Spotify: The Future Looks Very Bright (NYSE:SPOT)

Spotify: The Future Looks Very Bright (NYSE:SPOT)

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When we think about the technology and apps that have changed our lives in various categories, in the music space, naming Spotify (NYSE:SPOT) as a generational mover is ubiquitous. This global leader in music streaming has become almost synonymous with the music industry itself, and though Wall Street and the markets have had a love-hate relationship with Spotify since its direct listing near $150 per share, the business continues to produce excellent results.

Which is exactly why, when the broader markets are falling and tech/growth stocks continue to get punished (even companies with rock-solid fundamental performance), companies like Spotify should be aggressively bought. I’ve recently leaned into my position on Spotify, and will continue to be an avid buyer of the stock as it falls.

SPOT data by YCharts

Needless to say, I remain bullish on Spotify. The company is executing well on a number of key metrics – including strong Premium subscription adds, while also growing the ad-supported revenue stream. Yes, profitability is down right now due to opex growth, but that’s no different than what dozens of other companies are reporting.

I also think some recent initiatives that Spotify is embarking on are particularly exciting. The company, no stranger already to revenue and product diversification, may be entering the live event ticket sales space through its new site Spotify Tickets, occupying a space currently dominated by embattled vendors like Eventbrite (EB). The key challenge that companies like Eventbrite faced was scale. Especially during the pandemic, it relied a lot on smaller “indie” creators rather than mass-market events to drive its business.

Spotify, on the other hand, already has direct relationships with global stage idols. This kind of “vertical integration” into managing all of an artists’ distribution, from virtual music streaming to physical concerts, can represent a massive expansion of Spotify’s mandate and its eventual TAM.

Here’s a refresher of all my other reasons to be bullish on Spotify:

  • Spotify continues to roll out new products and prove that it has something for everyone. In 2021, Spotify rolled out a new paid tier called “Spotify Plus,” its cheapest offering at just $0.99/month. While this tier is still supported by ads, it gives users the ability to skip as many songs as they’d like within an hour, potentially opening Spotify up to a bigger batch of lower-end consumers. Alongside consumer innovations, Spotify has also improved the partner experience, with innovations including the Spotify Audience Network for podcast advertisers, giving them the ability to more effectively target podcast listeners and hopefully helping to increase monetization in podcasts (Spotify’s biggest growth category).
  • Successful price increases for Premium. Spotify raised the price of its Family plan in the U.S., the Family/Duo/Student plans in the U.K., and all plans in Brazil. The fact that Spotify reported no meaningful change in churn since the price changes went into effect is a testament of its relative inelasticity when it comes to music streaming. In addition, Spotify has proven itself to be a very sticky platform, with content like podcasts and playlists keeping subscribers hooked to the platform.
  • Two-sided marketplace. Another nascent revenue opportunity for Spotify: paid marketplace tools for content creators represent another way to fully integrate Spotify into the music ecosystem and expand its wallet share.
  • Margin builds and rich free cash flow profile. Higher advertising rates, a mix shift into podcasting, and the general economies of scale that come from paying for music content spread across a bigger base of users have helped Spotify dramatically increase its gross margin and free cash flow profile.
  • Work from anywhere. Spotify announced a remote-work option for all of its employees globally, which I view as a positive move that can reduce Spotify’s real estate footprint and drive lower operating costs in the long run.

Don’t turn a blind eye to the rich opportunities this stock affords. The drop is entirely sentiment-driven; there is nothing in Spotify’s recent quarterly results that merits the sharp ~60% drop the stock has suffered year to date. Use the dip here as a buying opportunity.

Q2 download

Let’s now go through Spotify’s latest quarterly results in greater detail. The Q2 earnings summary is shown below:

Spotify Q2 results

Spotify Q2 results (Spotify Q2 earnings deck)

Spotify’s revenue in Q2 grew 23% y/y to €2.86 billion, which beat the company’s guidance of €2.80 billion (+20% y/y) by a three-point margin. Revenue also kept pace versus Q1’s 24% y/y growth rate.

Strength was fairly broad-based across revenue streams. On the Premium side, which still represents the lion’s share of Spotify’s revenue, the company saw a 14% y/y jump in subscribers (again matching pace with Q1’s 15% y/y growth rate). The company also added 6 million net-new subscribers in Q2, which was notable especially after a relatively weaker Q1 add of just 2 million subscribers.

Spotify key metrics

Spotify key metrics (Spotify Q2 earnings deck)

The company noted that a slightly extended promotional window (5 weeks versus 4 last year) contributed to the success. On a geographical basis, the company called out that Europe benefited from strong reactivations of dormant subscriptions, while Latin America saw a big spike in Gen Z users alongside new music releases. We note as well that ARPU continued to grow, producing 22% y/y growth on Premium revenue versus 14% y/y growth in subscribers, with ARPU growth driven by the company’s successful price increases across its plans.

Ad revenue was another major standout. The company achieved 31% y/y growth in ad revenue in the quarter as monetization of podcasts improved, and ad revenue reached an all-time high of 13% contribution to overall revenue.

Spotify ad revenue disaggregation

Spotify ad revenue disaggregation (Spotify Q2 earnings deck)

The only potential weak spot was opex, but Spotify is suffering from the same cost/wage inflation that every other company is. The chart below shows how each component of opex grew y/y. FX was a major headwind here despite Spotify’s European domicile, as a stronger dollar stretched Spotify’s largely dollar-based expenses in Euro terms:

Spotify opex trends

Spotify opex trends (Spotify Q2 earnings deck)

Spotify’s leadership, however, is citing confidence in the future and no material impacts from macro clouds darkening in its business. However, the company is taking prudent steps to slow hiring to prepare for a downside case. Per CEO Daniel Ek’s prepared remarks on the Q2 earnings call:

Going forward, while the macro environment continues to present uncertainty, we are currently not seeing any material impact on our expectations for users or subs growth from the economic downturn. In fact, we are seeing several markets trending ahead of our forecasts. That said, in anticipation of a potential slowdown, we already shared that we proactively reduced our hiring by 25% and instituted a double-down weekly revenue monitoring. I have said this before, I do believe only the paranoid survive, and we are preparing as if things could get worse, but it’s hard to be anything but optimistic given what I am currently seeing.

Looking further ahead, recession or not, my confidence in our business and the unique Spotify machine that we are building is really unwavering. Audio is growing and Spotify with it. Hopefully, after last month’s Investor Day, this is a term you are all familiar with. And for those needing a refresher, we believe the Spotify machine is what differentiates us from other tech platforms. It leverages one consumer experience, powered by three revenue-generating business models: subscriptions, ads and marketplace. And as I detailed last month, we are confident in our ambitions to get to 1 billion users by 2030, while at the same time, we are also focused on improving our gross margins and continuing to generate positive free cash flow.

Key takeaways

With strong execution in its core business (subscriber growth despite price increases, doubling down on advertising as a secondary revenue stream) with potential new growth drivers like concert ticket sales ahead, there’s no reason not to remain bullish on Spotify. Use the dip as a buying opportunity.

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August 31, 2022 / Markets / Tags: , ,