Spotify Technology (SPOT) is the world’s biggest music streaming service provider with more than 381 million monthly active users (MAUs). Of these, 172 million are active premium subscribers.
With a leading position in an expanding industry, Spotify showcases some excellent traits, including a predictable revenue expansion route ahead.
That said, I remain cautious regarding the company’s compressed net income margins. In my view, the company’s future profitability prospects are rather thin, so investors should be wary of the potential risks surrounding the company’s ability to deliver strong future shareholder returns.
Still, the stock could have upside at its current levels, but only if the platform’s enormous user base is monetized through supplemental avenues. I am neutral on the stock.
Growing Subscriber Count & Revenues
Spotify’s success has been built on its multi-platform availability and access. In my view, the fact that anyone can access Spotify from virtually any device and operating system makes for a great growth catalyst for the platform.
Additionally, Spotify’s clever execution, including offering ad-supported streaming, has helped the platform attract potential subscribers by familiarizing them with Spotify before opening their wallets.
Hence, Spotify’s MAUs have been increasing quarter-over-quarter. With MAUs continuously being funneled via the company’s ad-supported business model, it’s only a matter of time before they turn into subscribers, powering the platform’s subscriber growth prospects.
In Q3, Spotify reported premium subscriber growth of 19%. This is a rather robust growth rate, considering the company’s 172-million subscriber count, which could suggest that the company is converging towards a maturity phase.
The company pushed a Premium promotion in Q3, which assisted the typical seasonality of its business and offset the tough comparables from the successful Q3 2020 launch in Russia.
Fortunately, the company’s average monthly Premium churn rate for the quarter declined sequentially and only increased marginally year-over-year against 2020’s historic lows. The company also expects the FY-2021 churn to be lower than 2020, which is great news. Spotify subscribers are highly unlikely to migrate to other platforms, as once one adopts and becomes familiar with the platform, including building playlists and sharing music with others, shifting applications would be quite the hassle.
Consequently, Spotify’s revenues should keep developing steadily. Revenue growth should undergo minimal fluctuations, as has been the case historically due to the platform’s previously discussed, sky-high retention rates.
Thin Net Margins
Despite Spotify’s high-quality revenue generation characteristics, the company’s bottom line remains very underwhelming. In Q3, Spotify’s gross profit margins were only around 26.7%, translating to €668 million in gross profits.
COGS mainly comprises royalties paid to artist/record labels. That’s why gross margins are so low. Of the €668 million, €593 million were allotted to R&D, marketing, and administrative expenses. Accounting for taxes, Spotify recorded just €2 million in after-tax net income during Q3. Investors should not expect a dividend anytime soon.
Wall Street’s Take
Turning to Wall Street, Spotify Technology has a Moderate Buy consensus rating based on 12 Buys, 3 Holds, and 1 Sell assigned in the past three months. At $330.77, the average SPOT price target implies 38.95% upside potential over the next 12 months.
Conclusion
Despite Spotify’s attractive attributes, the company is competing aggressively with multiple other services, such as Apple Music. With each service constantly trying hard to poach users from each other, advertising expenditures should remain very high.
Also, music labels have no incentive to negotiate against themselves for lower royalties. Hence, while Spotify is likely to keep growing, there is no clear plan for investors to see a richer bottom line, and thus, in my view, shareholder value prospects remain limited.
Disclosure: At the time of publication, Nikolaos Sismanis did not have a position in any of the securities mentioned in this article.
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