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Spotify - promotional activity helps boost user numbers

Sophie Lund-Yates, Equity Analyst | 5 February 2020 | A A A
Spotify - promotional activity helps boost user numbers

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Spotify Technology S A EUR0.025

Sell: 184.06 | Buy: 184.25 | Change 2.44 (1.34%)
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Spotify's fourth quarter revenue rose 24% to EUR1.9bn, which was in line with market expectations. That includes a better than expected increase in monthly active users (MAUs).

However, social taxes incurred from the increase in Spotify's share price meant operating losses widened to -EUR77m, compared to +EUR94m last year. Without these social charges, operating losses would have come in slightly higher than forecasts.

The shares rose 1.1% in pre-market trading.

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Our view

Since its unconventional stock market listing in 2018, 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 this 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. Spotify is also working to provide a route to market for individual 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 recent foray into podcasts seems to be delivering impressive results. Transferring users onto premium subscriptions offers significant revenue upside.

Unlike other rival streaming services Spotify is self-sufficient from a cash perspective. With no need to rely on investors for new cash the group's been able to undertake sizeable share buybacks with its surplus cash - which would be a pipedream for the likes of Netflix who need every penny to generate new content.

The path to profits isn't without pitfalls though. If Spotify can't deliver the required growth, the virtuous circle of higher revenues, lower average costs and improved cash flow will break. Competing with the likes of Amazon and Apple is no small ask either, while continued promotional activities, including discounted student and family packages has hit average revenue per user.

Overall, 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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Fourth quarter results

MAUs grew 31% to 271m, outperforming the high end of guidance, thanks to a reacceleration of growth in Spotify's biggest geographies, helped by promotional activity.

Growth in Premium subscribers was better than expected, up 29% to 124m, helped by the expansion of the "3 months on us" offer to new Family Plan subscribers. Churn improved more than 0.8 percentage points. Total premium revenue rose 24% year-on-year, reaching EUR1.6bn.

Average revenue per premium user (ARPU) was EUR4.65, 6% lower than last year, reflecting the extension of the free trial period. Excluding the impact of Trials & Campaigns, ARPU would have declined 2%.

Ad-supported revenue grew 23% compared to last year, reaching EUR217m, but this was slightly lower than the group expected. That reflects a slower start to the fourth quarter due to technical issues in the traditional Direct advertising business.

Improvement in the non-royalty component of gross margin meant group gross margin was 25.6%, towards the high end of the guidance range.

The group generated EUR169m in Q4 free cash flow, which was helped by the timing of some payments. Spotify ended Q4 with EUR1.8 billion in cash and cash equivalents, restricted cash, and short term investments.

The group expects 279-289m MAUs next quarter, with an operating loss between EUR65m and EUR115m.

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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 disclosure for more information.