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1 Potentially Troubling Trend for Spotify

By Evan Niu, CFA – Nov 6, 2018 at 4:39PM

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But it could be nothing to worry about.

Spotify (SPOT 0.93%) reported third-quarter earnings results last week, and they weren't music to investors' ears, as shares fell nearly 6% following the release. The company now has 87 million premium subscribers, and investors are likely overreacting to the company's tweaked guidance for 2018. Spotify now expects to finish the year with 93 million to 96 million premium subscribers, a modestly tighter range than the 93 million to 97 million premium subscribers it forecast in July.

Still, there's another potentially troubling trend within Spotify's user metrics.

Spotify on desktop

Image source: Spotify.

Inactive premium subscribers are growing

If you look at Spotify's user metrics, it reports premium subscribers, ad-supported monthly active users (MAUs), and total MAUs. However, premium subscribers plus ad-supported MAUs does not equal total MAUs like you might expect.

User Metric

Q1 2019

Q2 2018

Q3 2018

Premium subscribers

75 million

83 million

87 million

Ad-supported MAUs

99 million

101 million

109 million

Total MAUs

173 million

180 million

191 million

Data source: SEC filings.

When asked, Spotify's investor relations department confirmed to me that the difference is attributable to premium subscribers that do not qualify as MAUs since they are inactive. The risk is that a premium subscriber that has become inactive may soon cancel the service if they aren't using it. For reference, Spotify defines an MAU as a user who listens to more than "zero milliseconds in the last thirty days" of a given quarter. Historically, the number of inactive premium subscribers has been modest, usually 1 million to 2 million. But this figure has spiked over the past couple of quarters, and now stands at 5 million.

Chart showing inactive premium subscribers over time

Data source: SEC filings.

It's worth noting that the growing number of inactive premium subscribers in absolute terms isn't just a function of Spotify's growing user base. On a percentage basis, inactive premium subscribers now comprise nearly 6% of the premium subscriber base, up from just 1% in the first quarter.

Are they just part of family plans?

The best possible explanation for the rising number of inactive premium subscribers is the rapid uptake of family plans. Spotify has already highlighted the pros and cons of family plans: much stronger overall user retention (evidenced by lower churn) but declining average revenue per user (ARPU). Premium churn declined by 90 basis points to 4.8% in the third quarter, nearly a record low for Spotify.

Reported premium subscribers include all user accounts, including those registered in a family plan. If the uptick in inactive premium subscribers is attributable to users who are part of family plans that may not use the service often, then there's not much to worry about since the overall health of the user base is still improving. A family is unlikely to cancel their entire plan simply because one member doesn't utilize the service.

While it's not good for inactive premium subscribers to be rising, investors can rest easy as long as overall churn continues to trend lower.

Evan Niu, CFA owns shares of Spotify Technology. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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