Of all the companies crowding into this century's social media party, Snap has always seemed one of the most faddish and juvenile.

Its Snapchat messaging service allows users to send photos and images that brighten the recipients' smartphone screens for only a few seconds before fading to nothingness. Popular among tweens, Snapchat risked being just as ephemeral.

But it has defied naysayers and is growing its user numbers faster than either Facebook or Twitter. Up 18% for the recently ended first quarter, the figure now exceeds 332 million and has grown in every part of the world.

Figure 3: War in Ukraine, rising interest rates and supply-chain disruption are weighing on social media company Snap as it plows money into R&D.
(Source: Unsplash)

Engagement has improved as Snap has invested in new features. What started out as a means of sending basic images is morphing into an augmented reality (AR) service with some high-profile partners.

Snap is even making its own AR-based TV shows. Breakwater, a sci-fi series developed with Verizon, has attracted more than 10 million viewers.

Sales are rising. For the first quarter, they grew 38%, year-on-year, to surpass the $1 billion mark. Yet Snap has not been able to escape the gloom that currently pervades the tech sector. Its share price was down 4.36% in New York at the end of trading on April 21, and it has fallen by a dramatic 61% from a high point in August last year.

Figure 1: Snap's share price ($) (Source: Google Finance)

The latest worry is about a slowdown in sales triggered by the conflict in Ukraine.

"In the days immediately following Russia's invasion of Ukraine on February 24, we observed that a large number of advertisers initially paused their campaigns," said Derek Andersen, Snap's chief financial officer, on a call with equity analysts.

The rate of year-on-year growth remained below pre-invasion levels throughout March, he revealed.

Snap attributes this to the broader macroeconomic pain that has been a consequence of war in eastern Europe. Supply chains were already looking strained after the COVID-19 pandemic, and disruption is now worse.

Inflation and interest rates are rising, and geopolitics has become an even bigger worry for the marketing department of any major corporation. Analysts are revising their estimates of what Snap can achieve in sales growth this year.

Hey, big spender

On top of that, Snap continues to run up substantial losses. Despite the recent sales growth, its net loss for the just-ended first quarter ballooned 25% year-on-year, to nearly $360 million.

All those investments in AR and other whizzy new features are coming at the expense of profitability. Spending on research and development alone soared 31% year-on-year for the first quarter, to more than $420 million. Headcount is up sharply. About 4,000 people worked for Snap this time last year; today, it employs more than 6,100.

There was also a $92 million loss on an investment that became public in the second half of 2021. Without that, Snap's net loss would have narrowed by $19 million, to about $267 million. Executives did not indicate what this investment was.

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Profitability has been elusive for years. Since Snap first went public in early March, and including numbers for the 2016 fiscal year, it has racked up a net loss that totals nearly $7.7 billion.

The latest headwinds, and the indication that operating costs will be much higher this year, suggest the losses may continue for some time yet.

"Management noted '22 will be a significant investment year," said Brian Fitzgerald, an analyst at Wells Fargo, in a research note today.

One positive appears to be an ongoing improvement in Snap's gross margin.

The company did not publish that figure in its latest filing with the Securities and Exchange Commission (SEC), but Fitzgerald reckons it has risen 22 percentage points in the last three years.

Infrastructure costs for each daily active user (DAU) are at their lowest level since the second quarter of 2016, he adds.

Figure 2: Snap's revenues and net income ($ thousands) (Source: SEC filings)

The explanation seems to be more favorable deals with AWS and Google Cloud, the companies Snap relies on for its cloud-computing needs.

"We have now completed new multiyear agreements with both of our large infrastructure partners, and the lower pricing from these agreements drove the majority of the sequential improvement in cost per DAU," said Andersen.

That is a "powerful validation for our asset-light infrastructure model," he insisted. Snap's capital expenditure works out at less than 2% of revenues.

Maybe the figures do validate Snap's model, but the approach is not without risks, as the company has acknowledged.

Noting its reliance on AWS and Google in its recent annual SEC filing, Snap pointed out that its systems "are not fully redundant on the two platforms" and that moving from one to the other, or to an alternative cloud provider, "would be difficult to implement and would cause us to incur significant time and expense."

Snap would also be "seriously harmed" by disruption to either provider's service, it said. Last year's outages at AWS will have made at least a few investors sweat.

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— Iain Morris, International Editor, Light Reading