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

Good afternoon, everyone. Thanks for joining us. I'm Brian Goldberg, Head of Investor Relations at Spotify. I hope you were able to join our live stream event earlier today, Stream On. For those who weren't able to listen, the event is available for on-demand viewing on our Investor Relations website. Joining us today for the related Stream On investor discussion and Q&A will be Daniel Ek, our CEO; and Paul Vogel, our CFO. We'll start with opening comments from Daniel and Paul, and then open it up for Q&A. For those who are participating today via Zoom, please use the raise hand feature in Zoom to ask a question. Once you're selected, you can ask your question directly on the call, and please keep your video feed on. Before we begin, let me quickly cover the safe harbor. During this call, we'll be making certain forward-looking statements, including projections or estimates about the future performance of the company. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed on today's call, in our presentation and in filings with the Securities and Exchange Commission. And with that, I will turn it over to Daniel.

All right. Hi, everyone, and thank you for joining us. I really hope you enjoyed the event. And Stream On is hopefully the start of a new tradition at Spotify, where we're sharing more transparently our direction for creators and consumers alike. But before we jump into the Q&A, I wanted to take a moment to share some extra context for investors. So everything at Spotify starts with our Y, and that's our mission. To unlock the potential of human creativity by giving 1 million creative artists the opportunity to live off of their work and billions of fans the opportunity to enjoy and be inspired by it. And this mission guides really everything that we're doing at Spotify. If you can go to the next slide, please. So when you think about this mission and you think about the event that you just saw, I think there are 4 pillars that really stand out. And you should look at all the announcements that you saw today through those 4 pillars: create, grow, engage and monetize. And this maps perfectly into our mission as well. So if you think about unlocking the potential of human creativity, it is really create. And by giving 1 million creative artists, that's really growing, and live off of their art, is monetizing it and billions of fans is growing once again and enjoy and be inspired by it, is engaged. So think about those 4 pillars and how it connects to the mission, and you'll start seeing the Y? You can go to the next slide. And this is kind of how we're thinking about Spotify. So our platform of growth is those consumers and creators. And we are really the facilitators in the middle with the create, grow, engage and monetize pillars as the way to view all of our actions that we're taking as a company. So on the consumer side, as a user enters, they generate data. And those data points generates more ability for us to personalize the service, which, of course, leads to better user experience, which brings more users. And then on the other side, with our creators, you start seeing that more users brings more earnings potential, which, in turn, brings more creators, which, in turn, brings more unique content on our platform. So it's really 2 interlocking flywheels. And the way we interact with that is just facilitating more ways for creating, more ways to growing, more ways to engage and more ways to monetize. If you can move to the next slide, please. And we've really come a long way since our launch in 2008. We are 345 million users, 155 million subscribers, 8 million creators and almost EUR 8 billion in revenue. But we're still only in the beginning of where I think we will go in the long run. So I wanted to take a moment to really visualize what I think our opportunity looks like and sharing some more context how that informs you about the decisions we're taking as we're investing in our business and what that business ultimately will look like. If you move to the next slide, please. So this data, by the way, comes from a number of sources, including the Goldman Sachs research report, including Ovum report, IFPI and others as well. But the very simple way of looking at this is, obviously, to imagine that Spotify today is in the music streaming business and in the podcast business. And today, we're at, call it, around 40% market share in music streaming. And in podcasting, we're in an early stage, so we're about 25% growth, but we're growing very quickly and taking market share. And long term, I think you should expect us to be somewhere between that 1/3 to 40% market share as we think about this opportunity. But the more important point is when you look at and zoom out and think about where this opportunity will look like in the next decade. So if you go to the next slide, please. So something becomes quite obvious then, and that is obviously: one, that this is a very, very fast-growing market and that we have a lot of growth left in this opportunity. So the second thing that I think you should notice and see is that radio is really going from a gigantic business to becoming a much smaller part. And both music streaming, podcasting and paid audio is the main beneficiaries of that unbundling of radio. And I think if we zoom in, specifically on the 2030 part, you can see a few different things. You can go to the next slide, please. You can see: one, that music streaming, in itself, is growing by about 3x from where it is today. And you see that paid audio and podcasting combined is about a $55 billion revenue opportunity. So the combination of the markets that Spotify is in already today is about a $130 billion opportunity. And that's the close markets that I think we have the right to win. And long term, as I mentioned, we want to be at least 1/3 to 40% of market share in those businesses. And I think we're incredibly well positioned to play that role and to take those markets as it is today. And so another way to contextualize that and to think about it is that we have at least 5 to 7x growth left in just the businesses we are today. And then the obvious call out here would be live, that we're not in today. And I think just to kind of short circuit that, I think we'll play some sort of role, but I don't think it is as clear as the fact that we're the music leader in music streaming today. And I believe we'll be the leader in podcasting tomorrow as well. So those are the more obvious opportunities, but live is obviously a very interesting opportunity for us as well. So the question is then, what kind of business does that lead to long term for us? And with that, I want to hand it over to Paul to explain a little bit more about the details.

