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Spotify - premium subs beat guidance, profit disappoints

Sophie Lund-Yates, Equity Analyst | 3 February 2021 | A A A
Spotify - premium subs beat guidance, profit disappoints

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Spotify Technology S A EUR0.025

Sell: 251.54 | Buy: 251.55 | Change 7.85 (3.22%)
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Spotify's fourth quarter revenue rose 17% to €2.2bn, with monthly active users rising 27% to 345m. This was at the top end of management's guidance range. The number of premium subscribers (who pay to use the ad-free version of the service) rose 24% to 155m, which exceeded management's expectations.

Spotify reported an operating loss of €69m. This reflected higher than planned operating expenses, relating to payroll taxes linked to the group's share price performance.

The shares fell 5.8% in pre-market trading.

View the latest Spotify share price and how to deal

Our view

Subscriber numbers are the most important metric to watch at Spotify. Coronavirus hasn't disrupted the stream of new listeners, so we think the long-term attractions remain in play.

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.

This modus operandi remains intact. Monthly Active Users (MAUs) are still growing - faster than expected we might add- feeding the top of the revenue funnel. Some of that's being supported by less-lucrative promotions, 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. The company is working to provide a route to market for individual artists too, developing tools to help them thrive.

Unlike some rival streaming services Spotify is self-sufficient from a cash perspective. That means there's no need to rely on investors for new cash, giving it flexibility. It allows it to pounce on opportunity - like the recent Megaphone deal to help boost its reach in the mushrooming podcast industry.

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. And the continued promotional activities, weaker ad demand because of the pandemic, and increased popularity in less lucrative geographies, have hit average revenue per user.

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

  • Price/sales ratio: 5.5
  • Average Price/sales ratio since listing (2018): 3.6
  • Prospective dividend yield (next 12 months): 0.0%

All ratios are sourced from Refinitiv. 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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Fourth quarter results

Premium subscribers accounted for €1.9bn of revenue, up 15% on last year. The group saw growth in premium subscriptions across all regions, but this was led by North America (29% of subscribers) and Europe (40% of subscribers). Churn rate has declined compared to last year. Average revenue per user of €4.26 fell 3% once the impact of exchange rates is stripped out. That was driven by a less profitable mix of geographies, partially offset by reduced promotional activity.

Ad supported users made up the remaining €0.3bn of group revenue, growing 29% year-on-year.

The overall increase in Monthly Active Users was boosted by particularly effective marketing efforts in India. There has been increased engagement and demand for podcast material. There has been a "meaningful" increase in global consumption hours, compared to last year.

Gross margins rose almost 100 basis points compared to last year, reaching 26.5%. This was at the top end of guidance, and reflected reduced streaming delivery costs, payment fees and a beneficial shift to more podcast content. Operating expenses rose 17% to €644m.

Free Cash Flow fell €95m compared to last year, to €74m. That's because of the non-recurrence of favourable licence payment timing. Higher costs associated with increased podcast production also had an adverse effect.

The group had net cash of €1.2bn, compared to €1.1bn last year, as at the end of 2020.

To help expand its podcast reach, Spotify acquired Megaphone in December 2020 - the group said it's "one of the world's most innovative platforms for enterprise podcast hosting and monetization".

The group said "in 2020, we believe the pandemic had little impact on our subscriber growth and may have actually contributed positively to pulling forward new signups. From a revenue standpoint, advertising was negatively affected in the back half of Q1 and persisted throughout the rest of the year". Next quarter MAUs are expected to reach 354-364m, and operating losses are expected to be between €78m - €28m.

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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 Refinitiv. 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.