Spotify 2020 Q4 Earnings Overview
Summary
In this letter I’ll be reviewing Spotify’s fourth quarter results in the context of a year where a large amount of uncontrollable factors have influenced the business. I’ll be taking a look at the market opportunity present, the risks inherent to their business as well as some of the interesting aspects of innovation on display.
That being said, Spotify continues on its mission of being the world’s no.1 audio platform for music and ‘exclusive non-music content’. The macro shift in consumer behaviour from linear to ‘on-demand’ consumption will be a huge factor in the success moving forwards. Combining this with the strong revenue growth, user growth and increased expansion – I can safely say that I am very much bullish about Spotify.
Key Stats
In the last year alone the company has tripled the number of podcasts on the platform – from around 700,000 in Q4 2019 to 2.2 million today
25% of MAUs engaged with podcasts (up from 22% in Q3)
Market Cap of $60 billion
Total MAUs grew 27% y/y to 345 million in Q4 2020, and by 25 million since last quarter
Revenue of €2,168 million grew 17% Y/Y in Q4 (or 24% Y/Y)
Premium revenue growth of 15% y/y to €1,887 million
Indicator of purchasing power - raised price in 7 geographies with no meaningful impacts on churn/customer intake.
Before we start, and as outlined in my previous Spotify overview – I want to offer a very brief history of music and the various technologies used to be able to add context to the current market.
Music History
Pre-1850’s
Before we had the ability to record music, it always had to be live. I.e. in order to hear a musician’s work, you would have had to physically travel to the nearest village. In addition – the duration of a song was not capped. This led to the ‘not-so-surprising’ fact that classical music tends to last a much longer time than your standard modern song. Over time, however, this changed…
1850’s
In the mid 1800’s when the flat record came about, it standardised around the 78 (78 rotations p/minute). This came in two sizes – a 10 inch version, limited to approximately 3 minutes, and a 12 inch version which was limited to 4 minutes. For the first time in human history, music had a standardised duration.
This was later solidified in 1948 with the 45 RMP Vinyl single, which had about 3 minutes duration.
1927 to 1950
The launch of the radio broadcast in 1927 allowed people from across the country to listen to audio at very minimal cost.
Following this, the 1950’s resulted in the transistor radio – making this a portable experience too.
1982
The year 1982 saw the introduction of the CD, with ABBA being the first popular release. As you can see from the above graph, the CD encouraged personal consumer spend on music, which rocketed from $10 billion to $22 billion – with the peak in the year 2000.
2003
Fast-forward to 2003 and we have the launch of iTunes, which totally revolutionised how we consumed music and the business models behind it.
Apple were the first to de-construct an album into its respective tracks to be bought individually. In doing this, Apple were penalising artists for bundling multi-part songs into one track – e.g. Pink Floyd’s Dark side of the Moon.
This model encouraged the introduction of pirate sites such as Napster and Pirate Bay, which were a necessary pre-courser to the current streaming services we have now.
Then along came streaming…
2008 onwards
Somewhere around 2008/2009 Spotify launched its streaming service, bringing with them an all new way of listening and arguably an all new business model – consumers had ongoing access to all music ever created, whenever they wanted. This was never before possible.
Market Opportunity
Grand View Research values the global music streaming market size at $20.9 billion in 2019, growing at a CAGR of 17.8% from 2020, reaching $77.5 billion by 2027.
Research and Markets values the audio streaming market to be $26 billion in 2019 and projected to reach $46.9 billion by 2027
Statista values the music streaming market at $23 billion in 2021, with a CAGR of 9.7% to reach $50.1 billion by 2027
From the above research, we can take an average and estimate the TAM (total addressable market) for audio streaming in 2027 to be worth roughly $58.1 billion. Considering the current revenue for 2020 of $7.8 billion, there is absolutely room to grow in a significant way.
Another good proxy for growth is to look at the growth in Monthly Active Users (MAUs) which should give a good indication of demographics the company are expanding into.
Total MAUs grew 27% y/y to 345 million in Q4 2020, and increased by 25 million since Q3. This is supplemented by healthy double-digit y/y growth across all regions. On top of this, net additions to the platform grew by 16% to 74 million – a record number of new additions.