Great. Thanks, Daniel. If you could turn to the next slide. So just thinking about some of the long-term guidance we've given in the past and sort of updating some of those targets. So for us, we really are about sort of winning the audio space both growing users and subs and subscribers and being able to monetize them at a high rate, both through subscription revenue, through some of these add-on services as well as advertising. And so when you think about the long term, we're optimistic. And our goal is to continue to grow revenue at 20%-plus over that long-term period of time. And we want to do it, obviously, in way increasingly growing our gross margins. And we've talked about a number of ways this will happen. It will definitely take some time. But our goal now is sort of 30% to 40% gross margin, led by a number of the initiatives and a number of the things that you heard and saw in the Stream On event. And so that's sort of the targets we are. A little bit more precision around, I think, that target from what we gave at the Investor Day. And then from an operating margin perspective, I think our goal is 10% plus. I think that will potentially modulate up or down depending on when we have some investment. And when we're in investment mode and longer term, when we're not. But in general, we think 10% plus is a pretty good target. And when we think about sort of modulating between revenue growth and gross margin and operating margin, some of it all plays together, right? So to the extent we get to, obviously, a higher gross margin, we could have higher operating margins. But I also think when you think about the operating margin, you think about the 3 components there, you can expect us to continue to invest aggressively in R&D. It's kind of been between 10%, 11% for the last couple of years in terms of a percentage of revenue. I think if we continue to grow the business and gross margin expands, you could actually see R&D actually even increase as a percentage of revenue. We think that's really what's differentiated us in our product over time, and that shouldn't be anything new from what we've talked about in the past. And then when you think about sales and marketing and G&A, we definitely expect that we'll get leverage on both of those over time, which would significantly improve our operating margin. And we have been free cash flow for the last couple of years, and we continue to forecast and we'll continue to be free cash flow on an ongoing basis. Next slide, please. And then just quickly, wanted to sort of reiterate the guidance we provided because I figured we get some questions on this. No change to Q1 or full year guidance. We get the question all the time about what was expected in our guidance. Obviously, we've been working on the Stream On event for a while. So what was in the event was contemplated a number of the things that we talked about Stream On will take some time to roll out throughout the year. Obviously, there's still a lot of uncertainty with how quickly or not some of those things get rolled out, how quickly the new market launches take off, as an example. And so we're kind of reiterating the guidance that we gave you. And just in terms of Q1, in particular, since we are about 3 weeks removed from reporting earnings, again, we feel really good about the guidance we gave and feel like we should hit the targeted ranges that we put out there. I would just say, with one caveat, as most of you are well aware at this point, when our stock price moves up, relative to where we forecasted at the beginning of the year, we do have outside impact on noncash social charges. And given the performance of the stock price so far in Q1, we will expect to have a significant increase in social charges if the stock price -- if we were to end the quarter with the stock price where it is right now. So again, in terms of all of our major KPIs, MAU, subscribers and revenue and gross margin will be within the ranges we provided. And the operating loss will be towards the low end, so in terms of the higher loss given the impact of social charges. So next slide. And then we quickly just wanted to kind of highlight some of the big takeaways from Stream On at this point. We hope that most you were able to see the event and watch it. But obviously, there was a number of announcements we made. Just to highlight a couple. New market expansion is one that we were definitely focused on, 85 new markets, we'll now be in 178 markets. So really being able to bring audio globally, which, as Daniel mentioned in our mission statement, is being able to have 1 million artists live off their art and connect it into 1 billion-plus users. And so this sort of furthers that. Hi-Fi, which is our CD quality lossless audio, which will be coming out later this year. And then a number of features on the podcasting side, the advertising side and the marketplace side. So obviously, a number of announcements on the content side and creator tools, and we feel really excited about all the announcements we made. And with that, I think that was the last slide. Next slide. Yes. So with that, I will turn it back over to Bryan to call on some folks to ask some questions.

