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Spotify - revenues in line but losses worse than expected

Sophie Lund-Yates, Equity Analyst | 29 July 2020 | A A A
Spotify - revenues in line but losses worse than expected

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Spotify Technology S A EUR0.025

Sell: 250.90 | Buy: 251.09 | Change 1.40 (0.56%)
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Spotify's second quarter revenue rose13% to €1.9bn, reflecting a 27% rise in premium subscriptions to 138m - broadly in line with market expectations.

Operating losses widened to €167m, from a loss of €3m this time last year - worse than the market's expectations of a €63m loss. However, this was driven by higher than expected social taxes incurred from the increase in Spotify's share price. Without these charges, the operating loss would have been better than Spotify expected.

The group expects total revenue of €1.85bn - €2.05bn and operating loss of €70m - €150m next quarter, but remains mindful that coronavirus disruption means this could change.

The shares fell 2.8% 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. Advertising revenue continues to 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.

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. Monthly Active Users (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.

And we can't predict right now how long it's going to take for advertising spending to right itself. The group is cautiously optimistic for the full year, but it would be a mistake to think that these predictions are guaranteed to come true.

Crucially, we think the current disruption could delay the journey to sustainable profit growth, but it hasn't been derailed. 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. Investors should keep in mind though that there are likely to be near-term ups and downs.

Spotify key facts

  • Current forward 12m price to sales ratio: 4.8
  • Average 12m forward price to sales ratio since listing (2018): 3.4
  • Prospective yield: Spotify doesn't currently pay a dividend

We've introduced this section in response to recent survey feedback.

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Second quarter results

There was a 29% increase in monthly active users (MAUs) to 299m. Within that premium subscribers generated €1.8bn of revenue, an increase of 17%. Ad-supported MAUs rose 31% to 170m and this fed into ad-supported revenue of €131m - 21% lower than last year.

The increase in premium subscriptions was driven by Family Plan, as well as regular promotions such as "three months on us". Churn improved year on year, which was again helped by Family Plan as well as student plans, which have higher retention levels. The mix of products meant average revenue per user (ARPU) of €4.41 was down 9%.

Although lower, ad supported revenue was better than Spotify's forecasts. The slowdown reflects lower advertising spending in the wake of the coronavirus crisis, but "performance in the month of June showed significant improvement".

Overall global listening hours are back at pre-pandemic levels, apart from Latin America which is about 6% lower than peak levels.

Gross margins of 25.4%, compared to 26.0% last year. The decline reflects higher spending on content, which was partially offset by efficiencies elsewhere.

Lower profitability meant total free cash flow was €27m in the quarter, a €23m decrease. However, Spotify continues to think it can deliver positive free cash flow for the year. Spotify said it had access to €1.8bn in cash and cash equivalents at the end of the second quarter, and is currently debt free.

Find out more about Spotify shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. 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.