Twitter and Spotify Earnings: What You Need to Know

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Two of the scrappier big tech companies reported this week, and Industry Focus: Tech has the breakdown. Host Dylan Lewis and Motley Fool contributor Evan Niu go through the reports and tell investors what they should know about the trends, figures, changes, and long-term outlook for Twitter (NYSE: TWTR) and Spotify (NYSE: SPOT). Spotify reported its first-ever operating profit this quarter, and it doesn't look like that's just a weird one-off. Twitter changed up its reported metrics, and it's finally sharing a stat that so many investors have wanted to know. Find out what long-term investors should watch going forward, how healthy these businesses look, what risks and challenges they're going to have to confront, and more.

A full transcript follows the video.

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This video was recorded on Feb. 8, 2019.

Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, February 8th, and this week's Discover Weekly has hits from Spotify and Twitter. I'm your host, Dylan Lewis, and I've got's tech specialist Evan Niu on Skype. Evan, what's going on?

Evan Niu: It's been a hectic week. The kids had a snow day yesterday, their teachers are going on strike next week. I might take a hit to my productivity next week. We'll see.

Lewis: Hopefully that won't impact our podcast schedule too much. I make that "Discover Weekly" joke in the intro there because we're talking about Spotify today. Before we get into the company discussion, what have you been listening to? Anything recently?

Niu: I've been listening to My Morning Jacket. They're actually coming to Denver later this year, so I'm going to see them. Also, the lead singer's solo albums, I've been listening to. That's what I've been jamming to lately.

Lewis: Any particular songs you'd recommend for our listeners?

Niu: I honestly don't remember what the songs are called because I just put it on in the background. I actually use Discover Weekly quite a bit and just have it in the background, or I'll just put it on shuffle or something. I actually don't know what most of the songs are. [laughs]

Lewis: I'm a huge fan of Off the Record by My Morning Jacket, for the record. Dan Boyd, man behind the glass, what have you been listening to lately? Any recommendations for our listeners?

Dan Boyd: Yeah, Dylan, I like to listen to a lot of ska and reggae. Lately I've been listening to a lot of the Slackers.

Lewis: Oh, that's right! Yeah, while we were doing the Q&A for the YouTube Live that we did earlier this week, you had some Slackers on, right?

Boyd: Yeah. It's probably my favorite band.

Lewis: That's awesome! So, we got the Slackers, we have My Morning Jacket. I will throw out that I've been listening to the Smiths quite a bit lately. I was watching this Netflix show, Sex Education.

Boyd: I was going to say, are you feeling OK? The Smiths, sometimes they get pretty dark.

Lewis: [laughs] I'm really into broody music, all right? That's just kind of where my heart is. But, there's this Netflix show, Sex Education, which is excellent. Very not safe for family consumption, but a very good show. They featured Asleep by the Smiths, which is an excellent song. If that's where you're leaning into things with the weekend, I highly recommend that.

With that, we have our listener weekend playlist onto maybe some actual financial and business results, because that's why people are listening to this show. [laughs] Evan, you follow this company very closely. You're a shareholder. What stuck out to you in Spotify's results?

Niu: I think it was a pretty solid quarter. Quick note, we're going to mention all these numbers in dollar terms, even though they report in euros. Revenue is up 30% to about $1.7 billion. The user base is still very strong and growing. They added 16 million monthly active users during the quarter. They're now up to about 207 million. Added nine million Premium subscribers, now at about 96 million total. They added seven million ad-supported free listeners, which is now at about 116 million total. Remember, those numbers don't add up because there are some Premium subscribers that are actually inactive and do not qualify as monthly active users. This is the No. 1 paid music streaming service in the world. They're chugging along.

Lewis: One metric that a lot of people track with this company is the average revenue per user. We've seen this decline a little bit recently. There are some good reasons for that, though. It declined again this quarter, but that plays into the broader strategy with what we're seeing from this company.

