KEY POINTS
- WHAT WE DIDN’T LIKE: We’ll skip the results recap since P preannounced. P guided light on revenue for both 1Q17 and the year, but the growth rate clearly skews toward 2017 (17%) vs. 1Q17 (6%), which implies a pretty sharp acceleration in revenue growth through the year. We don’t have a problem with that assumption since that should be the case as subs gains stack on top of each other. But given mgmt’s history of poorly managing expectations, we would have just preferred a complete sandbag so we can sleep on the long this year.
- WHAT WE LIKED: P is clearly prioritizing the sub opportunity, but doing so at the expense of the ad model, which we see as the only way to capitalize on the former. P expects ad supported hours to decline by 5%-10% this year. Given what has been steady increases in per-user music consumption, the only way to achieve a decline is by putting some form of a listener cap back on. Remember, the 5% sub penetration rate that we know of today was really borne out of a 5-month mobile listener cap back in 2013. It was roughly half that previously. The point being is that the user won’t pay for music unless they're prodded to do so. Further, P will be increasing ad load on its remaining ad-supported users. While that has historically led to attrition, there are fewer places to consume free music in a post Web IV world. That said, increasing ad load could wind up driving sub conversions instead of pushing users off the platform. But if the user hops, it just sucks cost out the model since P pays per track on the ad-supported side (vs. % of revenue on subs). Further, if the labels force Spotify to curb its free tier offering, which we suspect will be a condition of any new license agreements, then we suspect that will give P more lattitude to increase ad load further.
- LONG THESIS SUMMARY: We’re playing the first year of the model transition. The main theme is very little sub conversion goes a long way toward year-1 revenue growth given the monthly ARPU differential between the ad-supported service and its subscription offerings (~$1 vs. $5/$10). Further, that sub conversion is also a boon to profitability; not just because of the ARPU capture, but because it is literally contractually profitable vs. the ad-supported business that historically been a cash drain. In short, our thesis isn’t so much that we believe in the sub opportunity, but that the comp is just really bad (i.e. the ad-supported model). Our backstop is an activist camp that is finding growing support from a frustrated holder base to sell the company. We suspect P would have no shortage of bidders as a market leader in two two big Tech battlegrounds: Music & Mobile. For context, AAPL paid $3B to acquire Beats, which barely qualifies as a competitor. P's current EV is just north of $3B.
Let us know if you have any questions or would like to discuss in more detail.
Hesham Shaaban, CFA
Managing Director
@HedgeyeInternet
P | New Best Idea (Long)
08/16/16 03:54 PM EDT
[click here]
