Analysts haven't been kind to Snap (NYSE:SNAP) since it made its IPO. Not one analyst has given Snap stock a buy rating, and shares have fallen considerably from its opening price at the beginning of the month.

Most recently, market researcher eMarketer lowered its expectations for Snap's U.S. ad revenue from $800 million to $770 million. The reason behind the lower estimate is "higher-than-estimated revenue sharing with partners."

Snapchat offers revenue sharing as an incentive for content publishers to use its Publisher Stories (formerly Discover) format. Snap is also partnering with various media companies to produce original shows, which may provide even more favorable revenue share for the content producer.

Let's take a look at how revenue sharing affects Snap's financials.

Snapchat logo on yellow background

Image source: Snap/Author.

Revenue sharing doesn't impact Snap's top line

While eMarketer is lowering its expectations for Snapchat, the actual decline in net ad revenue won't show up in Snap's top line. Snap reports gross revenue similarly to how Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) reports Google's revenue. Google lumps in revenue from its network partners with its search and YouTube revenue, and then accounts for revenue sharing as part of its traffic acquisition costs.

The amount of revenue Snap shares with its publisher partners is then reported as an item in the company's cost of revenue. So, eMarketer may have well said it expects Snap's cost of revenue to come in $30 million higher than originally anticipated.

A screenshot of Snapchat's Publisher Stories

Snap's Publisher Stories. Image source: Snap.

Last year, Snap says revenue sharing payments increased $48.2 million from 2015, but it doesn't provide a specific amount it paid to partners. That does at least provide a floor, and it's nearly 12% of Snap's $404.5 million in total revenue last year.

For comparison, Google paid out $10.9 billion in revenue sharing to its network partners (not including YouTube) in 2016. That's almost 14% of its total ad revenue for the year.

Revenue sharing may increase even faster

While most analysts expect Snap to grow its top line to around $1 billion this year, its path to that mark may mean less of that revenue makes it past the second line (cost of revenue) on its income statement. Snap has inked several high-profile deals with media companies over the last year.

It already has deals in place with NBC, ABC, BBC, Turner, New York Time, Discovery, Time, A+E Networks, and VICE to produce original shows for Snapchat. Snap is still actively pursuing these high-profile deals.

It's important to note that Snap says its revenue-sharing arrangements "generally do not contain minimum financial commitments to our publisher partners and are generally not tied to specific events or promotions." That seems to indicate Snap doesn't pay anything up front for these productions, but Snap may help out with the costs as "content creation costs" also show up in management's description of cost of revenue. Content creation costs include personnel-related costs, according to Snap's S-1.

With the growth of the Publisher Stories platform, investors should expect a stark increase in cost of goods sold due to revenue-sharing and content-creation costs.

Cost of revenue is already under scrutiny

Snap posted a negative gross margin last year as its cost of revenue overshadowed its revenue. The biggest factor behind it is Snap's hosting expenses, for which it primarily relies on Google Cloud. It's already committed to spending $3 billion in total on cloud infrastructure over the next five years, which will continue to put pressure on Snap's gross margin as it tries to scale.

Add to that the fact that one of its revenue drivers is growing content from publisher partners, which contributes to even more cost of revenue. While a few tens of millions of dollars is relatively small compared to the hundreds of millions Snap is spending with its cloud partners each year, Snap's margins are so thin that every dollar counts.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A and C shares). The Motley Fool has a disclosure policy.