Great. Thanks, Paul. [Operator Instructions] And our first question today is going to come from the line of Ben Swinburne.

Okay, I'll follow the rules and go with one. Daniel, if you think about that flywheel you just showed us, I think it's create, engage, monetize. I'm missing one of the pieces of the wheel. But where are we on marketplace and advertising specifically? You guys had a lot announced today. So as we digested and think about those parts of the flywheel, can you just give us a sense for where you think you are from an evolution and opportunity point of view because, obviously, those are 2 pretty big parts of the whole Spotify story.

Yes. So I think there are really 2 different maturity stages as well as businesses grow. So marketplace, much earlier, but growing very fast just as a business. And as we announced today, we're seeing tremendous pickup from labels and artist teams in just the utilization of the feature and even the results that they're seeing. And I'm, in particular, very pleased to see that not only are people seeing great response, but they're seeing that it translates into better revenue growth, which is a sort of telltale sign, I think, for even more further adoption. So it's early days. But very, very strong signals, and you'll see us launch these products more widely into the marketplace in '21. And then advertising is still relative to subscription. Obviously, a smaller business, but it's a more larger growth business for us. And there, in particular, as you've seen throughout the year, very excited about podcasting's impact on that. And even the announcement today on SAI, I think, will mean that we'll have more inventory. So if you looked at, in particular, in the U.S. and U.K., we were mostly inventory constrained in Q4. So hopefully, announcements like this means that we'll open up more inventory, which means further growth in advertising as well. So 2 different businesses, 2 different stages, but very excited about both of them. And overall, one should lead to marketplace, should mean better gross margins. Advertising should mean more top line growth. And depending on the inventory, also better gross margins.

Yes. And I would just add, Ben. Just as an update on marketplace. I think we'd given some guidance in terms of numbers for 2019 and said that we had expected marketplace contribution to grow at least 50% in 2020. And just to update that number, we grew better than that in 2020. So we feel good about the marketplace expansion in terms of the benefits to gross profit in 2020. And we do expect significant growth in marketplace contribution to gross profit in 2021 as well. And then just to reiterate what Daniel said. If you remember back to Q4, we talked about the strength in the podcast business. And that we were inventory constrained and that really we could have grown even faster. And so we think with Anchor and with Megaphone and with being able to add SAI into both of those platforms, and with all the increased ad inventory, I think we feel really good about being able to grow that business.

Our next question is going to come from the line of Rich Greenfield of LightShed Partners.

So kind of a 2-part question. The first one is Apple is clearly doing subscription to take on exactly what Patreon and OnlyFans and sort of allow creators broadly to monetize transactionally. And I think both David and -- sorry, both Daniel and Paul, you talked about this a lot on the conference call, about 3 pillars of monetization. I guess to the extent that Apple does subscriptions for podcasters or ways for -- to transactionally subscribe to podcasters, does that make it harder to move people? I mean, the dominant platform for podcasting is Apple Podcast. How does this make it more challenging to move over? And is that why you're launching this product? Or was that always on the road map? And then just because everyone is thinking about it, could you just give us your view on clubhouse and sort of where that part of live audio fits into the Spotify world?