Monthly active users consists of two camps – Premium subscribers (155 million), and Ad-Supported users (199 million), with premium subscriber’s revenue making up 87% of revenues (down 3% from Q2 2020). This indicates either the Average revenue per user for the premium subscribers is falling or that Spotify are getting better at monetizing their Ad-supported segment.
It’s useful to point out that with 345 million monthly active users, there is still plenty of room for growth considering the target market is ‘global’. For example, if Spotify can successfully target territories such as India (where there are currently about 1.3 billion people) we can look forward to increased growth moving forwards.
How does Spotify win?
For this part, we need to use our imagination a bit.
Part of the problem with Spotify as a company at the moment is the fact they don’t produce any net profits in addition to the fact that their margin is relatively low for a software company (26%). The majority of the reason for this is due to the vast fees (about 70%) they pay out to the ‘big three’ record labels in order to use the record label’s IP on the platform.
In order to tackle this problem and one day be in the position to increase their gross margin, Spotify need to create leverage over the record labels. One way to do this will be to acquire so many worldwide users and so many exclusive artists/podcasts that Spotify’s leverage trumps that of the record labels. At this point, Spotify itself will almost become a major record label.
Once this shift happens, Spotify will be able to reduce a large chunk of their operating margin in order to become a profitable company. Below is a nice summary:
Spotify is starting to consistently beat these record labels in terms of revenues. So we might be in the beginning of this thesis playing out.
Podcasting
2.2 million podcasts (+16%) from Q3.
25% of MAUs engaged with podcasts (up from 22% in Q3)
Podcast consumption hours nearly doubling since Q4 2019
As mentioned before, Podcasting will become an increasingly important aspect of the company’s overall strategy, and with that – investments in originals and exclusives are creating more reasons for users to choose Spotify whilst creating significant differentiation from competitors.
In the last year alone the company has tripled the number of podcasts on the platform – from around 700,000 in Q4 2019 to 2.2 million today. In addition, the number of podcast users on Spotify has also significantly grown (25% of all MAUs).
It’s difficult to say exactly when the compounding effect of these initial investments will start to pay off – however the future of podcasting looks to be promising and a crucial aspect of the overall plan.
Acquisition
Spotify Acquired Megaphone on Dec 8th in a concerted effort to grow audio monetization. Megaphone is one of the world’s most innovative platforms for enterprise podcast hosting and monetization. This acquisition makes sense as it gives Spotify the ability to enable SAI technology (Streaming Ad Insertion) across the platform whilst making it available to third-party publishers, thereby growing the pool of targetable podcast inventory for advertisers.
Financials
Revenues
Average Revenue per user is a useful metric to use in order to ascertain the efficiency with which Spotify are able to monetise the two sets of customers.
ARPU at €4.26 in Q4 (down 8% y/y) – somewhat due to increased geographical mix + reduced promotional activity.
Revenue of €2,168 million grew 17% Y/Y in Q4 (or 24% Y/Y)
Premium revenue growth of 15% y/y to €1,887 million
Ad supported revenue strong with 29% growth y/y (€281 million), exceeding expectations
Raised price in 7 geographies with no meaningful impacts on churn/customer intake.
Guidance exceeded here for the most part barring the ARPU figures. It’s encouraging to see the steady revenue growth at Spotify, with both premium and ad-supported streams making significant gains. It’s also encouraging to observe the effects of their pricing power (mainly down to the strong core product) which is demonstrated by the recent price rise with little to no negative implications on the churn rate/new customer intake.
Margin
Margin increased to 26.5% in Q4 up from 24.76% in Q3, beating estimates. This was mainly down to the improved cost of revenue efficiencies, a favourable revenue mix shift towards podcasts, and a change in estimated music royalties that were partially offset by higher non-music and other content costs.
Ideally, for a software company you won’t be overly pleased with the relatively low margins here. However, for the near-to-mid-term future of the business we will likely see margins hovering around the 25%/26% mark until the leverage over record labels and moat really starts to build.
Expenses
Operating expenses increased 17% y/y to €644 million in Q4. This was mainly due to higher ‘social charges’ (+622% from €9 million to €65 million) which are essentially ‘payroll taxes associated with employee salaries and benefits, including share-based compensation’. Sweden accounts for the bulk of the social charges.
Throughout 2020, the increase in overall expense as a proportion of revenue was up by 1% to 75%. From a quick glance at the financial statement, this was driven mainly by an increase in spend on R&D. This makes sense taking into account the strategy to get as many new customers as possible.
