Spotify: User Churn Rate Better Than Expected After Price Increase for Bundled Packages (2Q24 Earnings Call)

The following is the summary of the second quarter financial report conference call for $Spotify(SPOT.US) in 2024. For financial report analysis, please refer to "Spotify: Another Breakthrough? Music Giant Provides Standard Answers" here .

I. Review of Core Financial Information:

II. Detailed Content of the Financial Report Conference Call

2.1. Key Points from Executive Statements:

1) Operational Highlights:

① Business Strategy and Development:

• Expansion of subscription plans: Introducing new subscription plans (audiobooks, access rights, and basic levels), as well as existing premium plans (individual, duo, student, family, and mini passes).
• Price adjustments: Implemented price increases in several key markets (including the United States), with a lower-than-expected user churn rate.

② Enhancing User Value:

• Subscribers now have access to 250,000 audiobooks, over 6 million podcasts, and nearly all music catalogs globally.
• In the United States, the cost of accessing all this content is approximately $26, significantly higher than Spotify's subscription fee, making Spotify still a very cost-effective choice.

③ Market Strategy:

• Developed markets: Paid subscriptions are mainly concentrated in developed markets, with growth driven by net subscriber additions and strategic pricing.
• Emerging markets: Growth supported by free advertising is mainly concentrated in emerging markets, with the goal of converting these users into subscribers in the long term.

④ Marketing Strategy:

• Developed markets: Invest in marketing expenses when meeting ROI expectations. Marketing investment in developed markets has a high return on investment, strong penetration rates, and awareness, requiring precise targeting to acquire resources.
• Emerging markets: Great user acquisition potential, but unstable user behavior, varying engagement levels, slow conversion rates, and low return on marketing investment.

⑤ Future Outlook:

• Confidence in MAU rebound: Despite not meeting expectations this quarter, there is confidence in a rebound in the future, as the trend in annual MAU engagement is healthy.
• Changes in subscriber conversion funnel: Due to market differentiation and increased subscription products, the relationship from free to paid is no longer one-size-fits-all, with an increase in the proportion of users in developed markets directly subscribing to paid tiers.
• Revenue growth prospects: Achieving sustained revenue growth through price adjustments and high user engagement

2) Financial Highlights:

① Improvement in Free Cash Flow: Free cash flow reached a record high of 490 million euros, mainly due to the improvement in operating profit and favorable changes in net operating capital.

② Third Quarter Guidance:

• Expected MAU to reach 639 million, an increase of 13 million from the second quarter.
• Subscribers are expected to reach 251 million, an increase of 5 million from the second quarter.
• Total revenue is expected to reach 4 billion euros, with revenue growth calculated at a fixed exchange rate consistent with the second quarter.
• Expected gross margin of 30.2%, operating profit of 405 million euros.
• ARPU growth in the third quarter is expected to be between 100 and 200 basis points year-on-year, slightly slower than the second quarter.
• Historical price increases have the least impact on growth, and moderate user churn is expected in the third quarter.

③ Outlook for the Second Half of the Year: It is expected that the gross margin in the second half of 2024 will gradually increase, and operating profit and operating profit margin will also improve.

2.2. Analyst Q&A

Q: When evaluating the factors affecting MAU growth, do you think this is the result of cost reduction or increased market penetration? What measures are you taking to drive MAU growth?

A: Future growth will mainly come from developing markets, although achieving ROI in these markets is more challenging due to significant differences in user behavior, market channels, and ARPU compared to developed markets.

Our strategic adjustments mainly focus on three areas: 1. Marketing channel optimization: In developing markets, we will strengthen partnerships to enhance marketing effectiveness. 2. User acquisition strategy improvement: We will optimize marketing methods in these markets and may increase some expenditures. 3. Product innovation: We have already launched products in certain markets to increase user engagement, and we expect to introduce more products in the coming months to further enhance user engagement and lifetime value (LTV). With improved user engagement and increased LTV, we will be able to moderately increase marketing expenses while maintaining a positive return on investment.

Q: Can you discuss the driving factors for improving the profitability of music and podcasts to enhance the gross margin? How should we view savings from bundled royalties? Should it be directly reflected as profit or reinvested in other areas?

