Spotify Q4 18 – Into the night

The labels won’t go quietly into the night.

• Spotify reported its first-ever profit and underscored its move into podcasts but the fall in the share price just serves to underpin the view that Spotify still has no real business in being a public company.
• Q4 18 revenues / EBIT were €1.70bn / €94m compared to consensus revenues at €1.71bn.
• Crucial to profitability is the improving gross margin which now stands at 25.8% (26.7% excluding the Q4 18 Google Home Mini promotion).
• This is largely due to Spotify having the critical mass to push back against the record labels who I have long suspected are the main financial beneficiaries of the rise of music streaming.
• In the long run, this is unlikely to be the case given that Spotify (and Apple Music) will have the possibility to squeeze the labels out of the music business (see below).
• User metrics were all healthy with total MaU of 207m (consensus 204m) and premium subscribers of 96m (consensus 95m).
• However, FY 2019 guidance was a little soft with revenues of €6.35bn – €6.80bn forecast against expectations of €6.70bn.
• This is largely due to the weakening of average revenue per user from the increasing popularity of the family plan (6 family users for a 50% higher subscription) and the student plan.
• At the same time, Spotify has also cemented its strategy in podcasts with the acquisition of Gimlet Media ($200m) and creation app Anchor.
• The idea here is very similar to Spotify’s strategy to squeeze out the record labels in that it will become an end to end creator, producer and distributor of podcasts.
• The default app on iOS has over 50% of the podcasting activity despite being present on just 14% of devices globally meaning that there is a significant opportunity especially on Android and outside the USA.
• This is what Spotify is going after but if it is also successful in creating popular content that is not available on the iTunes podcast app, then it could also take some share on iOS.
• Spotify’s destination is to become a vertically integrated one-stop-shop for all audio content.
• Spotify’s knowledge and understanding of its users are very strong making it more than capable of fulfilling the historic activity (music distribution) of the record labels.
• However, the road to this destination is going to be bumpy as the record labels are unlikely to into the night without a fight meaning that revenues and profits could bounce around.
• This will create a lot of share price volatility which is a major reason why I think Spotify should have waited to go public.
• The stock remains below its IPO price and as one of RFM’s true unicorns which is keeping its much larger and stronger competitor successfully at bay, it is one to consider for the long-term.