The total workforce as of Q4 2020 was 6,554 full time employees.
Cash
€74 million in Q4, a €95 million decrease Y/Y
2020 included higher podcast-related payments
€1.8 billion in cash and cash equivalents, restricted cash, and short term investments and no indebtedness
Innovations
Taken directly from my last article as this part is unchanged:
Consumer behaviour
The change in business model from ownership of physical copies to streaming meant for consumers there was no longer an additional 99p marginal cost to consuming more music – therefore making their choice of music more adventurous. Which, in turn, should encourage more diversified (niche) artists to emerge and make a living from music.
E.g. A large amount of people listen to music as they sleep, which they probably wouldn’t do (or do less frequently) if there was a real marginal £ cost behind it.
Business models change your behaviour. Which is interesting.
Piracy
Piracy is very prominent in the software space, as somehow it is seen as ‘wrong’ in some way to charge for pixels on a screen (one’s and zero’s).
I remember a time where I was pirating almost everything. Thinking back, this was mainly due to the fact I was a kid with almost no money, which made me feel like I wasn’t able to access the vast array of music/movies/TV shows available on the internet.
The subscription model of Spotify (and now other software companies such as Adobe) means all the content was now so much more accessible and as a consequence has almost completely eliminated the need for piracy, as these products are so much more convenient.
Use of AI and Machine Learning to drive song predictions
One of the most undervalued parts of Spotify’s new service is the rich level of data provided by the users - not only in the ‘user data’ on songs and podcasts (when people pause or skip, how long they listen etc.), but also in the playlists people have created.
This quantity and quality of data allows Spotify to do really clever things with individualised predictions. Which is part of the reason why the ‘discover weekly’ service is so good.
Spotify are not only allowing us to listen to all the music we would ever want to listen to, they are also enabling us to explore and discover new music in an extremely efficient way.
Marketing
Spotify have had some of the most successful marketing campaigns and strategies over the last several years. For example the partnership with Google nest mini and Spotify’s own ‘end of year review’ stand out as particularly creative.
These campaigns have two main uses – to drive more people towards becoming a paid subscriber, and to get people to share on social media (creating essentially ‘free’ or very low cost advertising).
Risks
High levels of quality competition within the audio space could see Spotify lose their dominant advantage.
Labels have too much power
While it’s definitely true that at the current time the major record labels have the superior economics within this industry, the music industry is rapidly shifting. And it could be argued that Spotify are in the better position long-term.
Operating loss
Spotify are yet to announce net operating profit due to low margins stemming from the record labels. This needs to change at some point.
Penetration of new market relies on partnerships
Strategic partnerships are key (such as Samsung in Korea) in order to effectively penetrate into global markets.
Can they expand at scale
The past couple of years has seen Spotify expand rapidly, adding huge numbers of users to the platform. This growth needs to continue in order for Spotify to be successful in their goals.
Conclusion
Overall, it’s clear Spotify are still in the early days of building the business to be able to scale globally, which is an incredibly ambitious goal. The company are doing all the right things in terms of investing into podcasting, penetrating into new markets and acquiring high-quality synergistic companies in order to make this happen.
As mentioned before, their future success does rely on the effectiveness with which they are able to expand into global markets. For example, South Korea – an already mature market with plenty of competition. In this case, Spotify are relying on their strategic partnerships with companies like Samsung to assist in gaining significant market share.
However, I will point out that this business is by no means a sure bet. The competitors in the industry (Apple Music, Youtube Music and Amazon Music) all have incredibly deep pockets.
Q4 and 2020 as a whole was a good period for Spotify as they were able to withstand and navigate the changing listening demands due to Covid-19, and in doing so were successful in achieving good results.
I’m excited for what 2021 has in store for Spotify and will be following closely.
For full disclosure, Spotify is currently about 8% of my portfolio. Looking to add on any further major dips.
Cheers,
Innovestor.
In case anyone wants to take a look, I have hand-picked several interesting questions in the earnings call for you below…
Questions & Answers
Q1 Pricing Power
And our first question today is going to come from John Egbert of Stifel. The high-end of your 2021 subscriber guidance suggests you'll add fewer net new subs this year versus 2020. You noted churn should decline in 2021, but do you expect the newly announced price increases to represent a material headwind to sub growth in 2021? What other factors should we consider here?
