Why I’m Buying Spotify
Music and audio streaming giant Spotify reported earnings before the bell on Wednesday with mixed opinions from Wall Street. The stock dropped 4% on the news and has stayed down throughout the day. Personally, I was surprised and thought this was a great report overall, but we can get into that later. Here are the big highlights from the report:
Total Monthly-Active-Users (MAUs) up 29% Y/Y to 207 million.
Premium subscribers up 36% Y/Y to 96 million.
Total revenue up 30% Y/Y to $1.5 billion
Free cash flow and operating income both positive for the first time ever.
Some analysts, and rightfully so, are worried that Spotify’s average revenue per user (ARPU) is trending downward, down 7% Y/Y to $5.56 for the quarter. Spotify stated in the earnings release that they are planning for this to continue in the short-run because of the expansion to poorer areas of the world. Here is the full quote:
“The downward pressure on ARPU continues to be driven by product mix (Family Plan and Student Plan as a percentage of the total base), and is increasingly driven by market mix as growth in our relatively lower ARPU markets is outpacing geographies with higher ARPU.”
These acquisitions will help Spotify reach its goal of becoming a vertically integrated podcast platform. Gimlet is a premier producer of podcasts and Anchor is the best platform for content creators.
It looks like Spotify is learning from its fractured relationship with the music producing industry. Instead of paying royalties (although most shows are just free on the platform) Spotify will own both ends of the podcast industry, which could end up bringing in better margins than music listening.
Other Highlights from the Report
The company expanded its reach to 78 countries worldwide, up 13 from the previous quarter, and mainly coming from North Africa and the Middle East. They also hit a record 15 billion listening hours in the quarter, showing again how engaged users are with the service.
Here are two charts I look at every earnings release:
These charts show the geographical distribution of MAUs and premium subscribers on the platform. Interestingly, it looks like Europe is the only region with a larger percentage of subscribers than MAUs, which can probably be attributed to Apple Music’s success in the United States. Investors should look for increases in the “Rest of World” and “Latin America” regions as an indicator of success in those areas of the world.
Why I Would buy Spotify Right Now
Before I get into why I am so bullish on Spotify, here is a table comparing Netflix to the music streaming giant. NetflixSpotifyMarket Cap$154 billion$24.5 billionRevenue (last quarter)$4.2 billion$1.5 billionRevenue Growth27.4%30%Paying Subscribers139 million96 millionGross Margin39%26.7%Price-to-Sales9.7~4
*Data from Yahoo Finance and companies earnings reports. P/S for Spotify not provided from Yahoo so I based it on annualized quarterly revenue.
If you look at the companies from a pure valuation standpoint, it looks like Spotify takes the cake. Yes, they have a smaller gross margin and have to pay royalties to music labels, but the potential for growth and sheer numbers of paid subscribers gives Spotify the edge in my opinion.
On the earnings call, CEO Daniel Ek described his vision for the future of Spotify:
“Today, audio is only one-tenth of the size of the video market. So there is a massive opportunity here for audio to evolve into a more personalized, more immersive experience, much like how the video industry has evolved.”
I used to think Spotify was going to be the Netflix of music, but I now think they can become the “Netflix of audio” so-to-speak. It will start with podcasts by growing their original content offerings until they become the number-one player in the space. Then, once their premium subscribers reach crazy high numbers in 5-or-so years, they will start pulling a Netflix on the music labels.
Spotify’s addressable market is huge, the CEO/founder is great, and they have a first-mover advantage in the industry. As they continue to increase revenue, users, and gross margins over the next few years, investors may look back and ask “why the hell was Spotify ever a $25 billion company?” I’m bullish on Spotify after these earnings and think it is a buy at the moment.
Disclosure: The author may have interest in the companies talked about.