A: Quarterly fluctuations in gross margin are influenced by various factors. Growth in the music market and improved profitability of podcasts are the main drivers of the continuous improvement in gross margin this quarter. The outperformance this quarter compared to our previous guidance is mainly due to favorable changes in music content costs and market factors.

Regarding bundled royalties, many platforms have similar approaches, and we are no exception. We do not intend to disclose specific details of the transaction mechanism, but we are confident in our market positioning and development direction.

Q: What changes have occurred in Spotify's podcast engagement after major podcasters no longer have exclusive partnerships? As the industry shifts towards video podcasts, how do you plan to attract creators, increase engagement, and compete with platforms like YouTube?

A: We have observed that the engagement of podcasts on Spotify remains strong, and the popularity of video podcasts even exceeds that of pure audio content, indicating a positive development trend. This trend not only boosts the enthusiasm of creators but also encourages them to upload video content.

Currently, there are approximately 250,000 active creators on Spotify. Over time, we have found that consumers, especially young users, are very flexible in their choice of content formats, easily switching between audio, video, and reading. Therefore, creators are increasingly aware that they need to provide content in multiple formats to meet the needs of different users.

Our strategy mainly focuses on three aspects: 1. Utilizing the native advantages of the Spotify platform, such as converting existing podcast and music creators into video content creators to increase engagement and monetization. 2. Expanding to other platforms, encouraging creators who have already uploaded videos on other platforms to expand their content to Spotify to share costs. 3. Leveraging the unique features of the Spotify platform, we have noticed that long-form content performs exceptionally well on Spotify's video platform because users are accustomed to freely switching between background and foreground playback, making this content format particularly suitable for Spotify users' habits.

Overall, content creation and user engagement on Spotify are steadily increasing, with new creators joining our platform every day.

Q: Why has ad revenue growth not significantly increased? How will it achieve the long-term goal of ad revenue accounting for 20% of total revenue?

A: Firstly, our subscription business is growing at a pace exceeding expectations. We have successfully converted some of the most active users into paying subscribers, which, although to some extent reduces the potential for ad revenue, also helps optimize our business structure.

Next, we have been actively investing in the platform to drive the development of programmatic buying. While there is still room for improvement, we will continue to invest to enhance the platform's automated buying capabilities. Currently, our advertising business focuses on direct sales and the enterprise market, which are areas with significant market fluctuations. However, this also provides us with excellent opportunities for transformation and enhancing market adaptability, especially in expanding the small and medium-sized enterprise market.

Q: Please explain the relationship with record companies under the MLC legal action background. Can you explain the accounting treatment for reducing CRB rates?

A: I am unable to comment on the ongoing legal proceedings. However, I can emphasize that our relationship with record companies is not a zero-sum game; we aim for a win-win outcome. Whether in publishing or the record industry, our payments increase every year, reaching a record high in 2023 and even higher in 2024.

Our relationship with the music industry has been healthy and continuous for 18 years. Despite disagreements, the growth of the music industry is our common goal and mission. We are proud of the growth of the music industry and our efforts, which have been recognized by the industry As for the issues regarding MLC and CRB, it involves the rights of publishers, the situation is complex, and after careful consideration, we are very confident in our position. We do not disclose specific accounting details and therefore cannot provide more information on this.

Q: Although it is still in the early stages, can you share the initial consumer response and churn rate after the second price increase in the United States within a year? How should we view the frequency of future price adjustments? Additionally, should we expect more price increases in the international market this year?

A: In principle, we do not discuss forward-looking plans. However, we can say that for the three main markets where we recently raised prices, we are encouraged by the initial response, which provides a positive signal for the potential performance in other regions. Although it is still early, we have just implemented price adjustments and are closely monitoring the situation. So far, the churn rate is better than expected, which is a positive signal, and we will continue to monitor these indicators.

Q: Previously, it was mentioned that Spotify focuses on the lifetime value of users. With the growth of gross margin and user lifetime value, how will this guide our future investments in the core music business and emerging areas such as podcasts, education, etc.?

A: We always optimize based on the lifetime value (LTV) as a core metric. We place such importance on LTV because it comprehensively measures various aspects from user retention to average revenue, which is very suitable for a business model like Spotify's. Our main focus is on solving issues between creators and consumers. To understand our priorities, the key is to find win-win solutions. Our priority is to consider solutions that benefit creators while also being beneficial to our existing consumer base.

