Spotify Technology S.A. (SPOT) Earnings Call Transcript & Summary

All right. Hello, everybody. Good afternoon. I'm Mark Mahaney, Head of Internet Research here at RBC. My colleague, Jeannette Lee will join me in interviewing Paul Vogel, the CFO of Spotify. Thrilled to have him. I got -- love the background with the fire going on, Paul. You've got it set up with the DJ -- podcasting mic. You are -- you play the role, man. So thanks a ton for joining us. We only got 30 minutes. If anybody wants to ask questions, there's already some that have gotten in here, so just throw questions in the Q&A box. We'll do our best to bring them in.

And Paul, I want to start off with you. This is, for good or for bad, I don't want to glib about it, the vaccine conference. So we've had 2 major pieces of news that suggest that we may be reopening cultures, societies, economies, et cetera. How do you think that -- does that have any meaning for Spotify? Did the COVID crisis have a dramatic impact on your business? Which parts of the business were most impacted and which least? So maybe answer that. And then whether the reopening is going to have -- should investors think about that having a material impact on your business?

Yes. Thanks, Mark, and thanks to everyone who's on the webcast listening. Yes, I mean, look, obviously, at very high level, vaccines are great. So I mean, I think we'd all be super thrilled if the economy starts opening up again and people are -- feel safe and secure going out again. So that obviously goes without saying. From our perspective, business has been really strong throughout the entire year. We've exceeded our expectations for users and subscribers from where we were when we started the year. So we've actually added about 8 million more monthly active users in the first 9 months of this year than we did in the first 9 months of last year, about almost 3 million more subscribers in the first 9 months of this year versus last year. So from a very high-level perspective, the pandemic hasn't really impacted our business. I think we've been really, really pleasantly surprised with how well we've continued to grow, both from a user perspective and a subscriber perspective. As we've talked about, the listening behavior has definitely changed, and we've talked about this. We've seen a lot more listening in home, in-home speakers. Game consoles have been really, really strong for us. And we talked about how car listening really dipped in that kind of March, April time frame. It's come back, and now listening in the car's back above. But even with listening in the car, people are in their car for shorter periods of time. They're not commuting as much. And what we've actually seen on the consumption side, while consumption, again, is back above pre-COVID levels, the midweek, so Monday through Friday, looks more similar to a weekend than it did in the past, right? So weekend, obviously, has a certain cadence to the day. And the normal work week has a cadence in terms of where you normally see really heavy commuter times in the morning and afternoon and how listening shifts. On a weekend, the listening tends to be more spread out throughout the day. And we've seen more of the weekdays look more like the weekends. Again, overall consumption is strong and back above COVID levels, but we have seen those types of changes.

I guess that's actually pretty bullish. You have this dramatic impact on how people traditionally access Spotify during their commutes, during their gym workouts, at the club or whatever. And -- but then, it seems like the service was -- the value proposition must be highly resilient, and people just figured out other ways to listen to their Spotify. I guess that's a huge takeaway.

Yes. I mean we feel really good about it. I think to your point, we -- so one of the things we've always talked about, we've talked about this all the way back to before we went public and the Investor Day, was ubiquity and, right, how being ubiquitous across as many devices and platforms as we possibly can is really what's helped drive Spotify. And so we're on over 2,000 devices. And so that ubiquity strategy has really lent itself to success, right? So as we said, we've seen really strong growth in game consoles. The new PlayStation actually has a Spotify button built into the media remote, which is great for us. We've seen integrations continue to move forward with Xbox as well. So we're seeing even more lean in from them and success on game consoles from us, which is great. There's -- you'd be surprised how many people want to listen to Spotify on top of the music or the noise that comes with a normal game, which has been great. Smart speakers have been great. So that's actually been really great. And then to your point, I think when things do start to get back to normal, getting people back out into gyms and commuting and cars is only going to be additive to where we are right now.

And then, Paul, there was one element -- part of your business though that was negatively impacted by COVID, your ad revenue. Like that really chunked down in the June quarter, latter part of the March quarter. And I think there's some very interesting things you're doing there. But that should be -- that should see a nice recovery for you. I'd assume it was negatively impacted, you would expect that to recover well going into next year.

Yes. I mean it was down pretty significantly, the ads business, in Q2. We saw a return to growth in Q3. Our expectation is we'll grow even faster in Q3 -- or I'm sorry, Q4 year-on-year than we did in Q3. We exited the quarter feeling really good about the business. We have some strength in podcast advertising, a lot of strength in our Ad Studio business, which is our self-serve tool, which we feel really good about. And so we feel good about where the ads business is. Obviously, we'll have to see. I mean, I think we're clearly not out of the woods yet with respect to the pandemic. And obviously, we've all seen kind of how the numbers have risen for the last couple of weeks and months both in the U.S. and in Europe. But in general, I think we feel pretty good about where we are from an advertising perspective.

