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Spotify - losses narrow, but for the wrong reasons

George Salmon | 1 November 2018 | A A A
Spotify - losses narrow, but for the wrong reasons

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Spotify Technology S A EUR0.025

Sell: 227.77 | Buy: 228.15 | Change -4.88 (-2.10%)
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Spotify's third quarter revenue of EUR1.35bn is up 31% on last year and 6% on Q2.

The group's operating loss narrowed to just EUR 6m, from EUR 73 last year, a much better performance than forecast. However, much of this improvement is due to costs not increasing as fast as expected, due to shortfalls in hiring extra staff. That headwind has continued into Q4.

The shares fell 4% in pre-market trading the news.

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Our view

Since its unconventional stock market listing earlier this year, the world's largest music streaming service has reported consistently impressive growth figures.

Monthly Active Users and revenues are both on an upward trajectory. While Spotify remains loss-making for now, it's easy to see how it should break sustainably into the black soon enough if recent trends continue.

That's because the business should be very scalable. More subscribers help lower operating costs as a percentage of revenue, which ultimately moves the company into profit.

More listeners improves Spotify's bargaining power with major record labels too, especially with global streaming revenues growing by 41.1% in the last year to 38.4% of all recorded music revenue. Spotify is also working to provide a route to market for those smaller names, and is developing tools to help them thrive.

There's also opportunities to upsell. Over half of Spotify listeners are low revenue ad-supported customers. Transfer them onto subscriptions, and you've got another growth driver.

The path to profits isn't without pitfalls though.

Competing with the likes of Amazon and Apple is no easy task, while the launch of discounted student and family packages has hit average revenue per user. There's also teething problems around staff recruitment, and investment around R&D and content looks to be slightly ahead of previous expectations.

If Spotify can't deliver the required growth, the virtuous circle of higher revenues, lower costs and improved cash flow will break.

Nonetheless, we think the group is well positioned in the long term. Spotify is important to the industry, having paid out over $10bn to labels since its launch. The importance of streaming to music consumption is only going one way.

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Third quarter trading details

Subscription revenue rose 31% to EUR 1.2bn, with ad revenues up 30% to EUR 142m.

Total monthly active users rose 28% to 191m, 109m of which use the ad-supported service. Growth in the group's Latin American and Rest of World sectors continuing to outpace growth in more established markets.

The number of premium subscriptions rose 40% to 87m. Family and student plans continue to prove popular, and after teaming up with Hulu and Showtime, Spotify launched its first ever multi-partner bundle.

The group has also announced partnerships with Alphabet, to offer Google Home Mini speakers to certain account holders in the US during the holiday season, and Samsung, to become better integrated into new phones.

Looking ahead, Spotify expects fourth quarter monthly active users to rise 24-29% to 199-206m, with premium subscriptions rising to 93-96m.

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