Whether Spotify’s just-released financial results pave the way for the digital service to do an initial public offering of stock anytime soon is still anybody’s guess; yet, despite the much larger than expected net loss, there’s good news for the streaming service.
For one, the company is still growing at a fast clip with sales up €1 billion ($1.054 billion) to €2.93 billion ($3.09 billion) from the previous year’s total of €1.93 million ($2.1 billion). As of March, the streaming service had some 50 million paying subscribers — up from 40 million from the previous Sept. — and a 140 million active users. But as its revenue base gets bigger, a slower growth rate comes into play as its 52.1 percent in growth for 2016 is less, percentage-wise than the 77.8 percent growth rate produced for 2015 versus its 2014 revenues of €1.084 billion ($1.14 billion).
While its net loss of €539.2 million ($568 million) was more than double the €231.8 million ($244 million) it had in the prior year, if you overlook the non-cash charge of €245 million ($258 million) to write down the discount on the €1 billion in notes (due in 2021, because Spotify didn’t plan on doing a public offering within one year of that April 2016 financing), the adjusted net loss was €294.2 million ($310 million), according to one analyst. That’s a 27.1 percent increase in red ink, to be sure, from 2015’s $231.4 million net loss, but not as bad as the non-adjusted loss for 2016 would lead you to believe.
If the overall reported net loss is discouraging news, at least earnings before interest, taxes, depreciation and amortization held nearly steady at €161.2 million ($169.2 million) in red ink in 2016, versus the €170.7 million ($180 million) in a loss of EBITDA in the prior year, Billboard calculates.
Also good news, the company’s operating loss as a percentage of revenue has steadily decreased. In 2016, Spotify’s operating loss was €349.4 million ($368 million), which was 11.9% of revenue versus the prior year when it was €236.3 million ($238.2 million), or 12.3 percent of revenue. In 2014 it was even higher at €191.1 million ($201.3 million), or 17.6 percent of revenue.
Those decreases in operating loss, however, appear to have more to do with the rise in revenue then they do cost control; or whether Spotify can achieve economies of scale with sales and marketing and general and administrative expenses.
While product development costs held steady as a percentage of revenue in 2016 at €206.85 million ($217.9 million), or 7.1 percent of revenue, the same ratio as in 2015; general and administrative revenue grew to €175.2 million ($184.6 million), or 6 percent of revenue, from 2015’s expenditure of €105.9 million ($111.6 million), or 5.5 percent of revenue; and worse, sales and marketing costs totaled €417.9 million ($440.3 million), or 14.3 percent of revenue, from €258.7 million ($272.6 million), or 13.4 percent or revenue.
In contrast, in 2015 Spotify begun to achieve scale when all three of the above expenditures as a percentage of revenue were smaller ratios than in 2014. Its unclear why that experience wasn’t repeated in 2016, except in product development where the company says it has continued to spend heavily.
Without economies of scale kicking in, Spotify will be hard pressed to point toward a path to profitability. Yet, it so far appears to be trying a different path: Instead of getting its own internal costs under control — employee wages and benefits continue to rise, even if at a slower pace — Spotify has begun negotiating with music rights owners for lower royalties.
Spotify doesn’t break out exactly what’s in its cost of goods, but in addition to royalty payments to rights owners it also includes things like customer service costs, credit card and payment processing fees for subscription and salaries of certain employees.
Overall, its cost of goods in 2016 was €2.48 billion ($2.61 billion), or 84.6 percent of revenue. According to industry sources, the on-demand digital service model typically carries a cost of about 70 percent of revenue for royalty payments, of which 60 percent of revenue pays for licensing master recording and 10.5 percent of revenue for publishing royalties. Yet, those percentages are what’s known as the headline rate; each set of licenses — master recording and publishing — are actually set by as many as three or four formulas and whichever one produces the biggest revenue pool is the one used to calculate royalties.
In addition to the royalty pool that comes from 10.5% of revenue, publishing royalties can also be calculated by counting 50 cents per subscriber; or 21% of revenue paid…