Breakingviews - Spotify has bigger issues than slower growth

Headphones are seen in front of a logo of online music streaming service Spotify in this February 18, 2014 illustration picture.

LONDON (Reuters Breakingviews) - Skilled composers keep an audience interested by leaving unresolved tension in the music. Spotify Technology Chief Executive Daniel Ek has pulled off a similar trick with investors, having presided over a soaring share price despite failing to address the Swedish music-streaming group’s conspicuously low profit margins. It won’t work forever.

The main issue preoccupying Spotify shareholders in recent years has been growth. How quickly is the $60 billion company signing up new customers, and how much will they pay? Ek’s expectations for the year ahead, released on Wednesday, proved disappointing.

The recent surge in subscribers, probably aided by pandemic lockdowns, will slow. Spotify envisages having 178 million paying users by the end of 2021, using the midpoint of its forecast range. That implies signing up 23 million net new users; well below the 31 million the company gained last year. Ek’s revenue forecast, again using the midpoint, is 4% lower than the median analyst estimate compiled by Refinitiv. Spotify’s share price duly fell 8% on Wednesday morning, though it’s still more than doubled in the past year.

Focusing on user growth obscures a bigger problem: costs are growing roughly as fast as revenue, ensuring profitability remains a distant dream. Based on Ek’s 2021 expectations, direct expenses like song royalties will consume about three-quarters of revenue, while marketing and overheads will be between 27% and 28% of sales, pushing the company into another operating loss. That’s basically the same picture as 2018, when Spotify listed its shares in New York.

The lack of progress on slashing licencing costs and other expenses doesn’t seem to have bothered investors so far. Back in February 2019, the median analyst forecast envisaged an operating profit this year, according to Refinitiv data. Now, based on Ek’s guidance, the company could lose as much 300 million euros.

Yet that dynamic cannot last indefinitely. There’s limited value in signing up millions of new users if the company doesn’t reap any financial benefits from being bigger. Investors have so far ignored that central tension by focusing almost exclusively on the top line. Perhaps as growth slows, Spotify’s underlying cost problems will finally get the airing they deserve.


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