Okay. I definitely want to ask you about podcast advertising and the Megaphone deal. But first, just the impact -- just remind us of the impact of podcasting on Spotify's subscriber behavior and MAU behavior. This is -- I don't know why, [ but this room is full of writers ], this has really become the year of podcasting. Maybe the year of podcasting was every year last couple of years, but it seems like you really hit an inflection point. So what impact has that had on your user growth, retention, engagement?

Yes. So it's been positive. And so I think as we've talked about, 22% of our monthly active users now engage in podcast, which is great. That's pretty much ticked up every quarter for the last 5 or 6 or at least as long as we've been reporting it. So that's really great. We're seeing people who engage with podcast and engage with more content. And in general, we believe that the higher you have -- the more engagement you have, the better you retain, the lower churn goes. Those are all things. We're still early enough kind of proving out all of the causality relative to correlation on some of those things we're still working to prove out, but we feel really good about sort of the health of what podcast is doing for the overall business and ecosystem at Spotify. So -- yes, so I think we feel like we're definitely moving in the right direction.

And then I'm going to ask you a simple question and a more specific question. Talk about how you monetize that podcast usage. There's probably some simple answers to that. And then how does Megaphone deal come in to help you maybe better monetize podcast usage?

Yes. So I would think about podcast in 2 ways, right? And so there's the obvious and then there's the not so obvious. Well, maybe not so obvious in that it's hard for you guys to sort of discern what's going on. So the obvious is simply like we have podcasts. The more podcasts grow, the more ad inventory there is to sell across podcasts. From a business perspective over the long term, it's a lot more fixed-price content, which is great for us. And so as we sort of grow it, we'll have the ability to grow advertising on top of a different type of cost structure, which is really interesting to us. And so for us, it's really about -- from that one side, it's what's the overall bucket of cost we're going to spend and what's sort of the advertising revenue. That's sort of the obvious side. And then the second side is sort of what you talked about in your first question, which is what does it actually do for user growth, what does it do for subscriber growth, how does it help with retention, how does it help with engagement. And those are all the things that we're working to track right now and to understand the value of each piece of content we put on the platform. What is that overall value to us? How can we measure it in both the concrete way of what does it drive specifically for advertising, but also what does it drive for new users, new subscribers? Do they retain more? And then when you really think about it, there's more nuance in that as well, right? So for instance, you could have a show that is great because it's incrementally driving people to the platform, right? So obviously, we have Joe Rogan, who's now on our platform. It's going to become exclusive to our platform in December. And so we've built in some expectations of new subscribers or new users who will come to our platform that previously weren't there but will come now because of Joe Rogan, right? So that would be an obvious one. But then you have the not so obvious, which would be, okay, what if there's someone who's already on our platform, wasn't really a fan of or didn't know they were a fan of a certain piece of content but now we have it. And so they didn't come to the platform because we have that piece of content, but because we have it, they've now found it and made their experience that much better. And so now that user is also going to retain higher or churn lower. So all of these components are how we think about measuring the value that each piece of content has to us on the platform. And the second part was on, I think, Megaphone.

Megaphone, yes.

Yes. So look, I think, for us, Megaphone is -- we're really excited about it. We think it's a way to accelerate our ability to grow our advertising business. By having incremental inventory, we think we're going to be able to sell more. We think we're going to able to lean in from a technology standpoint. We're going to be able to grow SAI, which is something that we've only offered on our owned and exclusive podcasts, out to a wider range of advertisers. And so we think it's just an accelerant to what we're already doing. We're super bullish on the technology we have and the products that we are developing. And now you throw on top of it all this additional inventory that we think we'll be able to help monetize in an even better way. That would be really good for the business. And we're optimistic also from a margin structure that this is something that will be helpful to the business over the long term as well.

And I'm sorry, dumb it down just a little bit, Paul, if not for investors, at least for me. The -- this accelerates SAI and accelerates inventory. Why? Just step back a little bit, a little more basic on Megaphone, the win here for you.

Yes. So obviously, they have a ton of inventory that they have from people whose podcasts they're hosting and sort of selling that rented inventory for. And so being able to add all of that into our ecosystem, we think, will really be great in terms of helping them grow their business even more, but then eventually adding like SAI into their platform, which will then be another tool, another way to target for advertisers that will both benefit the creators of content because we think it will monetize at a higher rate for them but also grow our overall ecosystem. We feel really good about the demand for podcast and podcast advertising on our platform. And so it's really not a demand issue for us right now on the podcasting side. So adding more supply into the ecosystem, we think, will be really beneficial.

