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==Company background== Snap Inc. defines itself as a camera company, primarily because its flagship smartphone app, Snapchat, leverages the smartphone’s camera to create content, which is then shared with others. Content shared on Snapchat is ephemeral, remaining visible for only 24 hours, after which it is deleted from the platform. Snapchat averaged 158mn Daily Active Users (DAUs) in 4Q16, with 43% in North America (including Mexico and the Caribbean), 33% in Europe, and 25% in the rest of the world. The company generates revenue through advertising, with various ad types sold as Snap Ads and Sponsored Creative Tools. In late 2016, the company also introduced Spectacles – sunglasses with an embedded camera that captures short videos (10-30 seconds) and transmits them to the user’s phone via Bluetooth. Snap uses a tri-class share structure, with public shares having no vote. Co-founders, Evan Spiegel and Bobby Murphy together control nearly 90% of voting power, and Mr. Spiegel was given a stock grant in conjunction with the IPO that (as shares are delivered over the next 3 years) could potentially vest sole majority voting power in him, depending on whether he, or others, sell voting shares. Voting shares automatically convert to non-voting shares upon sale or transfer. Lastly, management has provided no formal guidance on financials, or user metrics like DAUs or ARPU, and has stated it has no intention of doing so as a public company. '''Snapchat encourages raw content sharing and frequent contact''' The Snapchat app was launched in 2011, with its key differentiator being its ability to enable one-to-one and one-to-many communication through ephemeral content. The app allows users to capture images, video, and text and share that content with others, with the expectation that the content will be only be viewable for 24 hours, and usually only held on Snap’s servers for 30 days. Pictures and videos created on the platform are referred to as ‘Snaps’. The ‘Memories’ feature, introduced in 2016, allows users to preserve their own (but not others’) snaps indefinitely. The company claims that the ephemeral nature of shared content, and the small network size encourage sharing of more raw content, as users would be less concerned with a network of 1,000+ people seeing their Snaps, and less concerned with those pictures and videos persisting indefinitely online. Some key Snapchat terms include: * Snaps – pictures and videos created by users and shared on the platform. Snaps disappear from the app after 24 hours * Stories – collections of Snaps that are aggregated and shared by users that disappear on a rolling 24-hour basis. For example, if a user posts one snap to stories every 2 hours, their User Story will contain the 12 most recent snaps at any given time. Stories can be viewed by all of a user’s friends/followers. * Memories – An area of the app where a user can save Snaps indefinitely. Snaps can be sent from Memories, but users cannot save friends’ Snaps to their own Memories. * Lens – an in-app augmented reality tool that leverages facial recognition to let users alter their pictures, most often by superimposing digital content on top of the user’s face (dog ears/muzzle, digital wigs/glasses, etc). Advertisers can sponsor unique lenses. * Filter – photo editing tools that allow users to customize their photos after taking them, by adding a digital frame, stickers, text, etc. Advertisers can sponsor filters. * Geo-filter – a specific filter that is only available to users within a defined geographic location. Can be created for communities, or sponsored by advertisers. Individual users can also design and purchase custom geo-filters via self-service. * Snapcode – a unique graphic similar to a QR code assigned to each user. Users can scan a Snapcode to add the associated user to their friend’s list. The app itself is structured to optimize content creation, rather than consumption, with key areas of the app set at the four cardinal directions from the home camera screen. The app opens on the camera, and a user can take a picture and post it to “Stories”, or send to a friend in seconds, with 4 taps on the screen. Opening on the camera emphasizes the creation of content vs. other platforms emphasizing consumption of content by opening on the news feed, or its equivalent. From the home camera screen, users can swipe up to see their profile, down to see Memories, right to see Stories, and left to see Chats (Exhibit 3). Swiping right twice opens the Publisher Stories/Discover Platform with partner’s stories, articles, and videos. Publisher partners include ESPN, BuzzFeed, MTV, Cosmopolitan, The Economist, Vogue, Esquire, Entertainment Weekly, among many others. '''Pace of Innovation''' One of Snap’s differentiating factors is the pace at which the company has been able to develop and roll out new products and features to its core app. The company has accelerated its pace of innovation as well, having introduced more major features and products in 2016 than it did in 2014 and 2015 combined. While some of the new features were added by way of acquisitions – Bitmoji, some lens capabilities, snap codes, and Spectacles came by way of acquisitions – we believe the majority of the innovation on the platform has been fostered in-house. '''Snapchat has highly engaged users, but relatively short average session times''' Snapchat’s daily users spend an average of 25-30 minutes per day on the platform. According to comScore, monthly users spend an average of 8-9 minutes per day on the platform, but this figure would include