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Spotify - First profitable quarter

Nicholas Hyett | 6 February 2019 | A A A
Spotify - First profitable quarter

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Spotify Technology S A EUR0.025

Sell: 110.21 | Buy: 110.35 | Change -4.17 (-3.65%)
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Spotify's fourth quarter results were ahead of company guidance, delivering positive operating income, net income and free-cash-flow for the first time. Fourth quarter revenues rose 30% to EUR1.5bn, with operating profit of EUR94m.

Monthly active users (MAUs) were ahead of guidance at 207m, as customer retention came in ahead of company forecasts.

The shares were broadly flat in early trading.

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Our view

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

MAUs and revenues are both on an upward trajectory. And while Spotify expects to remain loss-making next year, we can see a clear route to sustainable profitability if recent trends continue. 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% last year to 38.4% of all recorded music revenue. Spotify is also working to provide a route to market for smaller artists, developing tools to help them thrive.

There are opportunities to upsell too. Over half of Spotify listeners are low revenue, ad-supported customers and the group is dabbling in non-music audio with the expansion into podcasts. Transferring users onto subscriptions and grabbing more listeners offer more potential growth drivers.

The path to profits isn't without pitfalls though. If Spotify can't deliver the required growth, the virtuous circle of higher revenues, lower costs and improved cash flow will break.

Competing with the likes of Amazon and Apple is no small ask, while the launch of discounted student and family packages has hit average revenue per user. There's also been teething problems around staff recruitment, and R&D spend is ramping up.

Nonetheless, we think Spotify's well positioned in the long term. It's got increasingly direct access to content producers, relatively low and flexible costs, and a roll-out story that should help it leverage the benefits of scale.

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Full Year Results

Spotify's full year revenues rose 28.6% to EUR5.3bn, with growth in revenue from both Premium subscriptions and the Ad-Supported businesses.

However, a shift towards cheaper Family and Student subscriptions and lower margin markets mean underlying average revenue per user fell 6% in the fourth quarter. However, looking at the lifetime value of subscribers, that movement was largely offset by reduced customer churn. Ad-Supported revenues benefitted from the sale of products measuring ad effectiveness.

Good cost control across the year means full year operating losses moved from EUR378m to EUR43m. Lower losses meant free cash flow for the year nearly doubled to EUR209m. The group finished the year with EUR1.8bn in cash and cash equivalents.

Alongside results Spotify has announced the acquisition of Podcast producer Gimlet media and Podcast developer platform Anchor. The group expects to spend a total of $400-$500m on acquisitions across the whole of 2019 - including but not limited to the Anchor and Gimlet deals.

Spotify expects solid growth in MAUs, premium subscribers and revenue next quarter and for 2019 as a whole, but expects to return to an operating loss, impacted by costs associated with the acquisitions announced today.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.