Niu: Right. It came in at about $5.56. That's long been attributed to, Spotify has been really expanding these family and student plans, which help grow their user base and get more people stuck on service. That really helps retention. If you have a whole family of six people on one plan, you're really unlikely to move to another service. But, that also reduces your average revenue per user because they're pretty cheap when you spread it out across four or six people. Churn declined by about 30 basis points, which really underscores to why it's worth it. On top of that, they are seeing some of their market mix shifting toward these emerging markets, which have been a good source of user growth, where they are not getting as much per user anyways. If you remember, Spotify prices their service differently based on which market they're talking about.

Lewis: We might have buried the lede a little bit in talking about the financials because I was pretty surprised to see that they posted their first-ever operating profit this quarter. What made that happen?

Niu: I think that was the big milestone this quarter. It's their first-ever operating profit. Operating expenses have been coming down for a number of reasons, including -- we saw this play out in the third quarter -- hiring was slower than expected. That continued in the fourth quarter just like they said it would. The operating profit was $107 million. Also, a weird thing about their declining share prices actually helped because that reduces what they call accrued social costs, which are things like payroll taxes, mostly related to stock-based compensation. Most of that's recognized in Sweden, which is where they're based. But Spotify said that even if it weren't for that, they would still have been profitable.

Either way, it's a huge milestone. I think it's more significant than when they posted a positive net income in the third quarter, because that quarter, it was mostly related to revaluing their stake in Tencent Music. They still operated at a loss in the third quarter. This time around, it's much more meaningful because they were able to operate at a profit.

Lewis: Is this the kind of thing that investors should expect going forward? Or is this something that will fluctuate quarter to quarter for a little while?

Niu: I think it's going to fluctuate. Their full-year guidance does predict that they're going to swing back to an operating loss for the full year. They're still investing very heavily in this business. As we're about to talk about, they're going to really push into podcasting. They have a lot of things going on that are going to cost quite a bit of money. I don't think that they're going to be posting consistent quarterly profits any time soon. But, it's still important that they can.

Lewis: You mentioned the podcasting. Some of our listeners are probably aware that Spotify is dipping their toe a little bit into the podcasting world. They decided to really jump in recently with some acquisitions. These are some of the first big acquisitions that the company has made.

Niu: Right. They're acquiring Gimlet and Anchor, are two different podcasting companies. Gimlet's a membership-based podcasting platform. The rumored price tag was about $230 million. They didn't officially disclose it. Anchor provides a bunch of tools that allow podcasters to make, distribute, and monetize their content. All told, we have different parts of this podcasting piece that Spotify is investing in, between infrastructure and content. They also said that there's more to come. They're allocating $405 million total for 2019 for acquisitions, including Gimlet and Anchor. That's going to be focused heavily on podcasts.

Lewis: When you look out at the podcasting landscape, and you and I spend a lot of time thinking about this beyond just investing -- we both consume a lot of stuff in the podcasting world -- Gimlet is one of the big names. If you're thinking about who you can acquire in this space that would be a big splash, it would be Gimlet. You can't buy NPR, even though they're the established player. Maybe throw Stitcher in there, but it seems like they want to be independent. So this is going out there and getting a pretty big fish.

Niu: Right. The way that CEO Daniel Ek framed is that Spotify wants to be about all audio content, not just music. He sees the future of Spotify as expanding to other types of audio content. Podcasts is clearly another category that's huge in terms of audio content. It plays into Spotify narrative of becoming this two-sided marketplace and platform, connecting listeners and content creators. On top of that, a nice plus side is that it can boost their margins because the cost structure for podcasts is much more favorable compared to music because music has these massive licensing and royalty costs, whereas podcasting is more of a revenue sharing with maybe ads. Not sure exactly how they're going to do it. Either way, the cost structure is definitely going to be much more favorable.

Lewis: To me, this signals that there's the possibility that we could see Spotify also veer a little bit more into what we see with Netflix over the last couple of years. You have the flagship shows that bring people to your platform, and you become a little bit less reliant on the stuff that people can get elsewhere. If you can only get some of these podcasts through their platform, it's going to make a lot of consumers decide to go there instead of maybe an Apple Music.