days in the month when users did not visit the platform, which explains the discrepancy between comScore data and the figures reported by Snap. On average, DAUs visit the app 18 times per day, and over 25% of Snap’s DAUs post their personal Story every day. Given the 25-30 minutes spent, and the 18 daily visits, this would imply that the average session length for a visit to the app ranges from less than 1.5 minutes to 2 minutes. This may be indicative of the use case – users who leverage Snapchat primarily to send and receive messages will have far shorter session times, while those who visit the app to read and watch content will have longer session times. We believe that Snap’s ability to improve its monetization will depend to a great extent on its ability to drive usage to more content and away from pure messaging, where opportunities for advertisements are fewer, in our view. '''Snap’s most engaged users skew young relative to other social platforms''' Snapchat’s user demographics and engagements will vary somewhat depending on whether the base is segmented according to DAUs (how Snap discloses) or MAUs (as many 3rd-parties measure the base). The DAU metric is significantly more volatile than the MAU metric favored by some competitors, as well. As an illustrative example, if a base of 100 users uses a platform every day in a given month, DAUs and MAUs for that month would each be 100. If the user behavior in this example changes to 6 days a week vs. every day in the month, the MAU figure would be unchanged at 100, but the DAU number would decline by 14%. This phenomenon also helps to explain the changes in demographic data from Snap vs. 3rd-parties like comScore who only report metrics based on monthly users. We also believe that new users are less likely to be as engaged as established users with mature friend networks, so monthly users are likely to increase at a faster rate than, and serve as a leading indicator to, DAUs. According to comScore monthly unique users have increased at an average yoy rate of 117% over the last three months, while minutes per user have declined by an average of 13%. Snap has disclosed that over half of its DAUs are in the 18-34 demographic. However, the 18-24 segment makes up the largest portion of Snapchat’s DAUs. Snapchat also has more users who are under 18 than it has users who are over 35. These segments imply a median disclosed age of ~24 for Snapchat’s base of DAUs, though this metric may be somewhat skewed as well, as there is no mechanism in place to verify a user’s age other than the birthdate the user enters when initially downloading the app. Snap’s engagement skews significantly toward younger users, but the average age of its user base is rising – In the US, over 50% of daily new users are over 25. ComScore data from January 2017 shows nearly half of Snapchat’s monthly users are over 35, vs. the 15% of its daily users as reported by the company. This may indicate that younger users are more likely to engage on a daily basis, while older users may engage from time to time, but not frequently enough to comprise a larger proportion of the DAU base. As further evidence, Snap disclosed that DAUs under 25 visit the app more than 20x daily, while DAUs over 25 visit an average of 12x daily. The discrepancy between Snap’s reported DAUs and comScore’s reported MAUs may simply indicate a difference in data collection, skews from methodology in comScore’s measurement, or other unknowns. Regardless of the metric used, however, Snap’s user base skews younger than other social platforms. While this may limit the platform’s attractiveness to certain advertisers, it also presents an opportunity for many advertisers to find an audience that is increasingly difficult to reach on other social platforms. According to comScore (among US users), Facebook was by far the favoured social platform among all age groups in January 2016. However, when limited to mobile traffic only, comScore shows a dramatic shift among younger users over the last year, as Snapchat and Instagram both show higher daily minutes per user relative to Facebook in the 18-24 demographic (Exhibits 9 & 10). Based on our conversations with advertising partners, many advertisers view Instagram and Facebook as interchangeable, given the common ownership and shared technology, but those conversations also indicate encouragement among advertisers that there is another viable platform in the market now, through which younger demographics can be effectively reached in creative ways. Multiple levers for growth, but Snap must execute on all of them Snap reports its revenue as a function of DAUs and Average Revenue per User. While Snap generates the vast majority of its revenue through advertising, that advertising is sold based on audience size, engagement, demographic data, and other metrics that the company does not plan to disclose. As such, we model revenue growth based on the growth in DAUs and the growth in ARPU, by geography. Snapchat DAUs increased 48% yoy in 2016. North America DAUs increased 42%, Europe by 53%, and the rest of the world by 63%. We expect the company to invest in sales and marketing to drive adoption and improved monetization. We expect S&M investment to increase from $124mn in 2016 to nearly $350mn in 2017 and over $1.6bn in 2021. We expect ARPU to grow more rapidly than DAUs for the foreseeable future. Snapchat saw a marked drop in the pace at which it added new DAUs beginning in 3Q16, which coincides with two major events: # Instagram launched its Stories feature, which we believe had a negative impact on engagement among Snapchat users. We