Snap (NYSE: SNAP) CEO Evan Spiegel has set a high bar for his employees: a profitable 2018.
Snap, the company behind social media and messaging app Snapchat, lost $720 million in adjusted EBITDA last year. That's an increase over 2015 and 2016, when the company lost $293 million and $459 million, respectively.
But Spiegel sent a company memo several months ago outlining his goal to reach profitability in 2018, according to The Information. Of course, investors should know by now to take everything Spiegel says with a grain of salt.
Twitter (NYSE: TWTR) notably turned an operating loss of $367 million in 2016 into an operating profit of $39 million in 2017, and it produced a GAAP profit in the fourth quarter. Perhaps Spiegel was inspired by Jack Dorsey and the crew up Highway 1 from Snap headquarters.
Snap's losses are twice as large, and its cost structure doesn't have nearly as much leverage as Twitter's. But that's not going to stop Spiegel from trying to make Snap profitable ASAP.
Slimming down in a snap
Snap started laying off employees back in September. First it cut the hardware and marketing teams for its Spectacles glasses, which the company made a big inventory writedown on in the third quarter. Then it cut its HR staff as its recruiting needs declined.
Earlier this month, Snap made its biggest round of layoffs yet, letting go of about 100 engineers. The timing is suspect, considering Snap just finished rolling out its big Snapchat redesign, but Spiegel believes there's room to make the engineering teams more efficient. Snap might not be done with layoffs, either, according to Alex Heath, the reporter who first broke the story about the most recent round.
Layoffs were a key part of Twitter's turn toward profitability. The company made significant cuts in its research and development and marketing expenses in 2017 to help improve its operating margin.
Research and development is historically Snap's biggest operating expense, so a slimmed-down engineering team could help Snap save some money. On top of that, Snap is quickly transitioning to its self-serve advertising platform, which means it can scale the number of advertisers each of its marketing representatives handles. But the shift to the self-serve platform has also resulted in a significant decline in average ad pricing for Snap.
There's certainly some operating leverage in Snap, and Spiegel seems dead set on squeezing every bit of it.
Not much Spiegel can do about Snap's cost of revenue
Cost of revenue is the biggest challenge for Snap to overcome in terms of profitability. Last year, cost of revenue accounted for 87% of revenue. It's really hard to make a profit when you have only 13% of revenue left over for operating expenses. Snap's cost of revenue is improving, with gross margin reaching 36% in the fourth quarter thanks to seasonally strong ad revenue. For comparison, Twitter's cost of revenue was 35% and 30% of total revenue for the full year and the fourth quarter, respectively.
And Snap has some big expenses in that number that aren't going anywhere.
Most notably, Snap signed two massive deals with cloud computing companies with ramping-up spending requirements over the next four years. Spiegel says its decision to rely on the public cloud is a cost advantage over competitors such as Twitter that build out their own servers and data centers. But that's very short-term thinking, as it's much harder to exhibit leverage when you pay on a usage basis even if you can negotiate better rates.
Snap also includes revenue sharing costs, which it pays out to publishers that create Publisher Stories and Discover content. Snap is moving toward more owned ad inventory -- content on the left side of the app -- which could help reduce revenue share expenses as a percentage of revenue. That said, the company said the redesign is increasing engagement in the Discover section, which could offset the impact of opening more owned ad inventory.
Does Spiegel have a time machine?
It'd be an understatement to call Spiegel's goal a surprise. If Snap becomes profitable in 2018, it will do so about three years ahead of Wall Street expectations. Snap can cut costs all it wants, but it primarily needs to focus on driving user engagement and revenue growth if it wants to show a profit for the year.
Snap has so far disappointed investors in that regard, with analysts repeatedly lowering revenue growth expectations for the company. Wall Street currently expects 60% revenue growth this year and 50% next year. And since costs will surely climb with revenue, as they mostly stem from cost of revenue, the profitability equation doesn't work out, at least not this year.
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