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Snap (NYSE: SNAP) has stood behind its decision to rely on its cloud infrastructure partners Google and Amazon (NASDAQ: AMZN) instead of building its own servers. Snap argues the capital-light model will eventually lead to greater cash flow conversion. On the other hand, Snap can't realize as many benefits of scaling.
In order to reduce its infrastructure costs, Snap negotiated two massive long-term contracts with Google and Amazon in early 2017. The contracts were structured with the expectation that Snap's demands for cloud infrastructure would continue to grow rapidly. After several quarters of losing users, Snap admitted it couldn't keep up with its commitments and restructured its deal with Amazon in October last year.
Snap also amended its agreement with Google, but the details of those changes are not public.
Image source: Snap
Comparing the new contract
Snap's original contract committed it to paying Amazon Web Services $1 billion over five years. The new deal totals slightly more than $1.1 billion over six years.
| Year | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 |
|---|---|---|---|---|---|---|
| Original commitment | $50 million | $125 million | $200 million | $275 million | $350 million | N/A |
| New commitment | N/A | $90 million | $150 million | $215 million | $280 million | $349 million |
Data source: Snap annual report and S-1 registration filings. Chart by author. N/A = not applicable.
Importantly, both deals use the language: "If we fail to meet the minimum purchase commitment during any year, we are required to pay the difference. Any such payment may be applied to future use of AWS services during the addendum term, although it will not count toward meeting the future minimum purchase commitments under the addendum." In other words, Snap might have to prepay for its cloud-computing service, but it's not forfeiting the money outright.
It's unclear whether Snap faced any fees in its renegotiation with Amazon. Snap may have had to commit to higher overall spending in order to renegotiate without penalty.
In the short term, Snap will save itself from spending $35 million on cloud computing it likely won't need this year. It'll save even more in subsequent years. Additionally, the commitments ramp more slowly, which is important considering the significant slower growth outlook for Snap's user base going forward compared to two years ago.
Is Snap better off?
Snap has spent over $1 billion on cloud-computing servers over the last two years. That's more than 50% of its revenue during that period.