Niu: Right. That's part of the angle here, too. CFO Barry McCarthy even made a loose comparison to Netflix himself. If you remember, he's actually a former CFO of Netflix. They're trying to get a little bit more content exclusive and in-house in order to differentiate themselves. It's not going to be nearly to the extent that you see on Netflix, which is, nowadays, a lot of their originals are driving their engagement. McCarthy says that the majority of podcasts are not going to be exclusive. But they do want to have a little bit of that. Remember, Spotify has one of the largest and fastest-growing audio ad businesses in the world, which did about $600 million in revenue last year. They have clear ways to monetize podcasts. It could also boost retention, too. Daniel Ek also said that podcast users tend to be two times more engaged than music listeners. A lot of benefits.

Lewis: Yeah, I don't think we'll see Spotify going and spending $8 billion on original content anytime soon like Netflix has. But I think this is a step in the right direction for them. It's a point of differentiation and it makes their platform a lot stickier.

Besides all of the news that we saw with Spotify this week, Twitter reported earnings. This is a company that we particularly love to cover. They've been such an interesting story over the last couple of years. If you look back over the last 12, 18 months, we've seen a renaissance with this company. That renaissance took a little bit of a halt when they reported earnings recently.

Niu: Right. The big thing is that they are profitable now on a GAAP basis. That's obviously a pretty big, important milestone if you're trying to build a sustainable company, to actually be profitable. [laughs]

Lewis: Yeah, but unfortunately, Wall Street just wasn't happy with the guidance they were providing for these upcoming quarters. That's why stock sold off about maybe 10%, 13% after earnings.

You look at the numbers, though, Q4 revenue was around $900 million, up 24% year over year. They're guiding for growth somewhere in the 7% to 15% range for next quarter. That's why you see a little bit of the sell-off after they reported earnings. For the full year, the company brought in a little over $3 billion in sales. You mentioned that GAAP profitability. This is where we need to dust off your CFA a little bit here, Evan, and do a deep dive into the numbers, because some people will look and say, "OK, they posted $1.2 billion in net income. That's pretty darn good on $3 billion in sales." The reality is, that's not what people should necessarily expect going forward.

Niu: Right. There's a big caveat there, which is that they recognized $845 million out of that $1.2 billion. A very big chunk of that total number there was related to deferred tax asset valuation. To try to explain this as briefly and straightforward as I can, companies create deferred tax assets in general when they operate at a loss, which Twitter has historically done. Now, if the company thinks that there's a greater-than-50% probability that they will not be able to use those tax assets toward future profits, they have to create a valuation allowance that reduces the value of the tax asset. The valuation allowance releases, the benefits that Twitter's recognizing, basically showed that what the company is doing is they're more confident now that it can generate enough future profits in the future to apply those deferred tax assets against. In other words, Twitter now thinks there's less than a 50% chance that those assets will be wasted.

Lewis: If you want to look at exactly what Twitter's business does absent all of that, you mentioned that $845 million, this stuff that was from the operating business itself, net income was around $360 million, which would give you a net margin of around 12%.

Niu: Right. They're still profitable, even if you back all that out. On an operating basis, their operating margin was something like 15%, too. They're still showing that they can be profitable even if you ignore this tax asset stuff.

Lewis: When we've talked about this company in the past, Evan, we have frankly expressed some frustration over how they've reported their user numbers. For this report and for next report, we will get what we want. We'll get a look at daily actives and we'll get a look at monthly actives. That's going to change, though, because of some of the shifts that they're making in how they report their numbers.