Yes. So it's always been a part of our road map to try to support creators in more ways to monetize and expand on their ability. And by the way, I love your T-shirt, Rich, I didn't notice it until now. So that's an old school Spotify T-shirt. But the way to think about it is really streaming in the early inception was we had to make the proposition very simple for all the actors. So it was a one-size-fits-all. And we knew as the marketplace would get to maturity, that part of the strength of the business and the platform would be to enable many more ways to allow creators to grow their audience, engage with their fans and monetize their fans. And that is the multitude of ad-supported subscription and a la carte. So it's always been on the road map to support some sort of a transactional model. But obviously, we've been looking at the success of paywalls out there and seeing the rise of creators on a lot of these platforms that you mentioned, too. So it's in response to that. And I think you're going to notice that we're very focused and attuned to what creators want and helping serving them in more ways. So it's definitely part of that, not so much competitively. And then on Clubhouse, my fundamental view is like Clubhouse is really 2 things. I think it's a creative format, and it's super engaging for creators, very interesting with the interactivity. So we obviously pay a lot of attention to all social and interactive features. And then the second part is the listening part as well. Long term, I believe the major trend on the Internet isn't linear and live programming, but it's still time shifted and on-demand. And to that extent, I feel very good about where we're placed. But obviously, to the extent that creators find interesting ways to interact with their audience, that's definitely something that we're paying a lot of attention to and looking at and experimenting with as well.

And then just to clarify. When you say you're going to do subscriptions or paid subscriptions for podcasters, is that something that will eventually this year come to musicians as well?

No, I just mean you should think about it as the 3 pillars of our business model would be ad-supported, subscription and a la carte. There's no sort of specific announcement on whether we'll have a subscription-only service of some kind. But paywalls is an a la carte model that we're committing to do.

Our next question is going to come from Jessica Reif Ehrlich from Bank of America Securities.

I guess continuing on those lines of questions you've had so far. Discovery -- you just had such a wealth of information today. Just could you talk a little bit more about Discovery mode? How scalable is that service on your platform? And how do you think the economics of music content evolve over time? And on the advertising front, do you feel like you're at an inflection point? What can the Spotify audience ad network do now that you couldn't do -- now that you own Megaphone, what can you do now that you couldn't really do before? And how big is that opportunity?

Paul, do you want to take this one?

Yes. So I think on the advertising side, I think it's a couple of things. One, it's -- I think it's bringing the innovation and the technology into the ad platform. So having things like SAI and being able to marry that with what we've already done and then combine that with -- bringing it to Anchor creators and Megaphone publishers is really, really compelling. So being able to have a more targeted, a more unique advertising spot within that ecosystem is, I think, really exciting. I think we know that there's demand there. I think when you sort of marry the growth we have in content and content consumption with increased inventory, we'll be able to do a couple of things. One is, obviously, free creators, we'll be able to, I think, help them monetize at higher rates because we're going to give them a better audience. We're going to be able to sell their audience to a wider group of advertisers. And then for us, it's actually better for the advertisers as well because they're actually going to be able to reach a wider network of consumers through having more content and more inventory. So we feel really good about it from that standpoint. And then, Jessica, the first part of your question was?

Oh, it was just on Discovery mode and how...

Oh, Discovery mode. Yes. Yes, so look, we think it's a really exciting opportunity. We think the initial trends are really powerful. What's great about it is there's really no upfront cost to someone to participate in Discovery mode. So again, if it works for them and if we're able to sort of find spots within autoplay or radio that actually work, they're going to get more streams, so they're actually going to make more money. And it will obviously be at a promotional royalty rate, so it will benefit us as well. If it's something that doesn't work or, quite frankly, the music doesn't respond or relate, then it won't impact anybody. So we think there's a huge opportunity for artists to use it to amplify what they want to do in terms of getting their music and their creative heard. And it's a way to do it for them to sort of risk-free at first because there's no upfront commitment to them.

Just want to reiterate and add. Like the #1 question I hear from artists is how can I be heard more? And the #1 question I hear from consumers is how can I discover more great content? So this kind of double-sided coin is really the strength it's playing to. And when you look at labels, in particular, the #1 cost today is figuring out how to market their artists, and it's very, very expensive. So long term, I think you should view this as just creating a much more efficient ways for creators and consumers to meet. And that's the opportunity. And if we can make that efficiently, we can save money for labels and artists alike and obviously participate in some shape or form for facilitating those relationships.

Our next question is going to come from Heath Terry of Goldman Sachs. We will come back. Let's go to Matt Thornton of Truist Securities.

