Spectacles Are Totally Not Worth It for Snap, Inc.

By Evan Niu, CFA Markets Fool.com

Snap's (NYSE: SNAP) Spectacles are really just a novelty product. That fact is abundantly clear in the wake of the Snapchat operator's first public earnings release.

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Snap successfully pulled off a viral marketing campaign late last year when it launched Spectacles, which were only available in limited quantities and exclusively sold through a network of bright yellow vending machines. Perhaps more importantly, Spectacles also played a crucial role in why Snap has chosen to rebrand itself as a "camera company," since it was its first actual hardware camera product. At least so far, it hasn't been worth it.

Image source: Snap.

Spectacles lose money

Snap said that Spectacles revenue in the first quarter totaled approximately $8 million, which represented about 5% of total revenue. It's common knowledge in the world of consumer electronics that making compelling products that sustain demand is difficult, and margins are often slim. Snap also finally disclosed a breakdown of cost of revenue.

Non-GAAP Cost of Revenue

Q1 2017

Hosting costs

$99 million

Revenue sharing costs

$23 million

Other

$20 million

Total

$142 million

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Data source: Snap.

Let's be clear: that "other" category pertains predominantly to Spectacles. This is how Snap characterized cost of revenue in its prospectus:

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.

If that $20 million is tied directly to Spectacles, which appears to be the case based on the prospectus language, that means that Snap generated a negative gross profit of roughly $12 million from Spectacles.

Spectacles engagement is literally a rounding error

On the earnings call, CEO Evan Spiegel also noted that "over 5 million Snaps" had been created via Spectacles to date. At the same time, the company said that it saw over 3 billion Snaps created on a daily basis during the first quarter. If you do the basic math, that means that Snapchat had roughly 270 billion Snaps created on its platform throughout the first quarter.

So 5 million Snaps would represent 0.002% of all Snaps during the quarter. But Spectacles launched in November, and Spiegel's metric included all Snaps created via Spectacles to date, so Spectacles contributed to even less than 0.002% of Snaps created during the first quarter.

Not worth it

This should all underscore how absurd it is that Snap considers itself a "camera company," which suggests that it intends to keep innovating on camera hardware. The vast majority -- over 99.998% -- of content comes from smartphone cameras, a feature that smartphone makers invest very heavily in as a competitive factor. There's no way that Snap will ever make a better camera than what's already in an iPhone, as Apple has over 800 engineers exclusively working on the camera. That's almost half the size of Snap's entire headcount at the end of 2016.

Snap is selling a product that it loses money on which also fails to improve engagement in any meaningful way, all while entering a space where it cannot compete. Not worth it.

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Evan Niu, CFA owns shares of AAPL. Evan Niu, CFA has the following options: long January 2019 $20 puts on Snap Inc. The Motley Fool owns shares of and recommends AAPL. The Motley Fool has a disclosure policy.