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Spotify - results better than expected

Sophie Lund-Yates, Equity Analyst | 27 October 2021 | A A A
Spotify - results better than expected

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Spotify Technology S A EUR0.025

Sell: 123.63 | Buy: 123.64 | Change 0.90 (0.73%)
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Third quarter revenue rose 27% to €2.5bn, reflecting 22% rise in Premium subscriptions and a 75% increase in ad-supported subscriptions. Operating profit was €75m, compared to a loss of €40m this time last year - better than management expected.

Spotify maintained guidance for next quarter, and expects operating losses of €152m - €72m.

The shares rose 1.1% in pre-market trading.

View the latest Spotify share price and how to deal

Our view

We've been surprised - in the right way - by Spotify's ability to grow monthly active users (MAUs) in the third quarter.

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.

Spotify's business is very scalable. Extra subscribers should help it exit loss-making territory on a sustained basis. 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.

Performance is being helped by an about-turn in advertising revenue too. The pandemic saw marketing spending in the firing line, as companies hunkered down for the storm, but corporate wallets are appearing from the parapet once more.

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 on a sustained basis, 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 keeps a ceiling on Average revenue Per User.

The biggest question mark is around short-term demand patterns. There's a debate to be had about whether increased work-commutes, or stay-at-home orders are the better catalyst for demand for Spotify. We happen to think it's the former, which if true, could mean Spotify's growth will depend on the outcome of government responses to rising Covid cases.

We continue to think 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: 3.7
  • Average Price/earnings 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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Third quarter results

There are now 381m monthly active users (MAUs), a 19% increase on the same time last year and at the top end of Spotify's guidance range. 220m of these use the free, advert-supported version, and 172m are paying for the ad-free premium subscription. There was double digit MAU growth in every region.

Within Premium, there was a 22% increase in revenue, to €2.2bn with average revenue per user (ARPU) of €4.34, which was up 4%. New promotional partnerships were signed in the quarter, including Spotify pre-loads on some Nokia smartphones, plus free trials in partnership with a large South Korean telecom.

Ad-supported revenue rose 75% and reached €323m, which was better than expected. The group said "the strength in advertising was broad-based across all sales channels, with the United States and United Kingdom meaningfully exceeding expectations". There was double digit growth in the existing Spotify Podcast Studios.

Operating expenses were €593m, up 12%. Expenses relating to payroll taxes linked to the group's share price performance, were lower than expected.

Free cash flow was €4m lower at €99m. That reflects an increase in money owed to Spotify, podcast costs and licensor payments. Spotify had net cash of €3.3bn at the end of September.

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 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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