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Snap and Spotify Are Finding That Profitably Competing Against Tech Giants Isn't Easy

While Snap and Spotify are each delivering solid user and revenue growth, their cost structures and competition are making it hard for them to turn profits.

Even if a company is delivering healthy user and revenue growth while competing against deep-pocketed tech giants, doing so profitably can be a whole other challenge.

In their own ways, Snap  (SNAP) - Get Free Report and Spotify’s  (SPOT) - Get Free Report Q4 reports each drive this home.

Snap, which fell 14.7% on Wednesday, reported its daily active users (DAUs) grew a better-than-expected 17% annually to 218 million. And while revenue missed consensus estimates by $2 million, it was still up 44% to $561 million.

However, even after backing out a $100 million legal charge, Snap posted a $147 million GAAP net loss for its seasonally strongest quarter. And its free cash flow (FCF) came in at negative $76 million, below a negative $31 million consensus.

Moreover, Snap guided for Q1 adjusted EBITDA of negative $70 million to negative $90 million, below a consensus of negative $66 million. And on its earnings call, CFO Derek Anderson would only say that Snap expects to “make additional progress” towards becoming profitable and cash-flow positive in 2020.

Between them, the Q4 FCF print and Anderson’s remarks suggest that a pre-earnings analyst consensus for Snap to be slightly cash-flow positive for the whole of 2020 was too optimistic. They also call into question a consensus for FCF to soar to $395 million in 2021.

Spotify, which fell 4.8% on Wednesday, reported that its premium subscribers grew 29% annually to 124 million (near the high end of its guidance), and that its monthly active users (MAUs) grew 31% to 271 million (above the high end of guidance). The company also set 2020 premium subscriber and MAU guidance ranges of 143 million to 153 million and 328 million to 348 million, respectively.

However, Spotify also guided for a 2020 operating loss of €150 million to €250 million ($165 million to $275 million), up from a 2019 operating loss of €73 million ($80 million). In addition, the company guided for a 2020 gross margin (GM) of 23.2% to 25.2%, down from 2019’s 25.4%.

Unlike Snap, Spotify is cash-flow positive -- with a bit of help from some payment timings, it produced 2019 FCF of €440 million ($484 million). But this has much to do with working capital dynamics: Spotify collects subscription revenue before it has to make royalty payments related to those subscriptions to music labels.

On Spotify’s call, management signaled that the company’s swelling podcast/content investments will weigh on its bottom line this year. The Q4 report coincided with a formal announcement (following reports) that Spotify is buying Bill Simmons’ The Ringer, which has a substantial podcast operation.

When one looks at the specific factors that have made it hard for Snap and Spotify to make money, competition from tech giants suddenly looms large.

Snap is squaring off against Facebook’s  (FB) - Get Free Report platforms for both consumer attention and ad dollars, while having much less scale (either in terms of users or ad revenue) than Mark Zuckerberg’s company. And whereas Facebook’s services are hosted on its own, highly efficient, data center infrastructure, Snap is paying Google  (GOOGL) - Get Free Report and Amazon  (AMZN) - Get Free Report to handle its infrastructure needs.

Spotify has margin-crimping deals with big-3 music labels Sony, Universal and Warner, and has limited negotiating leverage with these firms since subscribers would revolt if any of the labels’ massive music catalogs vanished from Spotify’s services.

And along the way, Spotify is competing against tech giants that can promote their music services for free to their massive user bases and host the services on their own infrastructures (Spotify relies on Google). Also, while the tech giants’ deals with music labels are (from all indications) similar to Spotify’s, these companies can afford to treat their services as loss leaders meant to keep consumers hooked on their broader ecosystems, if they wish.

As Snap and Spotify’s latest numbers demonstrate, these structural and competitive issues are still making it hard for the companies to live up to Wall Street’s profit hopes, even as their user and revenue bases grow at solid double-digit rates.