Offshore Portfolio

Spotify, one of the leading streaming services, released its Q2 2024 results last week. Revenue for the quarter was €3.8 billion, up 20% year on year. Spotify also reported an operating profit of €266 million, an improvement from the operating loss of €247 million recorded a year ago. 

Spotify generates its revenue through two streams: its premium subscription and advertisements through its ad-supported subscription service. In the recent quarter, there were 626 million monthly active users, with 62% of these users utilizing the ad-supported subscription. However, revenue generated from advertisements only accounted for 13.6% of Spotify’s total revenue. Moreover, the ad-supported gross margin was 13.4%, and in some previous quarters, it has even been negative.  

Spotify’s gross margin increased from 24.1% a year ago to 29.2% for the recent quarter. Despite this increase, the gross margin remains relatively low compared to other tech companies. For instance, Netflix, which funds a good portion of its own content for television, reported a gross margin of 57% for its most recent quarter. 

Spotify’s low gross margin is primarily due to the high fees required by music labels. These labels generally hold the rights to the music streamed on the platform. In 2020, 78% of streams on Spotify’s platform came from four major record labels: Sony, Warner, Universal, and Merlin. Losing any of these deals could result in a significant loss of monthly active users, who might switch to other music streaming services, such as Apple Music, Amazon Music, or YouTube Music, with relative ease. 

Spotify also uses AI algorithms to creates playlists and recommendations based on listeners’ preferences and play history. Anecdotally, this is better than competitor’s app recommendations. 

In addition to the low gross margin, Spotify pays sales commission fees to Apple and Google, which host their apps in their respective app stores. Apple’s policy is to take a 30% commission on all in-app purchases in the first year an app is on its store, reducing the fee to 15% in subsequent years. Spotify is reliant on these app stores as they are the primary platforms through which people access their music on Apple or Android devices. This resulted in Spotify’s operating margin reducing to 7% this quarter.   

ASML and TSMC released their Q2 2024 results last week. These relatively unknown companies have developed key technologies that help create semiconductors, making our electronic devices smaller, more powerful, and more energy efficient.  

TSMC, a semiconductor fabrication company, manufactures the actual semiconductors, while ASML builds the lithography machinery used in the fabrication process. Lithography involves using light to etch the circuits on silicon. Some consider ASML’s lithography machinery to be the most complex technology ever created. If scaled out, the machine could shoot a laser to the moon and hit a target the size of a golf ball. 

For the quarter, TSMC reported a revenue of NT$673.5 billion (with $1 equalling NT$32.5), up 32.8% year on year, and an operating income of NT$286.5 billion, up 36.3%. High-performance computing, including revenue from manufacturing Graphics Processing Units (GPUs) used in AI models, accounted for 52% of TSMC’s Q2 revenue, growing 28% quarter on quarter. The second-largest segment for TSMC was revenue from smartphones, which accounted for 33% of the revenue but decreased by 1% quarter on quarter. 

 ASML generated €6.2 billion in revenue for the quarter, down 9.5% year on year, with an operating income of €1.8 billion, down 19%. Net bookings for the quarter were €5.6 billion, up 23.7% year on year. Some of ASML’s latest lithography machines sell for €350 million each, making the purchase not a trivial decision for their fabrication manufacturer clients. This results in ASML having lumpy earnings. ASML views 2024 as a transition year, guiding revenues and earnings to be similar to 2023, and expecting 2025 to be stronger as customers ramp up capacity.  

Despite TSMC’s strong results and ASML’s mixed results, both companies’ share prices decreased during the week. President Biden mentioned considering increased restrictions on selling semiconductors and semiconductor equipment to China, due to their dual-use nature in both civilian and military applications. Presidential candidate Trump also mentioned wanting Taiwan (where TSMC is based) to fund more of its own military operations. 

 ASML is held in the Lunar BCI Worldwide Flexible Fund, and in the offshore portfolios of our clients. ASML maintains an effective monopoly on lithography equipment, with no other companies currently matching their success. Such a monopoly inevitably attracts competition: companies may challenge ASML directly or seek to develop alternative technologies to achieve similar outcomes. 

Semiconductors or chips regulate electrical flow in electronic devices. They are vital for various products like computers, artificial intelligence (AI) systems, smartphones, automotive vehicles, and military equipment. Taiwan Semiconductor Manufacturing Company (TSMC) manufactures roughly 90% of the world’s cutting-edge chips, while ASML crafts lithography machinery essential for making these chips smaller and more energy-efficient.

Last week, TSMC and ASML released their Q1 2024 results. TSMC saw a 16.5% increase in revenue to NT$592 billion (with an average USD/NTD exchange rate of 31.4) compared to the same quarter last year. While ASML reported €5.29 billion in revenue for the quarter, marking a 21.5% decline from the same period last year. Due to the recent interest around AI, high performance computing chips accounted for 46% of TSMC’s revenue for the quarter.

ASML believes that the semiconductor industry is going to go through a transitory year this year. Orders for its machinery for Q1 2024 dipped nearly 4% compared to the same quarter last year and decreased by 60% compared to the previous quarter. Some of ASML’s latest extreme ultraviolet (EUV) machines go for around €350 million each. Consequently, manufacturers must be certain about their timing for acquiring lithography equipment. ASML anticipates its revenue for the year to remain consistent with 2023 levels. Subsequently, it’s positioning itself to escalate production for 2025.

The US Chips Act aims to encourage semiconductor manufacturers to establish plants within the United States. TSMC and Samsung have each secured approximately $6.5 billion in grants and subsidies to construct facilities in the US. ASML stands to benefit significantly from the Chips Act, given its near monopoly on the sale of EUV lithography machinery worldwide. However, due to the scale of these projects, there is an elevated risk of delays. Consequently, ASML faces the challenge of potentially building up inventory without the ability to deliver products, whilst these new facilities are being constructed. This could impact their near-term financial performance. However, when these new facilities are ready, they would need to be furbished with ASML’s lithography machines, which will likely be very positive for ASML.

The demand for more and more computing power to process the growing demand for AI, smartphones, EV’s and larger and more complex cloud service providers; is adding strain to energy grids. This is driving both the design and manufacture of more energy efficient semiconductors, as well as alternative energy solutions.

ASML is held in the Lunar BCI Worldwide Flexible Fund and by Lunar Capital’s Offshore Portfolio clients.