Snapchat's Performance Doesn't Match IPO Hype
If you want to know what "unicorn" hype is like at its grandest, read the initial public offering filing of Snap Inc., the parent company of messenger app Snapchat.
Snap isn't just wildly unprofitable, having lost $514 million in 2016 -- 38 percent more than in 2015 and more than it made in revenue; that's not a big deal in today's tech world. Though the firm describes itself as an "emerging growth company" under U.S. law -- meaning it had gross revenue of less than $1 billion and therefore is not obligated to reveal much financial data -- it reportedly values itself at $25 billion, and the shares it wants to sell, to the tune of $3 billion, won't have any voting rights.
You'd expect a company with such chutzpah to have a unique value proposition, a fool-proof business model and a dearth of competition. That is not Snapchat's case. It's a late mover in a market that already has strong players. Nothing is unique about its business model or the technological features on which it's based. Compared to competitors, it has the disadvantage of having to use outsourced storage and computing power. And Facebook, which offered to buy Snapchat for $3 billion in 2013, has successfully outflanked the younger company, matching its product's functionality on Instagram. Still, Snapchat will probably have little trouble raising the money on its terms because it has a glossy narrative and a record of fast growth from a zero base.
When Facebook chief executive officer Mark Zuckerberg made his offer to Snapchat co-founder and CEO Evan Spiegel, Facebook had a problem: Young users were fleeing or avoiding it. It had acquired the reputation of a service parents use. Snapchat had Generation Z flair. Zuckerberg made his pitch, but Spiegel heard, "We're going to crush you." It's doubtful that Zuckerberg actually said that, but he warned Spiegel that it would be easy for Facebook to copy anything Snapchat offered its users.
It took some trial and error, but Facebook figured out how to solve the young user problem, channeling those users to Instagram and having it match every new feature Snapchat introduced. The latest such copycat move involved Stories, the feature at the heart of Snapchat's ad selling strategy, which allows users -- most importantly from a bottom-line point of view, advertisers -- to post videos and photos to a timeline accessible to other users. Instagram doesn't even try to hide that it's copying its rival, and Snapchat cannot sue because the features are only formats, not unique technological products.
Three years after the Zuckerberg offer to Spiegel, Instagram has a higher adoption rate among young Americans than SnapChat 1 .
Snapchat's business narrative is based on the advertising industry's ongoing shift toward mobile. The IPO prospectus points out that younger people are seeing fewer and fewer traditional ads, whether on TV or on bigger computer screens. Within that logic, Snapchat appears to be well-positioned. The fall, 2016 "Taking Stock with Teens" survey from the investment bank Piper Jaffray showed that 35 percent of U.S. teens considered Snapchat their most important social media platform, compared with 24 percent for Instagram. But that advantage hasn't translated into relative success with advertisers, who are more impressed with size and reach than with the subjective importance users attach to various platforms.
Like Snapchat, Instagram only began a serious monetization effort in 2015. The results aren't commensurate with the companies' reach: Instagram, building on Facebook's ad selling expertise and clout, achieved disproportionate success. In 2016, Snapchat, according to the IPO filing, had revenue of $404.5 million. Instagram sold about $2 billion worth of ads.
Besides, the narrative about pushing more ads to young users may be fundamentally flawed. Late last year, eMarketer found that the Gen Z and millennial audience on both Snapchat and Instagram tended to hate or ignore the ads.
If over time advertisers find targeting young people through the social platforms less efficient than going after adults, Facebook, with its diversified platforms, will absorb any negative effects. Snapchat will find it far harder.
Snapchat isn't only less versatile in terms of audience demographics than Facebook -- it's far less developed geographically. Among young people, apps spread by word of mouth; a messenger or social platform becomes popular in a particular country once there's significant uptake and all your friends are on it. Snapchat, despite all the buzz around it, has done worse internationally than Instagram, according to SimilarWeb data on the two apps' installed base on Android phones.
Snapchat's uneven global expansion is not necessarily a growth problem that can be fixed with money and patience. According to SimilarWeb, both Snapchat and Instagram lost some of their installed base in the 12 months to March, 2016. That may well be part of a trend toward less screen time among young people, both services' core audience. Both, according to SimilarWeb, have recently lost significant amounts of time spent by an average user in the app -- less time than Facebook, with its more mature audience, lost.
Business-wise, Instagram has another important advantage over Snapchat. It uses servers owned by its parent company, Facebook, while Snapchat uses Google's cloud services. Facebook weaned Instagram off a similar arrangement with Amazon when it acquired it in 2012. On the big social media companies' enormous scale, own servers make more economic sense. Facebook's cost of revenue -- of which computing power is a major part -- reached $3.8 billion in 2016, about $0.14 per $1 of revenue or $2 per monthly active user. Snapchat's cost of revenue, at $452 million, reached $1.11 per $1 of revenue and $3 per monthly active user.
When Facebook went public in 2012, it valued itself at $104 billion, a little more than four times Snapchat's reported self-valuation. At the time, it had nine times Snapchat's previous-year revenue, and it had been consistently profitable for the previous three years. It also had more than five times the number of monthly active users -- and, unlike with Snapchat, there were no signs at the time that the user base growth was beginning to slow down. But most importantly, Facebook did not have a formidable competitor that could swiftly mirror each of its moves -- and back up this agility with superior resources, both in terms of computing power and ad sales.
Compared with Facebook at the time of its IPO, Snapchat presents a significantly weaker investment opportunity. That doesn't mean it's not worth a flutter -- there aren't too many new Facebooks entering the market -- but some caution is probably in order.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Some surveys show them more or less head to head. According to UBS Evidence Lab, 63 percent of U.S. teens (aged 13-17) use Snapchat daily, compared to 58 percent for Instagram, but 50 percent of those aged 18-34 use Instagram, compared with 41 percent for Snapchat.
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