Even with many people no longer making a daily commute to work and trips to the gym restricted, Spotify Technology (NYSE:SPOT) still did pretty well during the first quarter of 2020.

Coronavirus is taking its toll on ad revenue (8% of revenue in Q1), but premium subscribers increased 31% year over year to 130 million, with the total by the end of second quarter 2020 expected to be 133 million to 138 million. More than just an in-car radio replacement, Spotify is benefiting from increased music and podcast streaming at home on smart speakers, gaming consoles, and TVs.  

However, though Spotify continues to notch growth as the world transitions from a transaction-based to an on-demand usage-based audio entertainment format, the industry remains a low-profit-margin game. Barring any further negative disruption to the business, the audio streaming leader will be just fine. A world free of disruption is not the one we live in, but Spotify is nonetheless prepared.

A laptop, smartphone, and cup sitting on a desk in front of a window

Image source: Getty Images.

2020 starts with a net cash outflow

On the surface, it would appear Spotify is due to have another good year, with streaming at home on the rise and a long-term transition to subscription cloud-based services still under way. The company reiterated its outlook that it will end 2020 with 328 million to 348 million monthly active users -- 143 million to 153 million of those premium subscribers who pay for the service versus the advertising-supported tier.  

However, due to currency exchange rate headwinds and lower ad spending on its platform, Spotify issued new revenue guidance of 7.65 billion to 8.05 billion euros ($8.34 billion to $8.78 billion using exchange rates on May 4), compared with a previous outlook for 8.08 billion to 8.48 billion euros ($8.81 billion to $9.24 billion). Gross profit margin should be 23.2% to 25.2%.

Free cash flow (revenue less cash operating and capital expenses) ended up being negative 21 million euros ($22.9 million), the first negative cash outflow in nine quarters. While lower per-advertisement spending and exchange rates took a toll, Spotify said this was mostly due to timing of payments to music and content licensors. At the end of the day, the company reiterated it expects to end 2020 with positive cash flow, even as it spends to develop new data-driven ad products and its own library of podcast and in-house developed content.  

In times of duress, net cash is king

Nevertheless, an important line item turning red is never a welcome situation. Trailing 12-month free cash flow is now 246 million euros ($268 million), making the sticker price on the stock that much higher. Shares currently trade for 99 times 12-month free cash flow. The stock is priced for the expectation that Spotify will continue to grow at a fast pace for years to come, and that the bottom line will grow accordingly.

But the good news is that Spotify can afford the short-term squeeze. At the end of Q1, the audio streamer had 1.68 billion euros ($1.83 billion) in unrestricted cash and short-term investments, equivalent to over three quarters' worth of operating expenses based on Q1 2020 figures. The company also has zero debt, making for an enviable position given the current state of affairs in the world.  

To put it simply, the last quarterly report was far from perfect, and Spotify still has a ways to go before it starts regularly reporting strong free cash flow profit margins. But ad revenue will rebound, and conversion to premium subscriptions is still going strong. The audio entertainment technologist is in good shape and has the firepower to ride out the coronavirus storm.

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