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Spotify - operating losses reverse

Sophie Lund Yates (Equity Analyst) | 28 July 2021 | A A A
Spotify - operating losses reverse

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Spotify Technology S A EUR0.025

Sell: 118.74 | Buy: 118.76 | Change -3.67 (-3.00%)
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Spotify's second quarter revenue rose 23% to €2.3bn compared to last year. That reflects a 17% increase in revenue from premium ad-free accounts, and ad-supported revenues more than doubling. However, monthly active user growth was slower than expected, largely because of Covid disruption, including the pausing of some marketing. A technical issue also impacted MAU growth.

Operating losses swung from €167m loss to profit of €12m. The group forecasts revenue of €2.31-€2.51bn next quarter.

The shares fell 1.6% in pre-market trading.

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Our view

Subscriber numbers are the most important metric to watch at Spotify. While the growth in Monthly Active Users might have disappointed slightly, in reality 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, helped in part by less lucrative, but increasingly popular non-music content like podcasts. Monthly Active Users (MAUs) are still growing, 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 is very scalable, meaning extra subscribers should help it exit loss-making territory on a sustained basis. 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 also working to provide a route to market for individual artists, 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 Megaphone deal to help boost its reach in the mushrooming podcast industry.

The path to long-term profit generation 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, and increased popularity in less lucrative geographies, have hit average revenue per user.

We were also disappointed by news of a technical glitch which made sign ups more difficult. That's not the kind of thing you'd expect to hear from a company that hinges its image on being at the forefront of slick user-design. This is fixed, but it's the kind of slip up we don't want to hear about again or questions could be raised about control and due diligence processes.

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: 3.6
  • Average Price/sales ratio since listing (2018): 3.7
  • 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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Second quarter results

The total number of monthly active users (MAUs) rose 22% to 365m. The group said "better growth patterns" were seen in the later part of the quarter. Europe accounts for just over a third of total MAUs, with the rest split between North America (24%), Latin America and smallest region, Rest of World.

There was a 20% rise in premium subscribers - now 165m, which was ahead of expectations. Average revenue per user was flat at €4.29, ignoring the effect of exchange rates. Ad-supported subscribers were up 240% to 210m, and revenue outperformed Spotify's forecast, largely due to r Direct and Podcast sales channels.

On a per-user basis, global consumption levels returned to growth in the quarter.

Operating costs rose from €534m last quarter to €651m, including a 30% increase in research and development spending. Despite this, higher sales meant operating margins are no longer negative, and stand at 0.5%.

Free cash flow was €34m compared to €27m last year, despite a €6m increase in capital expenditure. Spotify had net cash of €2.4bn compared to €1.2bn at the start of the year.

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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.

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