Daniel Ek -- Chief Executive Officer, and Chairman
Yeah. This is Daniel. Long-term, again, this is a multi-billion user opportunity and I'm as confident about that as I've ever been. As I mentioned in my opening remarks, all that said, we are facing a global pandemic and that pandemic has shifted all user behavior in 2020. And as I mentioned also, did create some pull-forward effect throughout the year, that means that there are more uncertainty throughout the year on what will happen to the subscriber growth. So, again, our forecasting means that we do the things that were only very, very certain that we will deliver upon.
Specific to the price increases, Paul can probably address that to a greater extent. But we've seen very, very positive response from the price increases in October and we believe that will be the same for the price increases that we just concluded.
Paul, if you want to add anything?
Paul Vogel -- Chief Financial Officer
Yeah. I would just add a couple of things. I think to echo what Daniel said, I think in 2020 we obviously had a very, very strong year. Daniel mentioned in his opening comments, we pull forward the Russia launch. So Russia was a meaningful impact in 2020. We had originally thought that we wouldn't really see meaningful impact until 2021. So that helped 2020.
And in hindsight, we didn't really call out any specific quarter where we thought the benefits of people being at home or the tailwinds of streaming were necessarily in any one quarter. But in hindsight, when you look at it, it's a little bit tough to disaggregate how much was just better execution on our part, how much was some pull-forward from kind of the tailwind that streaming had in general in 2020? But we do believe that each quarter probably saw a little bit of pull forward as well.
When you go back and look at where we started 2020 and where we ended, we finished about 4 million, plus or minus, above where we thought when we started the year. So, definitely, some better execution there, probably some pull forward based on the tailwind that streaming had, as well as the pull forward in Russia.
And then when you look at 2021, I would say, Daniel mentioned, I think there is a higher degree of uncertainty than we normally have. There's lots of initiatives. I would say, uncertainty isn't always a bad thing. There is lots of things that could break positively. And there are some things that could be more challenging, but they're just probably more of them in 2021 than we've experienced in years past and that's all baked into the forecast.
And then as Daniel mentioned, with respect to the forecast, we've always said to you guys, we will give you guidance based on what we actually think we're going to do, and that is what we've done this year as well. But that being the case, it really is a base case model of what we have a high degree of confidence that we will achieve, and it doesn't necessarily assume that we're going to have the upside in some of the initiatives, uncertainties where if they break positively, we could do better. So, again, we've given you a best case forecast and one that we feel that we have a high degree of confidence we will be able to achieve.
Q2 – Social element to music?
Bryan Goldberg -- Head of Investor Relations
Okay. And the next question is from Allen Hao of Hao & Company. When will Spotify add social element of the overall experience like Tencent Music? Apps like Clubhouse could have an interesting entry to audio and Tencent Music could be a good way to follow up in some regard?
Daniel Ek -- Chief Executive Officer, and Chairman
Yeah. We're very interested and, obviously, pay close attention to everything that's happening in the markets around the world and new developments in audio. I've said this many times before, but I think we're in the early innings of the innovation of the audio formats. And creator-to-fan interactivity is definitely one of those things that we're paying attention to and looking at. And we are conducting experiments on it already. But I don't have any sort of specific here to announce. But there are plenty more things to come in the coming months in this year as well when it comes to sort of creator-to-fan engagements as well.
Q3 – How to build subscriber base in new territories?
Bryan Goldberg -- Head of Investor Relations
Okay. Next question from Richard Kramer of Arete. In entering markets like South Korea what is your strategy for building a subscriber base, given that the market has six very well-established players?
Daniel Ek -- Chief Executive Officer, and Chairman
Yeah. We always take a large amount of time to try to analyze the markets and South Korea certainly not an exception to that rule. So, some would even say that we're late to the party in some markets. Russia was kind of the same dialogue, but we've been studying the market for many, many years and we're well aware that South Korea is a mature market and that it will take time for us to establish ourselves.
I think the key is the same thing that we do in pretty much every single market, we deeply and we try to understand the content that we have. In many of the domestic markets, we try to bring an International flair to it and bring the creative talents that we have from all of our creators around the world to that platform. I think we can definitely do a good job there. I think our strength in personalization will certainly play incredibly well in South Korea.