do not believe there were a material number of Snapchat users that abandoned the platform, but given the sensitivity of the DAU metric (as discussed on page 10) anything that potentially takes attention away from Snapchat could have a material impact on DAUs in any given period. # In addition to increased competition, the company also introduced several new features during 3Q16 that, according to the company, had a negative impact on the performance of the app – slow performance, app crashes, etc. – which adversely impacted engagement temporarily. The company believes that all of these technical issues have been resolved. The slowdown in net adds in 3Q16 was more impactful in the rest of world segment than it was in North America and Europe. Net new DAUs in North America declined from 7mn in 2Q16 to 3mn in 4Q, with a similar decline seen in Europe. In the rest of the world, net adds declined from 7mn in 2Q16 to 0 in 4Q16. Users in geographies outside of North America and Europe over-index on lower-end Android devices, which Snap claims were most heavily impacted by the technical issues. We believe this provides further evidence that the slowdown in net adds was driven at least in part by technical performance issues. We also analyzed comScore’s US-only data over that time period. While the data provides no insight into the international trends seen in 2H16, we believe it does provide some credence to management’s discussion of technical issues causing the slowdown. According to comScore’s US monthly unique visitor metrics (which correlate with an rsquared of 0.91 to Snap’s reported North America DAUs, historically) the deceleration in net adds has been almost entirely on Android, with yoy growth in iOS monthly users accelerating in 10 of the last 12 months. The company’s strategy involves targeting the highest-value users in geographies with mature advertising markets, deemphasizing lower monetization ad markets in order to limit losses. Despite that focus, we believe that there remains a significant opportunity for Snap to add users within North America and internationally. Snapchat is a resource-intensive mobile app, with heavy data, memory, and bandwidth usage that is difficult to accommodate on lower-end smartphones more prevalent in developing geographies. Additionally, limited 4G network build-out makes it difficult to service users in many parts of the world. Given the higher costs, lower performance, and lower monetization rates of users outside of Snap’s target markets, the company has stated its clear strategy is to drive improving monetization of users in N. America and Europe rather than optimizing the strategy for user growth globally. '''Snap’s model is highly sensitive to DAUs and ARPU''' We performed a sensitivity analysis around Snap’s 5-year revenue potential. Given the company’s stated focus on driving revenue and user growth in North America and Europe, we focused our analysis on these geographies. Our sensitivity analysis assumes DAU growth ranging from a 5-year CAGR of 2% to 11% through 2021 vs our base assumption of 10%. For monetization, our sensitivity analysis assumes an ARPU range of $5 to $65 in 2021 vs our base assumption of $37. For context, we estimate a weighted average (across North America and Europe) 2017 ARPU for Facebook approaching $60, while we estimate Twitter’s US and International ARPU figures at $42 and $9, respectively. While we recognize a broad range of potential outcomes outside of our analysis here, these DAU and ARPU assumptions generate a potential 2021 revenue range of $650mn to $13bn, which illustrates the widely varying possible trajectories for Snap, given the current, very early stage of its life cycle. '''Monetization vehicles''' Snap generates revenue through Snap Ads, Sponsored Creative Tools, and Spectacles. While we believe there is potential for Snap to introduce new products and services that would serve as incremental monetization vehicles, our model assumes the vast majority of revenue growth will come through user growth, and increased monetization efforts through the products that currently exist. '''Snap Ads''' Snap ads are vertical, full-screen advertisements of various types served on the Snapchat app. On average, over 60% of Snap ads are viewed with sound on, creating a competitive advantage for Snap relative to other social/mobile advertising platforms where videos are more commonly viewed with sound off. Additionally, Snap Ads can be sold “with attachments”, which serve as extensions of the advertisement allowing the user to swipe up to view longer-form videos, install an app, read additional content, or take some other action. Snap Ads can be created in various formats, including video, articles, app install interstitials, and web view advertisements. Given the varied nature of the organic and partner content on the platform, we believe advertisements are more difficult to distinguish from native content on Snapchat than they are on many other platforms. '''Snapchat’s ad inventory''' We classify Snap’s ad inventory (excluding sponsored creative tools) in two categories – organic inventory, and partner inventory. '''Organic Inventory''' – We define organic inventory as ad slots placed among content on the platform that is created by, and shared among, the actual users on the platform. The principle example of this would be a Snap Ad that appears between friends’ Stories. '''Partner Inventory''' – We define partner inventory as ad slots that are placed adjacent to partner content, whether that content appears as “Featured” Stories below friends’ Stories, or among partner/publisher