At Snap, cost of hosting
sets high bar for revenue growth
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[February 04, 2017]
By Stephen Nellis and Liana B. Baker
SAN FRANCISCO (Reuters) - Snap Inc’s
initial public offering filing seemed to show a company with a basic
math problem: the company's cost of revenue for 2016 - the amount it had
to spend just to keep the messaging service running - was $47 million
higher than its $405 million in sales.
The high cost of revenue, which in Snap's case consists mainly of
payments to Alphabet Inc's <GOOGL.O> Google for hosting the service,
means that, on an annual basis, Snap lost money on every one of its 158
million users in 2016, even before accounting for salaries, office rents
or anything else.
Snap revealed in its IPO prospectus, filed with securities regulators on
Thursday, that it will pay Google at least $2 billion over the next five
years.
But the cost side of the problem may not be as serious as it seems. The
company's hosting costs are broadly in line with other social media
companies. Its cost of revenue per active daily user was 97 cents in the
last quarter of 2016, not much higher than the 85 cents that Facebook
Inc <FB.O> paid for each of its 1.23 billion daily users in the final
quarter of 2016.
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Further, while Snap’s cost of revenue was higher than sales on a yearly
basis in 2016, the company drastically tightened up hosting costs over
the course of the year. While costs were nearly double revenues at the
start of the year, by the fourth quarter, when Snap hit 158 million
users, the company eked out a small gross margin.
Snap’s bigger math problem is how much revenue it generates per user.
The $1.05 per user for the last quarter of 2016 was a massive increase
from the 31 cents per user it drew in the same period in 2015. In its
IPO filing, Snap said it hopes to increase its revenue per user by
focusing on more lucrative advertising markets, like North America,
where its revenue per user was $2.15 at the end of 2016, nearly double
the global rate.
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![](../images/020417pics/busine87.jpg)
The Snapchat logo is seen on the door of their headquarters in
Venice, Los Angeles, California October 13, 2014. REUTERS/Lucy
Nicholson/File Photo
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But even those higher rates for Snap pale in comparison to the $7.16 in revenue
per user that Facebook brought in in the fourth quarter.
“Snap’s issue is not cost, but user growth and revenue per user,” said Ethan
Kurzweil, a venture investor with Bessemer Venture Partners who backed startups
such as Twitch and Periscope but has not backed Snap. “If they can get revenue
per user into the kind of territory they think is possible, the cost of hosting
will be a hit to gross margin but it’s not going to be an issue.”
Facebook provides the example. Even though its cost per user rose 7.4 percent
between the last quarter of 2016 versus a year earlier, its revenue per user
grew at a much faster 27.5 percent, a difference that helped drive its $10.2
billion in profits for the full year.
All of that does, however, mean that Snap has little leeway in delivering
dramatic revenue growth in light of the high underlying cost of delivering all
those pictures and videos.
The cost of revenue figure, noted analyst Brian Wieser at Pivotal Group, "was
notable for what it indicates about the expense of running Snap."
(Reporting by Stephen Nellis and Liana Baker; Editing by Jonathan Weber and Bill
Rigby)
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