Spotify stock (New York Stock Exchange: Spot) is up 115% over the past year, but the market is ignoring a significant risk attached to the company’s investment proposition: the continued lack of meaningful returns with no clear signs of turnaround. Masu. Despite being a popular music streaming platform with over 570 million monthly active users, Spotify’s growth has paralleled mounting losses. This has raised concerns about the sustainability of the company’s business model and the valuation of its stock price. Therefore, I’m bearish on the stock.
Wall Street is overlooking Spotify’s profit shortfall
The way I see it, Wall Street seems to be overlooking the fact that Spotify isn’t making meaningful profits. Furthermore, there is a significant lack of a clear roadmap towards achieving sustainable profit margins. In fact, I would argue that Spotify’s business model is broken to some degree. Meanwhile, Spotify’s innovative platform enriches the listener experience and also helps artists grow their audience. On the other hand, narrow profit margins hinder a company’s potential to maximize shareholder value.
At the core of Spotify’s cost structure are the hefty royalties paid to artists and record labels, which cut into the company’s revenue and leave it with a meager gross profit. The company’s latest third-quarter results highlight this challenge once again, with Spotify’s gross profit margin hitting a modest 26.4%. While bulls may point to an improvement from last year’s 24.7%, the reality is that margins are still far from where they need to be to generate meaningful profits.
Clearly, when you take into account Spotify’s large expenses such as R&D, marketing, and administrative expenses (a staggering €853 million in the most recent quarter), these costs contributed to the company’s gross profit for the period. It becomes clear that almost all of the €885 million has been eroded. . As a result, Spotify effectively broke even, with an operating profit of just 32 million euros in the third quarter. This is not an impressive operating margin of 1% and could easily be erased by the impact of inflation on spending.
Re-accelerating Increase in MAUs Only half the picture
One point often cited by optimistic Spotify enthusiasts to explain the recent stock price surge is the company’s apparent acceleration in monthly active user (MAU) growth. However, this perspective seems to only capture part of the story, especially given that the acceleration in the pace of MAU growth has not translated into a corresponding acceleration in earnings. Let’s find out.
Spotify had 574 million monthly active users (MAUs) in the third quarter, a 26% year-over-year increase. Specifically, premium MAUs increased 16% to 226 million, and ad-supported MAUs increased 32% to 361 million. These growth figures compare to 20%, 13% and 24% respectively in Q3 2022, clearly indicating that growth was supposed to accelerate again. However, revenue growth for Q3 2023 was 11%, a significant deceleration from last year’s revenue growth of 21%.
Premium subscriber growth increased by 16%, but revenue from premium subscription fees only increased by 10% as average revenue per user (ARPU) decreased by 6%. The company attributed the decline in ARPU to a difficult product mix and market mix, in addition to currency headwinds. Spotify also noted that price increases will offset these challenges. Still, one wonders if these price increases caused a negative reaction from users (hence the “challenging product-market combination”). This may explain the higher growth of ad-supported accounts compared to the growth of premium accounts.
An examination of Spotify’s ad revenue also reveals a less rosy picture. Although the company showed a recovery in his MAU from advertising, revenue growth from advertising slowed to 16% from 19% a year ago. Additionally, Spotify’s ad-supported gross margin for the third quarter was 8.3%. This suggests that Spotify is likely operating at a loss in its advertising segment, considering all the other operating expenses associated with its advertising business, such as research and development and marketing.
ratings are meaningless
I find the stock’s current valuation puzzling, given Spotify’s continued challenge to achieve noteworthy profit margins and the apparent slowdown in revenue growth. This is especially true following Spotify’s extended rally in recent months.
First, Spotify’s EPS for the current fiscal year is expected to be negative, mainly due to the large losses incurred in the first half of the year. But even with Wall Street’s future projections in mind, valuations are still significantly inflated.
More specifically, according to forecasts, Spotify is expected to report EPS of $1.26 in FY2024, which would imply a forward P/E of approximately 139x. Although we have an optimistic scenario of rapid revenue growth, we question the outlook given the continued slowdown in revenue, but I am not sure how reasonable this valuation multiple is. is having a hard time understanding.
Is Spot stock a buy, according to analysts?
As for Wall Street’s view on the stock, Spotify Technology maintains a “Moderate Buy” consensus rating based on 16 buys and 9 holds assigned over the past three months. Spotify’s average stock price forecast is $188.39, suggesting a 7% upside potential.
If you want to buy or sell a spot stock and you’re wondering which analysts to follow, the most profitable analyst covering this stock (over a 1-year period) is Evercore ISI’s Mark Mahaney, with an average The return is 32.79%. Rating and 67% success rate.
Take-out
While Spotify’s stock price has skyrocketed, the market seems to be overlooking the important issue of sustainable profitability. The company faces challenges stemming from thin profit margins, high royalties and high operating costs, leading to doubts about the viability of its business model.
Additionally, despite the increase in MAUs, slowing revenue growth and questionable pricing strategy are leading to skepticism. At the same time, the current future value of the stock looks disproportionately high given that the hurdles to achieving large profits remain high. Given these concerns, I believe a cautious stance on the Spotify investment case is warranted. Therefore, I remain bearish on the stock.
disclosure