stories on the Discover platform. Ad placement on partner content varies based on the type and nature of the content. Many publishers on the platform create content consisting of a series of Snaps (separate short videos, still images in a story board format, text slides, etc.) with many of the Snaps giving the option to swipe up to see more content. The economic impact of ads placed on partner inventory also varies based primarily on whether Snap or the partner sold the ad. Snap shares ad revenue with the partners on whose content the ad appears, recognizing the revenue gross if it sells the ad itself, and recognizing it net of the partner’s share if the partners old the ad. In 2016, the company paid $57.8mn to partners under such agreements, vs. $9.6mn in 2015. While the company has not disclosed the economics of those agreements, assuming a 50/50 split would imply that 29% of 2016 revenue was generated on partner content and recognized gross. The company has not disclosed any metrics regarding ad load, nor has it disclosed the proportion of its revenue that is generated through sponsored creative tools. We believe ad load varies materially between users, based on geography, demographic, and the user’s level of engagement. Our model assumes that DAUs see an average of one for every 8-10 times they open the app. We expect this metric to trend up over time as user engagement and session times expand. We expect users to see (on average) one ad every 4-5 times they visit the app by 2021, with the average number of daily app opens slowly declining from 18 currently, to a global average of 15.5 in 2021. '''Targeting, Reporting, and Measurability''' Snap leverages internal technology and an ecosystem of third-parties to provide targeting, reporting, and measurement statistics for advertisers. In addition to targeting users based on demographic data (age, gender, etc.) the app can target based on precise location data, as the location function on the user’s device must be turned on in order to use some of the apps most popular features, like filters. Snap also has an Audience Match function that allows advertisers to use their own CRM data to target specific individuals, similar to what is offered by large-scale competitors. Snap partners with Innovid, Google DDM, and Sizmek for third-party ad verification, and leverages Moat’s video score for measurement on video ads. Snap partners with Nielsen mDAR and Millward Brown to measure reach and frequency of ad campaigns, and with Oracle Data Cloud to measure post-ad purchase activity. Snap has an ecosystem of partners including Tune, Adjust, Kochava, and others for the measurement and reporting of app-install ads. '''Sponsored Creative Tools''' Snap also offers advertisers the option to sponsor creative tools like lenses and filters that can be used to enhance Snaps before they are shared on the platform. Common free lenses include augmented reality tools that superimpose a dog’s face on the user’s photo, or create the illusion that a rainbow is coming out of the user’s mouth. Advertisers can pay to create unique sponsored lenses like those that were used in a promotion for a recent XMen film that made users look like different characters from the film, complete with superpowers. Filters allow users to enhance photos after they have been taken, adding stickers, time or temperature stamps, or other effects. Geofilters are filters that are only available to users within specifically defined geographic areas (ranging from 20k to 5mn sq. ft.), and can be purchased by advertisers or users via self-serve through Snap’s website (Exhibits 17-21 outline the self-serve process). '''Spectacles''' Snap Spectacles are sunglasses with an embedded camera that connects to the Snapchat app on the user’s smartphone via Bluetooth. Snap announced the launch of Spectacles in September 2016, in conjunction with its corporate re-branding as a camera company (and changing the name of the company to Snap Inc.). Originally, Spectacles were only available through custom vending machines called Snap Bots, that were strategically placed, for one day each, in cities across the US. Through February, there was only one persistent location (in New York City), but that location has since closed. Spectacles have been available online (with a 1-2 week wait time) since February, and retail in the US for $130 (Exhibit 22). Snap has not disclosed the unit sales or revenue contribution from Spectacles, other than to say that revenue from the sunglasses has been immaterial. The company has disclosed that it is selling Spectacles at a loss, and that it expects to continue to do so for the immediate future. Given the early nature of the initiative from Snap, and the immaterial revenue generated to-date, we have only very modest assumptions in our model for revenue and costs associated with Spectacles. Should Snap generate material revenue or see broad adoption of Spectacles, there would be corresponding upside risk to our numbers. We believe that Spectacles represent an opportunity for the company to drive further engagement and public awareness of its Snapchat app. Should Spectacles see broad adoption, we would expect engagement, DAU growth, and revenue above our current estimates, however increased engagement through Spectacles would also increase infrastructure costs as users generate and consume more HD video and leverage more storage. Snaps created through Spectacles are automatically added to Memories, which increases the storage expenses for Snap relative to snaps created within the Snapchat app itself.
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