Chances are, if you're a millennial, you use both Spotify (SPOT 11.41%) for your music and podcast streaming and T-Mobile (TMUS 0.55%) as your wireless service provider.
Spotify is a fan favorite as the global leader in music streaming, offering both subscription and ad-supported formats. T-Mobile, thanks to strong net additions and the recent acquisition of Sprint, recently surpassed AT&T (T 1.17%) as the second-largest wireless service provider in the United States.
Both stocks are up handily for the year, but as high-quality winners tend to keep on winning, both may be worth your investment dollars after last week's pullback. But which of these consumer favorites is the better buy today?
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The case for Spotify
Spotify makes its case as a highly coveted subscription business model and brand leader. Last quarter, the company grew premium subscribers by 27% and ad-supported monthly active users (MAUs) by 31%. However, revenue didn't rise as quickly, up only 13%. This is because the company's average revenue per user came down, as much of the expansion came in developing nations, along with many subs opting for group family plans, which drove down the average subscription price per user.
In addition, because of the recessionary environment, advertising revenue fell 21%. Advertising makes up only 7% of Spotify's revenue, as the company still garners most revenue from premium subscribers, but as we'll see, the company has been trying to change that.
Spotify has shown strong growth over the years, but its margins are very low compared with other subscription businesses like software-as-a-service, because it has to pay music labels high licensing fees for original music. However, management's new plan to grow margins is multi-pronged. On the product side, the company is investing heavily in original and exclusive podcasts. Most notably, the company paid over $100 million for a multi-year exclusive deal with the Joe Rogan podcast, which premiered on Spotify just this month.
On the advertiser side, Spotify is going after both traditional advertisers and musicians themselves. For traditional advertisers, the company recently unveiled its new strategic ad insertion (SAI) technology for its podcasts. The new platform should be able to better target listeners and deliver ads more efficiently, increasing the appeal to advertisers. Spotify has also launched a marketplace for musicians to promote their work on the platform directly to listeners.
Investors have cheered on Spotify's subscriber growth even though revenue and profits lagged last quarter, with shares surging 65% this year. Spotify has no earnings to speak of, but it trades at a price-to-sales ratio of 5.5.
The case for T-Mobile
Like Spotify, T-Mobile is also in the green this year, up 42.3% and continuing to look strong. Entering 2020, T-Mobile was the best-performing telecom stock over the last decade, as its "Uncarrier" ethos and lower-priced plans attracted price-sensitive customers to its wireless network. T-Mobile's network had long been a "good enough" laggard to larger rivals AT&T and Verizon (VZ 2.85%), but its network had improved over the years, paving the way for increasing net subscriber additions versus these rivals.
That story could even improve, however, with T-Mobile's recent acquisition of Sprint, which just closed on April 1. Buying Sprint will lower the number of large mobile carriers from four to three, which is usually good for the remaining companies. More importantly, T-Mobile expects to squeeze $6 billion in cost synergies from the deal, which should boost profits in the years ahead. And most importantly, Sprint brought with it important 2.5 GHz spectrum, which T-Mobile can use for ultra-fast 5G. With the acquisition, T-Mobile leapt ahead of competitors in terms of 5G spectrum capacity, and is now rolling out 5G nationwide as fast as it can.
Should T-Mobile leap ahead of competitors in terms of network quality in the 5G era, while also undercutting competitors on price, the company could scoop up even more market share in the years ahead.
Why I'm choosing T-Mobile
Both of these consumer leaders are great companies led by able management teams. But of the two, I'm choosing T-Mobile over Spotify for two main reasons. First, I'm a bit unsure how much Spotify can grow its margins in the years ahead. While the company has done a great job of executing and outlining a plan to increase profits, it will require lots of investment -- the $100 million for Joe Rogan as a prime example. Meanwhile, T-Mobile appears to have a much clearer path to profit growth through its Sprint synergies and the move to 5G.
Second, while Spotify is the de facto leader in music streaming, it also competes with basically all of the large cap FAANG stocks, except for Netflix (NFLX 4.17%), each of which groups music streaming with their bundles of other services. While Spotify could maintain its market share lead, I'm not sure it will be able to raise prices over time in that competitive environment. Meanwhile, I feel a bit more confident about T-Mobile's competitive position in the 5G era versus its two large incumbent competitors.
The telecom industry is often regarded as an unexciting, low-return sector for investment. However, after Spotify's big move this year and stretched valuation, I think T-Mobile is the better risk-reward today.