For example, with the music concert project we are currently undertaking, although it is still in the early stages, concerts are an important source of income for artists, and consumers love attending live performances. We leverage the loyal fan base on Spotify to help artists promote their concerts on the platform, providing fans with more opportunities to participate in live shows. This project called "Fans First" is widely promoted on Spotify and has received strong support from artists and consumers.

Overall, we enhance LTV by creating win-win situations. We aim to provide services to existing creators in new ways, such as concerts. Additionally, when we see that the invested areas and other groups of creators can also benefit from it, we will consider expanding into other areas such as podcasts and education.

Q: Faced with complex factors such as bundled sales, price increases, and package optimization, how will they affect ARPU growth from the second half of this year to 2025 on a currency-neutral basis? To achieve the revenue growth target of over 20% in the next three years set by Investor Day, how should the balance between volume and pricing be maintained?

A: You have mentioned many correct revenue impact factors. But what I want to emphasize is perhaps the most important factor on the list: whether our premium subscription plans continue to grow and attract user participation. This is actually a key leading indicator that provides us with flexibility in all other aspects of our strategy. I do not believe there is a fixed formula that directly determines the direction of the next three years, but the key is that we will flexibly apply these strategies based on the demand at different time points We are now discussing a product portfolio that provides us with flexibility and multiple choices.

Q: There are rumors that a super-premium package priced more than $5 higher than the existing premium package will be launched. Can you explain what additional services consumers will receive and how these features are determined?

A: We currently have 246 million paid subscribers, making us one of the largest subscription services globally, with the key to success being a simple and unified service commitment.

Over the past two years, we have achieved personalization of services by offering a variety of packages from basic to family, student, etc., meeting the needs of different users. Among these subscribers, some users wish to have a more premium Spotify experience. They are deep music enthusiasts who seek more flexible usage and higher quality music services. We are committed to driving the growth of the entire music ecosystem and believe that by offering a super-premium package, we can not only meet the needs of these users but also have a positive impact on the music industry, promoting further growth.

The planned super-premium package is expected to be priced around $5 higher than the current premium package, reaching $17 to $18, and will provide richer control options, comprehensive audio quality enhancements, and other yet-to-be-announced features.

Q: You have achieved the gross margin target set for Investor Day in 2022 ahead of schedule. Upon conducting a post-analysis, what factors contributed to this achievement? Since the target has been met, how should we expect the future development of gross margins?

A: We quickly move from one achievement to the next, ensuring our continuous progress. The key to achieving the gross margin target lies in our focus on enhancing monetization capabilities and becoming more cost-effective. We maintain the target set on Investor Day to achieve a 30% gross margin in the short term and have a larger long-term vision.

The entire company has been fully engaged in exploring multiple drivers that promote gross margin growth, including improving the profitability paths of the music market and podcasts, enhancing the efficiency of cloud services and streaming transmissions, and optimizing payment processing costs. These efforts collectively have created our proud gross margin performance and will continue to support us in achieving long-term goals.

Q: How have subscribers reacted to the price increase of the premium package? Can you provide some data, such as the number of cancellations, the number of users opting for the basic package, and the number of users continuing to use the premium service? Have you observed any differences in different markets?

A: Regarding pricing, we are still in the early stages. We have just implemented the second price increase within a year in three major markets. We are closely monitoring all relevant metrics, and preliminary indications show that the churn rate is better than expected. Additionally, we now have a basic package in our product portfolio, providing us with new ways to reduce user churn. While we do not have specific data to share at the moment, we are very encouraged by the current signals.

Q: How does the audiobook business impact your cost structure? How are costs recognized? How does the current gross margin for audiobook revenue compare to the 40% target set on Investor Day? Is this gross margin target still appropriate? What is the timeline for achieving this target?

A: The audiobook business adopts a variable consumption cost structure, which is crucial for understanding the business. As a new content area expanded by Spotify, we are currently in the investment phase, focusing on establishing market position rather than immediately pursuing profits.

We maintain confidence in the long-term gross margin target presented to investors, with the current focus on ensuring that audiobooks can enhance user engagement on the platform. Our goal is to continuously add value to the platform, with audiobooks being a manifestation of this strategy. From two years ago to now, Spotify has made significant progress in both user engagement and content diversity, receiving enthusiastic feedback from users, which gives us confidence in building a strong business.

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