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Spotify - revenue in line, but full year guidance lowered

Sophie Lund-Yates, Equity Analyst | 29 April 2020 | A A A
Spotify - revenue in line, but full year guidance lowered

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Spotify Technology S A EUR0.025

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Spotify's first quarter revenue rose 22% compared to last year to €1.8bn, in line with market expectations. Premium revenues were better than Spotify had forecast, but ad-supported revenues fell short, particularly in the last three weeks.

Operating losses narrowed to €17m from €47m last year. That reflects lower social taxes incurred from the increase in Spotify's share price.

The group has lowered full year revenue guidance to €7.65-€8.05bn, reflecting a slowdown in advertising spending and adverse exchange rate movements. All other guidance remains the same, including operating losses of €150m - €250m.

The shares were broadly flat in pre-market trading.

View the latest Spotify share price and how to deal

Our view

Coronavirus is throwing up some roadblocks for this streaming giant.

Amongst these is lower advertising spending. March saw advertising revenue shrink, as marketing is one of the first things rubbed off company shopping lists when times get tough, and some of Spotify's booked business is cancelling or pausing its commitments.

Combined with some significant swings in exchange rates as a result of the outbreak, revenue expectations have been tempered for the full year.

But we think the long-term attractions remain in play.

For starters, Spotify's model depends on people signing up to its service, whether that's through a free trial, or the free-to-use ad supported service. A decent proportion of these users then ultimately become premium, or paying, users, boosting revenue and margins in the process.

And this modus operandi doesn't seem to have been upended. MAUs are still growing, feeding the top of the revenue funnel. Some of that's being supported by less-lucrative extended free trials, but on balance this is still a very positive step in the right direction.

Looking beyond the disruption the business should be very scalable, ultimately helping it to exit loss-making territory. More subscribers help lower operating costs as a percentage of revenue, which ultimately moves the company into profit.

More listeners improve 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.

It should also be remembered that unlike other rival streaming services Spotify is self-sufficient from a cash perspective - albeit it was free cash flow negative last quarter, but this is expected to turn positive again in the not too distant future. Overall there's no need to rely on investors for new cash, giving it flexibility.

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 the continued promotional activities like discounts and free trials have hit average revenue per user.

Crucially, we think the current disruption could delay this journey, but it hasn't been derailed. It's simply too soon to say what the extent of any delay will be, but it will depend on how long lockdown lasts and the rate of economic recoveries. Spotify is 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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First quarter results

There was a 31% increase in monthly active users (MAUs) to 286m, which was slightly better than analysts had hoped for. Overall MAUs grew faster this quarter compared to last year. European and US markets outperformed.

Since lockdowns began Spotify is seeing growth in people reactivating accounts, and consumption has started to recover in hard hit countries like Italy and Spain. There has been an increased demand for podcasts.

Premium subscriptions rose 31%, and there are now 130m. Growth was better than the group expected, driven by Family Plan. Churn increased slightly but this was in line with expectations, following higher promotional activity last quarter. There were minor impacts from coronavirus, with some increases in cancellations.

Longer free trials drove average revenue per premium user (ARPU) down 7%, ignoring the impact of exchange rates. ARPU stands at €4.42.

Ad-supported revenue of €148m was disappointing, and reflects advertising spending declines across all channels in March. Prior to the outbreak Spotify had been pleased with performance.

Gross margins were 25.5%, which was at the high end of the group's guidance range. The largest driver of outperformance stemmed from the core royalty component.

Operating expenses were €489m, which was 16% higher than last year, and includes a 34.3% increase in sales and marketing costs. The group will slow hiring for the remaining three quarters of 2020 and has reduced open headcount by roughly 30% from prior growth expectations, in response to efforts to lower costs in the current disruption.

Free cash flow was negative at -€21m, reflecting timing shifts in certain payments to licensors, and Spotify expects to be free cash flow positive for the year. There was €951m of cash and equivalents on the balance sheet, and Spotify has overall liquidity of €1.8bn.

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