Niu: Right. They introduced this new number for the first time, giving investors what we've been asking for this whole time, which is an actual number in absolute terms around daily active users. They have long resisted and always pointed toward the percentage change. The new metric is monetizable daily active users, MDAUs is how they shorten it. It gets a little confusing because right now, what they're focusing on is daily users that they can monetize. It's a complete reversal from how Twitter looks at its user metrics in more ways than one. If you remember, back in 2017, the SEC specifically tried to get Twitter to start disclosing daily active numbers and Twitter refused, basically saying, "The percentage change is more important because that shows you the trends and engagement." Now, they're basically admitting, "Absolute daily numbers are in fact important," which everyone knew all along. [laughs]

But also, there's another contrast. Even further back, under CEO Dick Costolo, they had this total audience strategy where they would basically highlight their total audience and say, "It's two to three times larger than our monthly active user base when you include all these users that are not logged in." That would put their total audience somewhere in this 500 million to 800 million range around that time. What they were trying to do is say, "We want investors to appreciate that Twitter has this reach that's beyond our platform." The problem with that approach is always that Twitter can't monetize a lot of that reach. For example, if a third-party website embeds a tweet in a news article, Twitter's not showing an ad there, it doesn't create a lot of value for them other than expanding the brand presence or whatever. They're not benefiting from it financially. This new MDAU approach is very specifically focusing on users that are logged in and can be monetized by showing them ads.

Lewis: If the SEC couldn't convince Twitter to make this switch, why are they doing it now?

Niu: I think a lot of it is that the MDAU number is going up and the MAU number is going down. [laughs] So, clearly, they would want to highlight the one that's going the right direction.

Lewis: So, for you, it's just, this is the more marketable figure that they can put out to Wall Street?

Niu: Right, exactly. The monthly user base has started to shrink. That's not something you want to highlight to investors.

Lewis: While we have this overlap here, where we can see what MDAUs and MAUs look like, we'll have MAUs this quarter and in Q1 of 2019, we can see what percentage of monthly actives actually engaged daily. They threw out, it was 39% recently. It's going up a little bit. That's because the daily active number, the numerator is going up, but it's also because the denominator is going down.

Niu: [laughs] Right. And if you compare that to Facebook, which has always provided both numbers, roughly two-thirds of Facebook's monthly users globally are active every day.

Lewis: Right. So, this speaks to one of the big things with Twitter. The people that love it love it. But the audience growth seems somewhat capped. Because those MAUs are declining, you're working with a really dedicated user base, but one that is not expanding beyond the people that it already attracts.

Niu: Right. There's also some geographical considerations too. Their ability to monetize in the U.S. is much stronger than international. Where they can expand in some opportunities is if they can improve monetization on international users. That can help while they're still trying to push monetization on U.S. users. But it's already much stronger in the U.S. We'll see how that plays out.

Lewis: I mentioned that Wall Street didn't like these results because of the guidance. I did see some good stuff in here, though. One of the big things that I've been tracking with this business is what's going on with their ad prices and their impressions. Those are the two things that are really going to drive revenue growth for an ad-based business. For the longest time, we've been seeing that all of the revenue growth has been fueled by the fact that they've shown more impressions on their platform. That's because ad prices have been precipitously falling. It's been double-digit-percentage, year-over-year declines going back to Q3 of 2015. In this most recent quarter, we saw a 7% decline. It's possible that we're starting to get to the bottom of ad pricing and that some of the new ad concepts that they're rolling out are looking good. I'm really encouraged by that.

But to go back to some of our frustrations with how management handles reporting, they stopped including that in their presentation this quarter. They've included it every single quarter going back as far as I remember. And yet now, when it's starting to trend well, I can't find it. I have to look in the press release and start digging around in some of the other stuff. It's not a number that they're trumpeting and highlighting, which is curious to me.

Niu: Yeah, they're making all these changes in how they present their data. Video ads are certainly helping mitigate some of those declines, because video ad prices are pretty attractive in general.

