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Spotify: Further Support for the Long-Term Thesis

A look at the company's 3rd-quarter financial results

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The Science of Hitting
Nov 05, 2020
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On Oct. 29, Spotify (

SPOT, Financial) reported financial results for its third quarter of fiscal 2020.

It was another quarter of impressive user growth, with Premium subscribers increasing by 27% year-over-year to 144 million subs and ad-supported monthly active users (MAU's) climbing by more than 30% to 185 million. In total, Spotify ended the quarter with 320 million MAU's, an increase of 29% from the year ago period and up 7% from the second quarter. As shown below, the company's total MAU's have nearly tripled over the past four years (led by higher growth in Premium subs).


Despite the 29% increase in total users, revenues only increased by 14% in the quarter, to 1.98 billion Euros ($2.23 billion). The discrepancy between user growth and revenue growth was attributable to two factors. First, currencies were a meaningful headwind in the quarter, reducing the growth rate by roughly 500 basis points. Second, the company continues to experience headwinds from product mix shift (lower average revenue per user, or ARPU, from Family and Duo plans), as well as a smaller impact from geographic mix (outsized growth in markets with lower ARPU's).

Gross margins in the quarter were 24.8%, down 70 basis points from the year ago period. Premium gross margin was 27.3%, up 40 basis points, while ad-supported gross margin was less than 1%, a decline of 1,200 basis points year-over-year (as a reminder, content costs associated with podcasts are 100% allocated to the ad-supported business). I don't want to get too hung up on short-term financial results, particularly in light of the fact that the company is still in the early innings of its podcast efforts, but this is honestly an area where the Spotify story gets tougher for me. User growth is greatly – but the ability to translate that into attractive long-term economics for shareholders is the real goal. Will the investments that Spotify is making in podcasts improve user economics through higher retention and / or higher ARPU's? I think they will, but it's still the early days – and there's also the very real possibility that competitors like Apple (

AAPL, Financial), Amazon (AMZN, Financial) and Alphabet (GOOG, Financial)(GOOGL, Financial) will try and replicate this strategy with their own original and exclusive podcasts. The path to true differentiation could be a difficult and costly one.

With that said, management has become more transparent about the impact of the podcast investments. For example, the number of MAU's engaging with podcast content was 22%, or 70 million subs, in the third quarter, compared to 14% a year ago. In addition, management disclosed that Original & Exclusive (O&E) podcasts like The Michelle Obama Podcast and podcasts from The Ringer Podcast Network accounted for 19% of all podcast listening in the third quarter (and if I understand how this metric is being reported, we should see another step up when Joe Rogan's podcast becomes exclusively available on Spotify by year end). Finally, average monthly Premium churn continues to improve, falling below 4% for the first time (an improvement of 89 basis points from the year ago period). All-in-all, I think continued growth in podcast consumption, and particularly Original & Exclusive podcasts, is an encouraging sign; it remains incredibly important to the long-term investment thesis.

Another interesting revelation this quarter was the company's decision to raise the price on its Family Plan in seven markets (Australia, Belgium, Switzerland, Bolivia, Peru, Ecuador, and Colombia). As CEO Daniel Ek noted on the call, the decision to raise prices ultimately comes down to the value that they are delivering to consumers, as well as competitive dynamics:

"Another benefit of the investments that we made in our content and user experience is that Spotify listeners are enjoying greater value than ever before. And we believe this presents two distinct opportunities. One, with about 60% of Spotify subscriber starting out in our free tier and our outperformance on MAU's in 2020, we are confident that we have a long runway to continue to grow our subscriber base in the months and years ahead. And two, long-term, if engagement and / or our listener value per hour is high, it gives us the ability to selectively increase our price… We've seen engagement and more specifically value per hour grow substantially over these past few years. And I believe an increase in value per hour is the most reliable signal we have in determining when we are able to use price as a lever to grow our business. And while it's still early, initial results indicate that in the markets where we test that increase in prices, our users believe Spotify remains an exceptional value and they have shown a willingness to pay more for our service. As a result, you will see us further expand price increases, especially in places where we are well positioned against the competition and our value per hour is high."

I would be fascinated to know how Spotify management sees itself on these metrics in a major market like the United States. My sense is that raising prices on the home turf of companies like Apple, Amazon and Alphabet is not something that Spotify will consider until they have a clear sense that their investments in podcasts, data / personalization, playlists and other areas have meaningfully differentiated them from competitors in the eyes of consumers. If I had to guess, I'd be willing to bet that Spotify will not try to raise prices in the U.S. within the next year.


When I wrote about Spotify last month, I stated the following:

"To justify today's valuation, you must believe the business will continue to report significant user growth for years to come, in addition to building a more attractive financial model that results in a step change in profitability (on both of those fronts, higher customer retention will be an important variable). Based on the research I've done, I'd say that outcome is more likely than not. Looking out over the next 10 years, I think you can paint a picture where Spotify ends up being worth more than $100 billion."

While it's important to not read too much into the results for any given quarter, I think what Spotify reported for the past three months provides incremental support for that conclusion. If they can deliver the trifecta of double-digit user growth, higher customer retention and higher ARPU's, the future will be very bright for Spotify.

For now, I'm still on the sidelines – but that may change before too long.

Disclosure: None

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