Spotify's (SPOT -1.18%) stock recently tumbled after the streaming music company's third-quarter numbers missed analysts' expectations. Its revenue rose 14% year-over-year to 1.98 billion euros ($2.3 billion), but missed estimates by 20 million euros.
It reported an operating loss of 40 million euros ($47 million), compared to an operating profit of 54 million euros a year ago. On the bottom line, it posted a net loss of 0.58 euros per share, which missed estimates by 0.03 euros. Those headline numbers were disappointing, but Spotify remains a solid investment for six simple reasons.
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1. Its impressive user growth
Spotify's total monthly active users (MAUs) grew 29% year-over-year to 320 million during the third quarter, which exceeded its prior guidance for 312 million to 317 million MAUs.
Its number of paid subscribers grew 27% to 144 million, which hit the high end of its prior guidance of 140 million to 144 million, and its number of ad-supported MAUs rose 31% to 185 million.
2. It didn't miss its own revenue guidance
Spotify's third-quarter revenue of 1.98 billion euros missed the consensus forecast, but actually exceeded the midpoint of its previous forecast of 1.85 billion to 2.05 billion euros. That's likely because the consensus forecast was likely modeled on higher ad revenue.
Spotify's ad-supported revenue rose 9% year-over-year (15% in constant currency terms) as companies started buying ads again, marking a return to growth after a pandemic-induced decline in the previous quarter, but that still represented a slowdown from the segment's 20% constant-currency growth last year.
Therefore, Spotify's revenue "miss" was relatively minor, and its ad revenue should continue rising again after the pandemic passes.
3. Its gross margins are healthy
Spotify's gross margin dipped 70 basis points year-over-year to 24.8%, approaching the high end of its prior guidance of 23.1% to 25.1% and surpassing the consensus estimate of 24.7%.
Spotify's gross margin was throttled by its weaker growth in ad revenue, podcast investments, and other content costs. However, the gross margin of its premium business still expanded 40 basis points to 27.3%.
The expansion of that higher-margin segment, along with its healthy growth in paid subscribers, suggests Spotify still has plenty of pricing power in the crowded streaming market.
4. A narrower-than-expected operating loss
Spotify's operating loss of 40 million euros was also better than its prior forecast for a loss of 70 million to 150 million euros. It attributed that narrower loss to lower-than-expected payroll taxes, share-based compensation, and marketing expenses throughout the quarter.
In other words, Spotify surpassed its own MAU forecast even as it spent less money on marketing campaigns -- which is a clear sign of strength for the streaming music leader as it fends off larger tech giant rivals.
5. It raised most of its guidance
Spotify slightly lowered its fourth-quarter revenue guidance, presumably due to the continued weakness of its ad-supported business, and slightly reduced the high end of its MAU forecast. However, it still raised its expectations for its premium subscribers, gross margin, and operating loss:
|
Q4 2020 Guidance |
Previous (Q2) |
New (Q3) |
|---|---|---|
|
Revenue |
2.05 billion to 2.25 billion euros |
2.00 billion to 2.20 billion euros |
|
Total MAUs |
328 million to 348 million |
340 million to 345 million |
|
Premium Subscribers |
146 million to 153 million |
150 million to 154 million |
|
Gross Margin |
23.7% to 25.7% |
24.2% to 26.2% |
|
Operating Loss |
(145 million) to (45 million) euros |
(112 million) to (32 million) euros |
Source: Spotify Q2 and Q3 Earnings Reports.
Those numbers clearly indicate Spotify isn't losing ground to challengers. Instead, it's retaining its early-mover's advantage and gradually leveraging its scale to narrow its losses.
6. It's still reasonably valued
Spotify's stock dipped 10% after the company released its third-quarter earnings report, but it remains up 60% for the year. Investors might still be reluctant to buy Spotify after that year-long rally, but it trades at less than five times this year's sales -- which makes it surprisingly affordable compared to its industry peers.
Tencent Music, which Spotify owns a major stake in, currently trades at nearly six times this year's sales. SiriusXM, which owns Spotify's rival Pandora, trades at just three times this year's revenue but is growing at a much slower rate than Spotify.
Spotify isn't an ideal stock for conservative investors, but it remains a "best in breed" play on the growing streaming music market. Its stock could remain volatile as it gradually stabilizes its ad business and narrows its losses, but I believe it still has plenty of room to run.