Thanks for doing this, it's very helpful. Maybe a bigger picture question and then a housekeeping question. I guess, first off, when you think longer term, I think you went out to 2030 in the slide deck. How do you think about the mix of subscription versus advertising at that point? Is it something like 80-20? Any color as to how you're thinking about mix longer term? I remember several years ago, I think it was Barry that talked about advertising is something like 20%, but that was really before the big push under podcast. I'm just curious any update there. And then just housekeeping question. Obviously, given the rollout of new markets here, which is probably a little more aggressive than any of us expected this year. Can you just maybe talk to what the impact is of minimum guarantees in that gross margin guidance you gave for the full year?

All right. I'll take the first part of the question, and then perhaps, Paul, you can take the latter part of the question here. So I think the answer long term is that we expect to be a major player in all 3 types of monetizations, so both subscription, advertising and a la carte transactions as well. And I think all of them are going to play a role. And today, we like to believe that these Internet companies are only one thing. But I think the future media companies are actually going to have a combination of different business models. It's hard to imagine exactly what it will be. Today, it's 90% subscription, 10% on advertising. I know it's definitely not going to be the case, and advertising will be a bigger portion than that. If you look at the closest comparison, we've talked for quite some time that we're actively competing against radio in those hours. You're talking about a market there that only advertising in itself is, call it, $50 billion to $70 billion in revenue, mostly supported by advertising. So if you think about that and you think about the $130 billion TAM that we talked about in -- at 20, 30, it's clear that advertising can be somewhere between 20% to perhaps even 40% of our revenue mix going forward. I don't know exactly where it will end up. I think a large part of that will be the more transactional part of that as well. So the a la carte part, which is kind of the unknown, because that's the unique thing on the Internet that you can't model on, past businesses.

Yes. And then just to the second part of the question. Obviously, I'm not going to give any specifics on there. I would say, just in terms of reiterating our philosophy around guidance is we always include in our guidance anything we know we're going to do, whether or not we've announced it or not. And so obviously, we've been working on the Stream On event for a while now. So you can assume that the things that were in the Stream On were contemplated when we gave you our Q1 and 2021 guidance.

I think Heath Terry's mic is working now. Let's try him again.

So just to the extent that you've got a pretty wide range there on the gross margin targets, can you give us a sense of sort of what variables put you at the top end of that versus the bottom end of that? And then just on the Spotify audience network, can you give us a sense of what kind of traction you're expecting out of that with non-exclusive podcast partners just in terms of what's going to drive them to work with Spotify versus whatever existing option they have for advertising?

Yes. So I think if you look at the gross margin, there's a number of factors that are going to impact the long-term gross margin. We've talked about advertising growth and podcasting growth. We've talked about marketplace. We've talked about some of the a la carte items. And so there's a number of things. I think, for us, a lot of it will depend on sort of the mix moving forward and exactly how that nets out. How many of these things grow, and to what extent. And so I think we obviously have built a model where there's a decent amount of variability or optionality in those long-term forecasts. And I think we feel very comfortable at the low end of that range. And I think in order to get to the mid- to higher end of the range, we'll have to see how some of these things break and how big some of them go over time. So that's kind of where the range comes from. But there's a -- as you saw, there's a number of initiatives we have, both for creators and consumers and market launches and product that will all impact the gross margin in different ways. And that doesn't even speak to how any other relationships on the music side may evolve over time. So I think that's how I would think about the optionality on the gross margin side. And then the second part of your question, Heath, was?

Spotify audience network. What's going to drive sort of new partners into that as far as it being the best option for them?

Yes. I'll take the first stab, and then if Daniel has any comments on that. I think it's -- a lot of it's about bringing innovation and bringing actually a focus on this that just hasn't existed in the past, right? And so when you think about SAI it's -- in particular, it's a product that nobody else is really offering anything like it. We know, and I think we spoke about this when we first launched it. That the minute we launched it, the amount of demand that we were getting from people who wanted to participate in it or publishers who wanted to participate in it and when we were only offering that type of an opportunity for our owned and exclusive content, we knew there's a huge opportunity to grow it. And so by actually having more inventory, by being able to showcase more inventory to more creators and more publishers and then being able to do in a way that's actually going to help them monetize at higher rates, we think will all be really, really great. And then it's just again -- not to overuse a word, but it's another flywheel that will exist where, to Daniel's point, you bring more people, you have more creators, they monetize higher, it's going to bring more creators because they're monetizing better. And there's going to be more content. So there's going to be more users that keep coming and on and on. So I think that's how we feel about the opportunity.