Spotify Q1 18 – Law of large numbers

Reply to this post

Only scale slows growth.

• Spotify reported maiden results that met expectations but disappointed the speculators who have driven the stock up since the IPO on the hope that a rabbit would be pulled out of the hat.
• As a result, some of the speculative premium was lost as these investors are now certain to exit.
• Q1 18 revenues / EBIT was E1.14 / LOSS E49m compared to consensus at E1.14bn.
• Spotify reported 170m MaU of which 44% or 75m are premium subscribers paying a monthly fee.
• Despite the good results, I suspect that it was the slowing growth in the outlook which spooked the speculators but I see this simply as the law of large numbers.
• Spotify is still adding subscribers at around 2m per month but as the subscriber base gets bigger, growth is inevitably slowing.
• This was clear in the guidance where premium subscriber growth is expected to slow to 34%-41% YoY from the 45% YoY seen in Q1 18.
• I see this as nothing more than a normal development as Spotify has been steadily adding subscribers at this rate for considerable time and not much has changed to alter that trajectory.
• All focus remains on the paid subscribers, but I think that it is the paid and the free subscribers together that are responsible for Spotify’s leadership.
• This is because the free subscribers act as a great funnel for adding paid subscribers, but most of all, Spotify is getting data from all 170m users.
• It is this data that allows Spotify to be able to refine its algorithms and improve its ability to categorise music as well as recommend it to users with increasing levels of accuracy.
• I have long believed that this is what will allow Spotify to eventually go directly to the artists and cut out the labels.
• This would have a substantial and positive impact on Spotify’s gross margins as well as the artist revenues.
• This is because I have long seen the labels as the main reason why music streaming is so unprofitable for both streaming companies and artists alike.
• However, this is going to take a long time to materialise and in the meantime, margin improvements are likely to be incremental and derived from scale benefits and operating leverage.
• Hence, although the long-term outlook remains pretty good, the short-term valuation remains high and I can’t blame anyone for thinking of taking money off the table.