The Biggest Source of Growth for Snap

Snap (NYSE: SNAP) reported better-than-expected third-quarter results, with daily active users climbing to 210 million and revenue up 50% year over year. The photo- and video-sharing app saw improved engagement across geographies, devices, and its various features.

Snap's strongest area of engagement growth is Discover, the section of its app featuring professionally created content, including its Snap Originals. Management said time spent in Discover grew 40% year over year. That compares to just a 13% year-over-year increase in active users.

CFO Derek Anderson noted on theearnings callthat the company also saw "growth in Snapchatters posting and viewing Stories" during the quarter. CEO Evan Spiegel later noted that the introduction of an "infinite scroll," so to speak, on Stories led to greater engagement, and premium content Stories also found in Discover helped supplement user-generated content.

Increasing engagement with premium content is a great source of revenue for Snap, since it's strongly differentiated from companies like Facebook, which keeps trying to copy its Stories and messaging products, or TikTok, which is focused exclusively on user-generated content.

Artwork for three Snap Originals: Commanders, Can't Talk Now, and Sneaker Heads.

Three Snap Originals. Image source: Snap.

Snap, the media company

Snap has made a concentrated effort to improve the content found in its Discover section. It's striking new deals with big media companies to produce exclusive content, and it's creating new original content itself.

The diversity of popular content on the platform shows how far Snap has come. It now boasts 100 different channels reaching a monthly audience of 10 million viewers. That compares to 21 different shows in the third quarter last year.

Indeed, Snap has positioned itself as a great place to find an audience, particularly younger viewers, for both media companies and advertisers. That's beneficial for everyone involved. Advertisers know where to find an audience of over 100 million daily viewers (Snap said half of users used Discover daily during the first quarter), and media companies and Snap get to share in the ad spend those marketers bring to the table.

Snap's revenue share costs increased 73% year over year in the third quarter to $46 million. And while that number is growing significantly faster than Snap's overall revenue, it's relatively small compared to the bigger costs of running Snapchat. Infrastructure costs totaled $146 million for the quarter, up just 4% year over year, and total operating expenses of $271 million increased just 11%. Snap is showing good leverage in other areas, which gives it an opportunity to invest more in media partnerships and Snap Originals.

Can Snap keep growing Discover?

Snap's growing engagement on Discover is encouraging, but the company may have a harder time increasing that engagement in the future. It's already showing some signs of slowing down, with year-over-year growth in time spent going from 60% in the second quarter to 40% in Q3.

Moreover, Snap will be lapping the big push it made into original content in the fourth quarter last year, and it's unclear whether reupping the investment this year with new originals and second seasons will have the same impact in drawing users to Discover. Management did note, however, Dead of the Night, one of its new originals, has already garnered 14 million viewers.

Snap's disappointing outlook for fourth-quarter revenue may indicate a further slowdown in Discover engagement. Whether that's due to tougher year-over-year comparables or competition from TikTok, Facebook Watch, or other big video products set to launch in the near future from tech and media giants remains to be seen. Next year, Snap will face competition for premium video content made for mobile from Quibi, which recently secured $150 million in up-front ad spend six months before its launch.

Discover has proven an extremely valuable piece of Snapchat, and its continued growth in watch time will be instrumental to Snap's future financial success. Investors should look for Snap to continue investing in new content and media partnerships in order to keep viewers engaged and draw in new users, especially as the company is showing strong leverage from the spend. But if Snap can't repeat its success with Discover over the next year, it could see a significant slowdown in revenue growth.

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Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Facebook. The Motley Fool owns shares of and recommends Facebook. The Motley Fool has a disclosure policy.

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