The world’s biggest music streaming service Spotify [SPOT], used by 180m listeners across the world and with a market cap of $25bn, has announced its earnings for the third quarter of 2018.

The company largely performed in line with its own expectations in Q3; revenue was $1.54bn, up 31% year-on-year and slightly edging analysts’ expected $1.5bn. Premium revenue was $1.37bn, up 31% year-on-year. It was also the first profitable quarter for Spotify. The company earned an adjusted $0.26 per share when analysts had expected a loss of $0.41 per share. But with weaker-than-expected growth forecasted going forward – including a projected return to loss making – and a slip in average revenue per user due to ongoing promotions, Spotify stock was sharply down by as much as 10% as the markets opened on Thursday, following the report.

 

Revenue percentage change, Q3 YoY+31%
Performance over last 3 months, 2018-22.8%
Market cap$25.4bn

Source: Yahoo finance, as at 2 November 2018

 

The results were generally good in terms of subscriber growth. The music streaming service had expected to increase its monthly active users (MAU) to between 188-193m, a 25-29% year-on-year increase, and for premium subscribers to rise to 85-88m, a 30-37% increase. In actuality, the number of MAU grew 28% year-on-year to 191m at the end of Q3. Premium subscribers increased to 87m. The company expected total revenue of around $1.36-1.59bn – up 17-36% on 2017 Q3. The $1.54bn revenue it accrued in that time hits the upper band of its expected earnings. 

Spotify went public by direct listing at a value of $30bn in April of this year, for $165.90 per share. In the run up to earnings the company had hit an all-time low of $139.11 on Monday, before rebounding to the $149 mark. Over the past three months, Spotify stock has fallen by more than 25%.

!*!*!NASDAQ interactive chart, as at 2 Novemeber 2018

 

The Swedish tech company, founded in 2006 and launched globally in 2008, now employs over 3000 staff. It generated $1.5bn in revenue in Q2, up 26% on last year. The company has however been hit hard by the tech sell-off through October. Last quarter it missed expectation on earnings per share (EPS) by $2.72.

 

New avenues for growth

Spotify has benefitted from expansion into new markets and an increase in premium service users, now numbering 87m. In the second quarter, the company implemented a new affordable family plan aimed at hooking more users on to the paid-for service (the primary means by which the company earns money), which seemed to have worked, though average revenue per user (ARPU) fell 12% year-on-year. In Q3, ARPU was $5.39, a 6% decline, a particular sticking point for investors. 

It did however grow 4% over Q1. Thanks largely to Spotify's biannual campaigns to drive growth and user sign-up with the premium service, its active users grew 30% year-on-year in Q2, powered by strong results in South America and other developing markets. 

Mid-year figures revealed by Midia showed Spotify had a 38% market share, double that of nearest challenger Apple Music with 19%. Amazon Music are third with 12%, while Pandora and Tencent Music followed. A tax benefit related to an investment made by Spotify into Tencent is widely seen as the reason for the company’s profitable status in Q3.  

Morgan Stanley was bullish on its rating of the stock prior the earnings release, defining it 'overweight' last week, based on the large and growing global market for streaming. 

 

Future stock movement 

Despite its already far reach, there should still be user growth opportunity for Spotify. The global music streaming market is expected to grow at a compound annual growth rate (CAGR) of 19.8% between 2018 and 2026, according to Persistence Market Research. The market is projected to be worth $33.5m by 2026, with the report citing decreasing data charges and increasing internet speeds. 

Growing consumer spending power and adoption of advanced consumer technology in nations like China as will increasing awareness against the use of pirated music, will also likely aid Spotify in the search for new growth opportunities. 

However North America remains the biggest, most dominating market, due to its large population, widespread 4G and high-speed broadband near universal. Apple Music, Spotify’s greatest competitor in that market, may well show signs of further encroachment into Spotify’s dominance when it announces its Q3 earnings report.

A lingering fear that Spotify will be unable to maintain its growth may be playing some part in its share price decline. The company admitted in its Q3 report that its partnership with Google, where it will offer Google Home Mini speakers to people on its Family plan as a Christmas promotion, ‘will have an adverse impact of approximately 50 basis points on our Gross Margin profile in Q4’. Investors appear to be growing tired of the company’s constant reliance on promotions.