Okay. All right. Let me switch gears a little bit and talk about pricing power. And -- oh, I know people who have been asking Spotify about this for years. And it seems like you've started to do a few price experiments recently. So just remind us or tell us what are these -- what are some of the pricing steps that you've taken recently? And do you plan to do this broadly globally? And do you think you have pricing power?

Yes. So -- well, obviously, we get this question a lot. And so we've experimented with pricing over the last couple of years. We've done a couple of very small ones, New Zealand obviously. I think a lot of people have heard about the test we did in the Nordics, where we saw very little impact on any of our metrics in a negative way. So those went really well. So we've now lead into an additional 7 markets, where we're going to continue to test and learn and think about where we can have pricing and where we have pricing power. And so for us right now, it's really trying to understand we have -- where we are in terms of some markets with respect to overall streaming penetration, where are we in terms of market share in those markets to really understand sort of the type of pricing power we have. That's number one. Number two is when you look at it from sort of a value per hour standpoint, we've added a ton of value into the Spotify ecosystem. We haven't really changed prices at all since we've launched. Our goal has and continues to be growing top of the funnel, right? So growing users and growing subscribers. But we also recognize that we've added a ton of value into the ecosystem. There might be some markets where we do feel like we're giving so much value to users and adding pricing that won't really be a big deal or a hindrance. And so that's kind of where that -- the first step was. That's where this incremental step is. And then we'll see about where it goes in 2021. I think there's a potential for us to continue to raise prices in some additional markets. We're obviously going to be very mindful of COVID and the pandemic and sort of how people are doing and how the economies are doing as well as seeing how sort of these next 7 markets go in terms of performance. But it's definitely something we talked about on the call. We have some markets we're testing, and it's likely but not guaranteed that we would test some more in the upcoming year.

What's the biggest country, market where you've actually raised prices? Is that...

New Zealand and Australia.

Okay. It's probably Australia because I know that that's bigger than New Zealand. Should we expect a price increase in the U.S.? If COVID does get reasonably controlled in the next 12 months, should we expect a price increase in the U.S.?

Yes, it's tough to say. We haven't obviously announced any additional markets. But like I said, I think, right now, we're testing some bigger markets, some smaller markets and some markets in different geographies, different languages. And so I think we'll take the learnings from that and then from there, figure out what makes sense for potential increases in additional markets.

Okay. Let me switch and ask you a couple of P&L questions. The subscription gross margins, where do you think about where they can go long term? And I know there's a series of different drivers. Has something become materially bigger as a driver of subscription gross margins in the last 12 months?

Yes. I would say -- I mean look, I think at a high level, we don't really -- well, we think about gross margins as a consolidated basis, right? And so I think as a lot of people know, the entire cost of the podcasting business is being -- the brunt of that is being -- impacting the advertising gross margin and not the premium gross margin, right? And there's obviously a benefit from a retention standpoint and a conversion standpoint on the premium business, even though, just from a financial perspective, we account for all in advertising. So I think there's a little bit of a mismatch there that we try and just wanted -- that I just wanted to highlight. And I really think about it just as a consolidated, what's our gross margin, right? And so call it, plus or minus 25% right now. And the question is how are we going to get higher. I think we have a couple of avenues to do it, right? I think advertising growth in general is one, both on podcasting in general, where, as I said earlier, the model could be a little different; two, advertising where there's some markets where we really undermonetize. And we actually take a little margin hit in some markets where we don't generate enough advertising. So just growing advertising in some of those markets where that would really benefit gross margin. We're optimistic about the two-sided marketplace and the opportunities there from a monetization standpoint and a benefit to gross margin; new to us, but Megaphone and what that potentially could do on the margin side; and then as we go further along, how we can work with the labels kind of in smarter and different ways that potentially could benefit us and benefit them as well. So we think there are a number of factors that will help gross margins over time. As we've talked about, we are continuing to invest in the podcasting business. And so as we think about the investment in 2020 but what we might want to do in '21 and '22, that could impact it. And again, that will be really driven by some of the successes and learnings we have from the current investments, which will then help us dictate how much we continue to spend. And I think as we've also said a number of times, if you see us continue to spend aggressively in podcasting, it's probably a good indication that we feel like the benefits to the overall business, both from an advertising standpoint but also from a user growth and retention and churn standpoint, that we're seeing that as well.

At the time of the IPO, you talked about long-term gross margins of 30% to 35%. Any particular factors that have made you more confident in that range or less confident over the last 2 years?

Yes. We haven't really updated that, but I don't -- we haven't changed our views on where margins could go. I still feel like there's a lot of opportunity for us to move margins up over time.