Snap (NYSE:SNAP) had a bad 2018. A botched redesign and pressure from competitors like Facebook's (NASDAQ:FB) Instagram left the company with fewer users of its flagship app, Snapchat, at the end of the year than it started with.
During the company's fourth-quarter earnings call, management was upbeat about its progress toward turning things around. It noted iOS active users were up year over year, and engagement among those users increased as well. Snap's efforts on Android have lagged behind, but it finally released its completely rebuilt app for Android and announced a bunch of new features and content at its first-ever partners' summit earlier this month.
Still, the efforts might not be enough. Snap could lose more than 2 million users in the U.S. this year, according to research firm eMarketer. The analysts also expect Snap's domestic user growth to remain flat into the next decade after this year's decline. Here's what's holding Snap back and what it means for investors.
Blood in the water
Snap was already struggling to grow Snapchat going into 2018, but when it launched its redesigned app and Kylie-gate happened, that's when the real trouble started. Users started leaving Snapchat in March, the month following the redesign's broad release, according to management's commentary on the company's first-quarter earnings call last year.
Users flocked to Instagram Stories. The copycat feature grew from 300 million daily active users in November 2017 to 500 million daily active users in January of this year.
Facebook smelled blood in the water, and ramped up its efforts to grow its Stories products last year. At the start of 2018, CEO Mark Zuckerberg said sharing in Stories would be more popular than sharing with posts in feeds. Before the end of the year, Facebook said it had 1 billion daily active users sharing Stories in its various products.
The challenge for Snap is that users who haven't signed up for Snapchat have no incentive to do so when they can just use the WhatsApp or Instagram account they already have.
Will new features change anything?
Snap introduced several new features at its partners' summit earlier this month.
The company unveiled Snap Games, which offers free-to-play multiplayer games to users. The games could produce a network effect, as existing users invite nonusers to play in the app.
It also showed off some new Snap Originals -- short-form series developed specifically for Snapchat's Discover section. Snap Originals themselves are unlikely to attract a lot of new users. Facebook has struggled to attract an audience for its Watch platform despite pouring hundreds of millions of dollars into content. It's hard to believe Snap could do much better.
Another interesting new feature is App Stories, which allows developers to enable users to share their Snapchat Stories in other apps. Snap could benefit from users who want to use the Stories format in apps like Tinder or Houseparty, requiring them to download and use Snapchat.
Overall, however, these new features are more likely to increase engagement among existing users rather than attract new ones.
An important consideration for Snap investors
If Snap is unable to grow its user base over the next few years, it must increase its user engagement. Snap really needs the new features it released earlier this month to work.
That's because Snap has long-term commitments with cloud computing providers totaling more than $3 billion. The company already had to restructure those contracts last year in order to keep its annual costs under control.
Without significant user growth, Snap's demands for cloud computing simply won't meet its contract minimums. Increasing engagement should help Snap meet its cloud computing quota, especially with more intensive features like Snap Games. Still, it's in a precarious position with its long-term cloud partners.
It doesn't look like Snap can resolve its user growth challenge, and that presents a big problem for it. If engagement doesn't improve, investors need to consider Snap's cloud costs and how they impact its bottom line.