Snap missed Wall Street’s targets last quarter, but its future could still be bright

Snap, the company behind the very popular Snapchat app, released its first quarterly financial results as a public company, and the results weren’t pretty. Revenue was well below Wall Street’s expectations, and losses were larger than expected. Markets responded by slashing 20 percent off the company’s share price.

Yet there’s still some reason to be bullish about Snap’s prospects.

When Snap went public earlier this year, there was a lot of discussion about whether it’s the next Facebook (e.g., poised for massive growth and profitability) or the next Twitter (slowing growth and continued losses). Like Twitter, Snap is still losing a ton of money, and like Twitter, its user growth has not been impressive recently — the company now has 166 million daily active users, up 36 percent from a year ago.

But it’s misleading to compare Snap to social media companies, because it isn’t one, really. Instead, you should think of Snap as a pioneer in treating smartphone images, video, and interactive content as a new medium in its own right.

With a young audience open to experimentation and coveted by advertisers, Snap is ideally positioned to develop this medium and then sell ads on it. And so while Snap’s early financial results have been far from stellar, there’s still a lot of room for a turnaround.

Snap is pioneering a new medium

Photo by Carl Court/Getty Images

“Snap Inc. is a camera company,” the company wrote in its IPO filing. That’s an oddly analog way of saying it is a company built around the new medium of smartphone-based images, video, and interactive content.

One sign of Snap’s distinctive strategy is the fact that there’s no web version of Snapchat at all. Facebook and Twitter began as websites; Instagram at least lets users log in to see their friends’ photos and videos using a desktop browser. In contrast, when you log in to Snapchat on the web, it hardly lets you do anything at all. You can change your password and delete your account, but you can’t access any of the major Snapchat features.

Staying totally focused on a smartphone app has allowed Snapchat to deliver the best possible experience for mobile users — avoiding the compromises that would have been necessary for a cross-platform service.

For example, the company has prioritized vertically oriented video, a choice that irritates video format snobs but is the natural format for devices people hold with one hand.

Snapchat also has a feature called Snapchat Discover, where news organizations (including Vox) publish news stories formatted in a distinctive, Snapchat-only format. A Discover story is a sequence of vertically oriented images and videos that users navigate by swiping from one to the next. It’s a format that works well on a smartphone and would be almost unusable on a desktop computer.

Snapchat’s mobile-only approach has been particularly important for its advertising strategy.

“When we first approached advertisers to create Snap Ads, we learned that many of the partners we worked with didn’t want to create custom video advertisements just for Snapchat,” the company wrote in its IPO document. “They wanted to repurpose television advertisements and show them on Snapchat because it was easier and saved money.”

But that was a terrible user experience, because most users hold their phones vertically, and as a result, “the video appears very small in the center of the screen and it is no fun to watch.” So Snapchat encouraged advertisers to create separate ads designed for the vertical orientation of a smartphone. The ones that did so found they got much better responses from users.

Snap also created Lenses, software that adds features like animal ears or eyeglasses to a user’s face. It’s a tool that’s hard to imagine on any other platform, and it could become a big moneymaker. The company has experimented with building custom Lenses for advertisers. For example, last year 20th Century Fox paid Snap for a series of X-Men-themed lenses that allowed users to take pictures of themselves as members of the X-Men squad.

The key thing to note here is that Snap is still actively exploring this new medium. Last year it introduced Snapchat Spectacles, glasses with a built-in camera that takes images in a novel round format that can be viewed full screen either vertically or horizontally.

Snapchat’s growth has been slowing

Users of the original Snapchat used the app to send each other pictures — often selfies — that would disappear after a few seconds. Like most new internet activities, this seemed totally pointless to the old people of the day, but teenagers loved it. Snapchat messages, known as snaps, were a quick and easy way for friends to let each other know they were thinking of each other. The informality and ephemerality of snaps made people more willing to send them on a whim — much as an earlier generation of teenagers would wave to each other as they passed in the hallway between classes.

By 2014, Snapchat had grown to more than 100 million monthly users, and at the time of Snap’s IPO the company had 158 million daily active users — a figure that has risen to 166 million daily active users today. Twitter doesn’t publish numbers on daily active users, but the service is believed to be a bit smaller than Snapchat by this metric of daily active users. In contrast, Facebook is vastly larger: It now has 1.23 billion daily active users.

There isn’t much sign that Snap is enjoying Facebook-like exponential growth. If anything, growth seems to have slowed over the past nine months. Here’s the growth chart from the company’s IPO:

It looks more and more like Snapchat’s users base might be leveling off the way Twitter’s has over the past couple of years. Twitter, of course, is still an extremely popular service among certain populations, including journalists, celebrities, and technology elites. But it has become clear that Twitter is unlikely to ever come close to Facebook’s audience size.

Snap’s young user base could be its secret weapon

Snapchat is more skewed by age than any other major social media platform. A 2016 Vox poll found that among Americans ages 18 to 29, Snapchat is more popular than either Twitter or the Facebook-owned Instagram, but its popularity drops off dramatically among older users. More than half of Americans over age 65 are on Facebook, while the comparable figure for Snapchat is 1 percent.