Lewis: One other encouraging thing for me from this call was that Jack Dorsey was asked about some of the product changes that he was particularly excited about. One of his answers really landed for me. He'd said that Twitter is an interest network in his mind, and that people come to the platform in order to follow very specific interests, and they realize that they need to make it easier for people to opt into, express, and follow those interests, particularly as new users are coming onto the app or reengaging with the app. I look at that and I say, "OK, that sounds like a little bit more of a user opt-in on either some sort of tagging system or a like-based system, which sounds a lot like the targeting that Facebook has on a lot of its users."

Niu: Right. That's the funny thing about Twitter. There's so many different forms and sections of Twitter. There's Tesla Twitter, there's finance Twitter, Apple Twitter, tech Twitter, news Twitter. There's all these different types of Twitter and they're all jumbled together in the same timeline. If they can think of ways to maybe separate them a little bit better and say, "If you're interested in this, you can go here," that would be interesting to me.

Lewis: That seems like a huge win all around. If you're able to make the platform a lot more intuitive for users, make it a lot easier for them to find the stuff they're looking for, and on the advertising side, be able to say, "Hey, your targeting is going to be way better," I have to imagine that that leads to better user metrics and also far better advertiser ROI because they're getting the audience that they want to be accessing.

Niu: Right, exactly. Especially if you're removing friction and making it easier for the users. You can't just rely on everyone always putting in hashtags for certain topics or dollar signs for certain stocks. Sometimes people want to talk more organically. If they can improve how they organize all this content into these interests, to your point, they can improve ad targeting, because you obviously know what these people are interested in.

Lewis: Where I do get stuck with this business, though, is there's upside, and they continue to see that they're able to add more ads to the platform. They might be able to engage the existing audience and continue to grow DAUs. But it feels like at a certain point, you're going to run out of ways to juice the audience that you have.

Niu: Right. On top of that, their costs are going up, too. There's a lot of pressure on the cost side of the business. You have to be growing revenue enough to cover these costs. They're predicting that operating expenses for 2019 are going to be up about 20% as they continue to invest very heavily in safety and platform health as their No. 1 priority right now, because Twitter can be a toxic place for a lot of people. They need to really tackle that. They've been so bad at tackling it for so many years. They're starting to make some progress but they still have a lot of work to do. But that's going to cost quite a bit of money, and it could also pinch margins. It's ultimately worth it, but it's something that investors should expect.

Lewis: All told, looking at this business, my view on things, Evan, is I think they're making a lot of the right investments. They're doing right by a lot of their users. Unfortunately, I don't look at this any differently than I have over the last couple of years, where I've just wondered, how big can this business get with the audience it has and the way that ad rates have been moving? Even within stabilizing a little bit, I just wonder what the upside really is.

Niu: Yeah, I've never touched Twitter stock, long or short. I've always put it on the sidelines. It's been an interesting thing to see play out over the past few years, as so many things have changed, from management and leadership to product changes to reporting changes. I agree, I'm not really excited about it. Otherwise, obviously, I would probably buy the stock. They're making a lot of good progress in terms of platform health, financials, profits, but I'm still not really interested.

Lewis: All right, Evan, thanks for hopping on the show today.

Niu: Thanks for having me.

Lewis: Hopefully things don't get too crazy at the house. Hope you get to enjoy your weekend a little bit!

Niu: I'll do my best!

Lewis: Dan, thanks for your work behind the glass today, too!

Boyd: Hey, you got it, bud! That's what they pay me for!

Lewis: [laughs] That's what they pay you for! Listeners, that does it for this episode of Industry Focus. If you have any questions, or if you want to reach out and say hey, you can shoot us an email at, or you can tweet us at @MFIndustryFocus. If you want more of our stuff, you can subscribe on iTunes or catch us on Spotify, or you can check out videos from this podcast over on YouTube. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. For Evan Niu, I'm Dylan Lewis. Thanks for listening and Fool on!

Dylan Lewis owns shares of Apple and Facebook. Evan Niu, CFA owns shares of Apple, Facebook, Netflix, Spotify Technology, and Tesla. The Motley Fool owns shares of and recommends Apple, Facebook, Netflix, Tesla, and Twitter. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.