, the bottom line is a lot less healthy — Snap is losing money by the truckload. This may be one of the first companies I’ve seen file for an IPO whose cost of revenue alone outweighs its revenue in the most recent financial year.

Most margins are literally off the charts

It literally makes no sense to include here one of my customary charts showing various margins over time, because both of the biggest ones — operating and net margins — have been at -100% or multiples of it throughout Snap’s reported history (the only time I’ve seen anything like it is when looking at Alphabet’s Other Bets segment). Gross margin is the only one which is anywhere near positive, and was positive in the second half of 2016:

Snap Gross Margin

Snap’s cost of revenue is made up of two larger buckets and some smaller ones — hosting costs are by far the largest, and those scale fairly directly with user growth. Snap doesn’t break these hosting costs out in detail, but they grew by $192 million in 2016, and total cost of revenue in 2016 was $452 million, so my guess is that hosting costs were around $300–350 million in 2016. Snap signed a deal in January with Google to extend its use of Google’s cloud infrastructure, which has a minimum revenue commitment of $400m for each of the next five years, so it’s a good bet Snap is expecting to spend at least that much in 2017.

The second largest, albeit much smaller, contributor to cost of revenues is Snap’s revenue share with its publisher partners. When Snap sells ads (which it did for 91% of its ad revenue in 2016), it gives publishers a cut, and this revenue share amounted to $58m in 2016, up from just under $10m in 2015. When partners sell the ads, they give Snap a cut, and it records only this net amount as revenue, so there’s no reported cost of revenue associated with that smaller chunk. The only other notable contributors to cost of revenue are content creation, where expenses rose $13m in 2016, and inventory for Spectacles, which only hit the books in late 2016.

I usually like to include a chart on cost components as a percentage of revenue, but in Snap’s case it makes more sense to show them as a multiple of revenues, as for most of the company’s history that’s what they’ve been. The two charts below show first a zoomed out view over the whole of the reported period and then a slightly shorter-term view excluding total costs and expenses, to make it easier to see what’s happening in detail with some of these expense lines.