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Spotify is a great product. After 18 years, the music streaming pioneer is finally showing that it could be a great business too.
The Swedish company dominates audio streaming, with 626mn monthly active users worldwide. But profitability had long been elusive. Until now. Spotify last week posted its second consecutive quarter of profit. Net income was €274mn compared with a loss of €302mn in the year-ago period. It could manage its first ever full-year profit.
The stock has more than doubled over the past 12 months. The excitement is understandable. The €1.3bn in forecast net income this year is a nice change of pace from about €4bn in net losses the company has racked up over the previous eight years.
Even so, at 41 times forward earnings, the stock looks rich. Spotify faces limits on how fast it can increase profits.
The company has embarked on aggressive cost cutting. It announced three rounds of lay-offs last year, including plans to cut nearly a fifth of its workforce back in December. It has dialled back its podcasting ambitions after spending heavily to expand. The moves have helped bring operating expenses down 16 per cent year on year during the second quarter to €846mn. Gross margins rose more than 500 basis points to 29.2 per cent.
This cannot be repeated every year. Its biggest cost centre remains song royalties and fees to artists. Cost of revenue — a proxy for these payments — rose 12 per cent to €2.7bn during the second quarter. Recent changes to the way Spotify pays out royalties have already prompted outcries and a lawsuit.
The good news is that Spotify’s price increases are paying off. The company has raised prices for its premium subscribers twice in the past 12 months. Users have shrugged it off. Spotify ended the second quarter with 626mn monthly active users (MAU), a 14 per cent increase from the year-ago period. Within this, the number of paid subscribers was up 12 per cent to 246mn. The remaining users are on free accounts that are supported by advertising.
Spotify faces a delicate balancing act. Results from Universal Music Group suggest Spotify has extended its lead over Apple and Amazon. But its premium subscriptions now cost more than those of rivals, giving it less room to increase prices further. There is talk of a new ultra-premium tier for diehard audiophiles. It could also do more to boost ad revenues. But it will be tougher to keep singing the profit song without users tuning out.
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