Spotify Earnings: A Forecast Rise in Costs Spooks the Market, but the Business Looks Very Healthy

Key Morningstar Metrics for Spotify

• Fair Value Estimate
  : USD 500
• Morningstar Rating
  : ★★★
• Morningstar Economic Moat Rating
  : Narrow
• Morningstar Uncertainty Rating
  : High

What We Thought of Spotify’s Earnings

Spotify’s SPOT first-quarter sales, profits, and user metrics were all very good, as were second-quarter sales and subscriber outlooks. The only negatives we saw were a second-quarter operating profit forecast well below the FactSet consensus and an ad-supported business still struggling.

Why it matters: The operating profit forecast prompted a steep stock selloff that we think is a drastic overreaction. The firm has a history of uneven progress on margins, driven by long-term investments that have nonetheless led to a long-term trend of sharply improving profitability.

• Higher near-term costs are due to investment in AI and cloud services, as well as marketing expenses to highlight new features that these investments have produced. Our forecast already included a slowing in the rate of margin expansion.
• The firm’s outlook still implies second-quarter operating margin expansion of nearly 350 basis points year over year, including 130 basis points in gross margin expansion. This forecast implies a sequential contraction in operating margins that would mirror last year’s second-quarter contraction.

The bottom line: Our forecast is unchanged. The USD 10 reduction in our fair value estimate, to USD 500, is due solely to EUR/USD exchange rate fluctuations since our last update. We believe Spotify has a narrow moat, and we don’t see any weakness in subscriber levels or pricing.

• Spotify added 10 million net new users during the quarter, more than tripling the number added in the same quarter last year. As Spotify forecast, 3 million of those users were premium (paying) subscribers, 2 million lower than last year. In the second quarter, Spotify expects to add 17 million users, including 6 million premium subscribers.
• Excluding the impact of currencies, first-quarter revenue grew 14% year over year, and average revenue per premium subscriber was up 5%. The only top-line weakness was ad-supported revenue, which was up only 3% in constant currency.