SNAP’S Q1 REVIEW — SHAREHOLDERS BEWARE

3 months ago I wrote a post on the SNAP (aka Snapchat) IPO, and I brought up some underlying concerns about the company.

Very recently, the company released their first ever 10Q, which gives us an opportunity to dig a little bit more into the company’s progress, and glean some insights.

Last time I talked about the importance of comparing SNAP to itself, and not ad-hoc comparables to other known social networks. This led to a deeper dive in to the company’s revenue, operating costs, and CAC metrics. Let’s keep going with those same metrics, and add on results from the recent quarter.

SNAP increased their DAUs to 166M, but Rev/DAU dipped from last quarter to $.90.

This could be simple seasonality, as advertising budgets tend to peak in Q4 around the holidays. It will be important to watch this metric next quarter to see how this develops. If we compare Q1 2017 to Q1 2016, we do notice a big increase, where the advertising revenue per user tripled over the course of the year. This is a good sign. More and more advertisers are seeing Snap as a viable publicity platform to pitch product.

This is all well and good, but I want to add another layer to this — the COGS per DAU.

The company defines COGS as:

Cost of revenue consists primarily of payments to third-party infrastructure partners for hosting our products. Hosting costs primarily include expenses related to bandwidth, computing, and storage costs. Cost of revenue also includes revenue share payments to our content partners, content creation costs, which include personnel-related costs, and advertising measurement services. In addition, cost of revenue includes inventory costs for Spectacles and facilities and other supporting overhead costs, including depreciation and amortization.

When we overlay Rev/DAU with COGS/DAU we get an interesting perspective of the company:

What we see here is that for a brief period of time in Q4 2017, SNAP was covering their COGS with the revenue they made per user. In this quarter, though, SNAP again dipped in to scary territory, where the company isn’t even able to cover hosting costs per unit.

The quick-talking guys at HyperChange point out in their review that some of this could be caused by one-time IPO related costs, but the fact remains that the direct costs associated with the production of SNAP’s “product” — effectively hosting costs — are higher than the revenue they make per DAU. And this is BEFORE they have paid anybody in the company anything!

This is a problem, a big problem, and it will be critical to watch what happens with this in the coming quarters.

Finally, let’s look at CAC vs. new DAUs. Last quarter we saw a massive increase in sales/marketing spend, and we were hoping it would pay off in new users.

It seems to be that the push is trending in the right direction, but the ROI seems to be a little shaky. The huge increase in CAC for new users paid off with 8m new DAUs, but these new users were significantly more expensive to acquire than ever before. It will be interesting to see if the current quarter’s investment in sales/marketing translates to big increases in new users for next quarter.

Bottom Line:

SNAP has 166M people who log in to it at least once a day over a 24hr period. That is a huge number and shows very high engagement. These engaged users are an asset, just not in a direct financial sense to shareholders.

There are some clearly shaky foundations to SNAP as a sustainable business from what we see so far, and if the trends we are seeing now continue for another two or three quarters, the company’s stock price will tank. Anybody who purchased the stock from IPO to today will see their value decrease substantially, which is concerning for unsuspecting people who are wrapped up in this stock via a mutual/pension fund.

Even though there is an uptick in new DAUs, with very little noticeable churn, ultimately all of these new potential users will be irrelevant if the ad rev they get per user is less than the cogs per user, and this is before the company has even paid salaries or rent.

To summarize, I’m going to quote myself from the last post:

So Snap will most likely raise its $3B (they did), VCs will make money (Benchmark and Lightspeed — lots), and regular public market stockholders will take on the risk of poor financial returns (they will).

If I was a hedge fund I would wait another two quarters, and if the situation doesn’t change then short.