And specific to the South Korean market, we obviously have a lot of partnerships. For instance, with Samsung, which is a major player in South Korea. So that and the 2000 other devices that Spotify is on is the major contributing factor I think to why the user experience is better and why I think South Korean consumers are very excited about Spotify.
Q4 – Competition in podcasting
Bryan Goldberg -- Head of Investor Relations
Okay. Next question from Rich Greenfield of LightShed Partners. We've seen Amazon buy Wondery to integrate podcasts into Amazon Music and Apple appears to be gearing up to launch some form of subscription podcast product. While this is clear strategy validation, curious, how you expect it to impact Spotify and the ability to make acquisitions in the category?
Daniel Ek -- Chief Executive Officer, and Chairman
Yeah. I mean, what I would say is, I definitely do believe that and we're not surprised that something like audio that interest billions of consumers around the world also will catch the attention of the big companies because there aren't [Phonetic] very few spaces that have hours of most consumers time of day and reach billions of people at the same time. So, we're not surprised that this is happening. And we also do look at it as a validation that we're heading in the right direction.
Again, we did expect this, hence, why we have also been very aggressive previously with the acquisitions. Most of our strategy going forward, while we don't exclude any further acquisitions, it is about ramping the ability of our own production capabilities that we now have through all the studios that we have acquired.
And just to put that in a finer point because I think this is kind of one of the internal points that I use to our team most of the time. I believe about three years ago, there were fewer than 30 people at Spotify that were actively producing content, that ended up on our service in one way or the other. And that number now is, I would say, certainly during '21 will be closer to 1,000 people. So it's really a tremendous kind of shift as a Company and even our skill sets that we have. And we're looking to use some of those muscles that we have added to our roster throughout the last two years and create even more amazing content for our users to experience.
Q5 – Podcast advertising and utilizing acquisitions
Bryan Goldberg -- Head of Investor Relations
Okay. Next question from Rich Greenfield. There was a recent article about podcasters being disappointed in the Anchor's ability to deliver sponsorship with ads often for Anchor/Spotify. What happened and does this tie into why you bought Megaphone?
Daniel Ek -- Chief Executive Officer, and Chairman
Well, what I would generally say is, we're early on in our podcast platform monetization efforts. So most of the focus so far has been how do we get more great content on the service and the vast majority of podcasters on the service today are self-monetized. We have been experimenting with various forms of monetization, including, of course, the ability of one for podcasters to monetize themselves, but then our -- the Anchor monetization efforts that you mentioned and now also with Megaphone as part of that. We are very bullish on the opportunity to provide a meaningful way for podcasters to monetize through the platform efforts. And I hope to be able to talk a little bit more about what our plans are in the near future on that. But, again, lots of experimentation that you should feel comfortable that there is a lot in our capabilities and portfolio that I think we can bring to be amazing creators that are doing podcasts on the platform today.
Q6 - ARPU
Bryan Goldberg -- Head of Investor Relations
We've got a related question in the queue from Josh Le of Covenant Capital. You expect 2021 gross margin to be lower than the current level, while seeing premium ARPU improvement. Can you elaborate on content cost and podcast investments in 2021?
Paul Vogel -- Chief Financial Officer
Yeah. Let me address a couple of that. So, with respect to ARPU, I think we said is improvements in ARPU, up year-on-year. When you look at it on a -- on an FX-neutral basis, I think for the full-year, ARPU will probably roughly flattish. Currency is still a pretty big impact on our business. It's pretty material in Q1, as I think we wrote in the shareholder letter. So, it will still be down a little bit in the first half of the year. We do expect ARPU to increase sequentially throughout the year. But, again, because of currency, it probably still be slightly negative from a reported basis.
The second part of the question was just on gross margin in general. Yeah. I mean, I think there's always lots of puts and takes in gross margin. If you look over the last couple of years, we've sort of hovered between 25%, 25.5% gross margin. We do have some control on our investment to how much we want to spend and what we feel comfortable with respect to where we -- what are on the growth curve, where we want to continue to double down on spending. And so, I mean, there is a continued increase in podcast spending in 2021. The revenue against podcasting is growing very, very nicely as well. So we are seeing that. We're not quite at the point yet where the revenue is outpacing the continued investment. We are very optimistic that over time we will get there. But as Daniel mentioned, we're going to continue to invest and that investing has a compounding effect and a compounding benefit on the business. And so, that's where we're headed.