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Spotify - revenue beats expectation, ad growth slows

Third quarter revenue grew 21% to $3.0bn, beating analyst estimates.

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Third quarter revenue grew 21% to $3.0bn, beating analyst estimates. Growth was supported by Premium and Ad-Supported revenues, 22% and 19% respectively.

Monthly Active Users (MAUs) reached 456m, up 20% and slightly ahead of guidance. Premium Subscribers grew 13% to 195m.

Spotify generated an operating loss of $228m, driven by operating costs that were 65% higher. That compares to $75m profit last year. Spotify pointed to a ''softness in advertising'' as a contributing factor to lower margins.

The group expects to add around 23m MAUs in the fourth quarter, with total revenue of $3.2bn and an operating loss of $300m.

The shares fell 6.7% in after-hours trading.

View the latest Spotify share price and how to deal

Our view

Spotify has had a tough start to the year. And while third quarter results pointed to strong top line growth, pulling that down to help boost profits (or reduce losses as is the case with Spotify) continues to be a struggle.

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. Historically, a decent proportion of these users then ultimately become premium, or paying, users, boosting revenue and margins in the process. Though, that cycle's likely to come under pressure if consumer income's keep getting squeezed.

Finding ways to improve the profitability of its users is key for Spotify because the underlying cost model isn't supportive of margin growth. Spotify's variable cost base, with a large portion of costs coming from royalties paid to record labels and publishers, doesn't leave too much room for natural margin expansion.

There lies one of the toughest hurdles to overcome for Spotify, and the music streaming industry for that matter, which is the reliance of record labels for access to content. Labels can, in theory, push prices up as streaming providers grow the top line, meaning little of that growth falls into profit.

Spotify needs to grow premium users, as mentioned, or increase profits from advertising for those who'd rather listen for free. But, as we've seen in recent results across the industry, advertising spend looks to be coming under pressure as businesses rethink budgets in light of weakening economic conditions.

The other challenge facing Spotify is the lack of real barriers to entry to the market. Competitors with much deeper pockets like Amazon and Apple have the firepower to keep knocking on Spotify's door. Ultimately for listeners there's not much difference between the various products on offer, which means there's little in the way of pricing power on offer.

There are some positives though, unlike some rival streaming services Spotify is self-sufficient from a cash perspective - albeit only marginally. 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.

We still admire Spotify's 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. But we're a little more cautious than we have been in a while. Markets look to share that sentiment with the group trading hands well below its longer-term price to sales ratio.

Spotify key facts

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.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. 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 disclosure for more information.

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Written by
Matt Britzman
Equity Analyst

Matt is an Equity Analyst on the share research team, providing up-to-date research and analysis on individual companies and wider sectors.

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Article history
Published: 26th October 2022