The case for Snapchat pessimism goes like this: Snapchat is mostly an app for teenagers. A lot of teenagers already use it, so there isn’t much room for growth. Even worse, teenagers are fickle, so Snapchat’s user base could evaporate at any time.

But if you think of Snap as pioneering a new medium, then a young user base could be a secret weapon rather than a vulnerability.

A young customer base may be willing to try experimental products and features. Teenagers don’t yet have established routines and media consumption habits, so it’s easier to convince them to try things like vertical videos and news stories organized as slideshows. Young people are also more open to defying social conventions. Only a company with a lot of young users could hope to get a product like Snapchat Spectacles to catch on (it’s too early to tell if it will or not).

And this points to the big difference between Twitter and Snapchat: Twitter is basically a finished product. The core product works essentially the same way as it did five years ago, and attempts to get users interested in new products — like Vine six-second videos or live sports broadcasts — haven’t been very successful.

In contrast, Snapchat is still evolving rapidly, and new features such as Lenses have seen rapid uptake by users. So whereas Twitter is likely to look about the same in 2022 as it does today — and therefore attract a similar-size audience — Snapchat may evolve significantly over time, growing its audience in the process.

This is especially true because technology trends tend to percolate up the age distribution. Some technologies — like Facebook or telephones — are so compelling that young people eventually convince their parents and grandparents to adopt them. But even if that never happens for Snapchat, the simple aging of the population should expand Snap’s audience. Today’s teenagers are the 20-somethings of the next decade and the 30-somethings of the decade after that, so as long as people don’t stop using Snapchat, the audience will grow.

And crucially, Snap is in the ad business, and advertisers are particularly eager to advertise to customers in their 20s — an age when people are buying a lot of products for the first time and developing brand loyalties. Snapchat’s smartphone-only format also makes it ideal for delivering full-screen video ads, which could fetch top dollar from advertisers.

Snap has a lot of room for revenue growth

Photo by Sean Gallup/Getty Images for Burda Media

Almost every one of today's big internet companies — Google, Facebook, and Twitter — faced skepticism in their early years. Back in 2007, Kara Swisher (who now runs Recode, which, like Vox.com, is part of Vox Media) expressed astonishment that Facebook could be worth $15 billion. A year before that, a Slate headline read "$1 Billion for Facebook? LOL!" (Facebook is now worth nearly $400 billion.)

Then each of these sites made a ton of money with advertising. With hundreds of millions of users, they've been able to generate billions of dollars in revenue. Facebook and Google have generated big profits. Twitter hasn't turned a profit yet, but it generated $2.5 billion in revenue in 2016.

Snapchat is following the road map laid out by its predecessors. Facebook's ad revenue was paltry until it signed an ad deal with Microsoft in 2006. Twitter waited until 2010 to announce its advertising plan. Both companies' advertising revenues surged as their user bases and sales forces grew.

So too with Snap. The company earned around $3 million in 2014, $59 million in 2015, and $404 million in 2016. In the latest quarter, Snap earned $150 million. That was short of Wall Street’s target of $159 million, but it was still a nearly fourfold increase from the $39 million the company earned in the first quarter of 2016.

Snap’s revenues have grown much faster than its user base for the simple reason that Snap only began focusing on selling ads — hiring ads sales teams, building technology to serve ads, and so forth — relatively recently, and it takes time to fully ramp up. But there’s little doubt that Snap will see its revenue grow significantly over the next year or two.

This is why, as Recode’s Edmund Lee points out, Snap is worth 35 times its estimated 2017 revenue while Facebook is worth just 11 times its revenue. Facebook’s ad sales operation is already built out, so boosting ad sales depends on attracting more users or getting them to spend more time on the site. In contrast, there’s a lot of room for Snap to make more ad money from the users it already has.

Of course, boosting revenue won’t necessarily lead to profits. Twitter managed to lose money on its $2.5 billion in ad revenue last year. But it’s a mistake to see this as evidence that an ad-supported tech company the size of Twitter can’t turn a profit. Twitter is losing money because it’s spending big on efforts like live video in order to restart growth. If it abandoned that effort and accepted a low-growth future, it could likely slash its costs dramatically and turn a profit without too much trouble.

The big question for Snap, then, is not whether it can make a profit. It’s how big it can get before growth stalls out. And there are three reasons to think Snap could do better than Twitter on this score:

• Snap’s young user base and video-oriented ad formats may be more attractive to advertisers than Twitter’s older audience and more text-oriented ads.
• As Snap introduces more and more features, it may be able to entice users to spend more time on the site.
• Snap’s young user base may provide more room for user growth. The company’s more experimental culture may produce compelling features that expand Snapchat’s audience. And even if that doesn’t happen, Snap may be able to attract a new group of teenagers every year — without losing longtime users as they enter their 30s.

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