Demand for digital subscription services, such as music listening, news, video, and even gaming, has been increasing in recent years, and Spotify Technology (SPOT 3.10%) and Apple (AAPL 1.78%) are two of the leading brands that consumers are turning to for their digital fix.
Spotify is the audio leader, with 124 million paying subscribers. That is twice the subscriber base of Apple Music, which last reported 60 million subscribers in June 2019. Spotify is also growing a lot faster than Apple overall. But does Spotify's lead translate to a better investment? Let's find out.
What's the situation at Spotify?
Spotify reported revenue growth of 24% year-over-year in the fourth quarter of 2019. That is much faster than Apple's total revenue growth of 8.9%. Spotify is on a mission to be the largest audio provider in the world, and it seems to be well on its way to achieving that goal. It has 271 million total monthly active users, including both paying members and users who engage with the free ad-supported side of the service. The total user base increased by 31% year-over-year in the fourth quarter.
Spotify has been expanding into podcasts to extend its long-term growth runway. The company has scooped up a handful of podcast producers recently, including Gimlet Media, Parcast, and The Ringer, which is a leading creator of sports, entertainment, and pop culture content.
The podcast market is growing very fast. Total podcast advertising revenue was estimated at $479 million in 2018 and is expected to reach more than $1 billion by 2021, according to a report from the Interactive Advertising Bureau and PwC.
Management so far has found podcast content increasing engagement and member retention on Spotify's platform. Most importantly, podcasts are helping to convert free users to try a paid subscription.
This is beneficial for Spotify's business for a few reasons. It should keep more members locked-in to Spotify's platform, creating a stronger competitive moat. It also provides Spotify a way to invest in original content that users can't get anywhere else.
What's happening at Apple?
While many people will keep their subscription to Spotify during a recession, Apple is at a disadvantage in the short term because it mostly relies on selling more iPhones, iPads, and Macs every quarter to grow revenue. While revenue from its services business (e.g., Apple Music, News+, Apple TV+, Apple Arcade, Apple Pay, and the App Store) grew 17% year-over-year, the segment only made up 14% of Apple's total revenue last quarter.
The iPhone maker's dependence on hardware sales will make 2020 a rough year, given the economic shutdown and spike in unemployment from the COVID-19 outbreak. Apple's Foxconn factories in China that assemble iPhones are operating again, but retail stores outside of China remain closed. Apple has already guided that its March-ending quarter sales will come in lower than its previously announced guidance.
An analyst with Goldman Sachs has painted a dire picture for the company in the short term, predicting that lower consumer demand for pricey iPhones will cut sales by 36% in the fiscal second quarter (which ended in March). The analyst also expects that average selling prices for hardware products will plummet this year much like it did in the 2008 recession.
On the other side, Spotify may not have a great quarter either. An analyst with Raymond James found that Spotify's top 200 streams worldwide are down 12% during the outbreak, with the U.S. and Italy down even more. The analyst also found that downloads of music apps, in general, have slowed since the outbreak, as more people engage with productivity and entertainment apps instead.
But those numbers may not tell the whole story at Spotify. The company recently reported that usage patterns have shifted during the outbreak, with people listening to different things besides music on its platform. Overall, Spotify is in a better position to weather the storm, given that it has a substantial revenue stream that comes from monthly subscriptions as opposed to expensive hardware like Apple.
Which is the better buy?
Both companies have cash-rich balance sheets, which is invaluable when the economy goes south. Here is a comparison of key financial metrics between the two stocks:
|Market cap||$25.58 billion||$1.17 trillion|
|Revenue (TTM)||$7.57 billion||$267 billion|
|Free cash flow (TTM)||$490.3 million||$63.9 billion|
|Net cash||$3.65 billion||$99 billion|
|Price-to-free cash flow ratio||51.8||19.07|
Apple has plenty of cash to continue paying a quarterly dividend and investing in new products. The upcoming iPhone 12 could trigger a huge upgrade cycle, given expected new features like 5G wireless technology and 3D cameras. However, it's unclear whether the novel coronavirus will delay that launch or the 5G capability.
Either way, Apple should come out of this crisis stronger. Consumers may delay purchases of iPhones now, but demand will come back once the economy recovers. Lower consumer demand in the short term doesn't change the fact that Apple has one of the most valuable brands in the world.
Still, Apple's share price is vulnerable to a sell-off if the iPhone 12 is delayed or doesn't sell as expected. The stock currently trades at a forward price-to-earnings ratio of 22.2 and a price-to-free cash flow ratio of 19.7. Those are high multiples for a company that has grown free cash flow per share by just 18% over the last five years and will likely report a drop in earnings in the next few quarters.
Meanwhile, Spotify has grown free cash flow per share 182% over the last two years. The shares sport a high valuation based on earnings and free cash flow, but Spotify is cheaper than Apple on a price-to-sales (P/S) basis:
- Apple P/S ratio: 4.71
- Spotify P/S ratio: 3.46
I don't believe now is the best time to buy Apple stock. I would go with Spotify, which has a higher ceiling for growth over the next 10 years and has recently been growing revenue much faster than Apple.