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Why Spotify's Post-Earnings Drop Shouldn't Concern Long-Term Investors

By Brett Schafer - May 3, 2021 at 7:50AM

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The company's growth trajectory is still intact.

Before the market opened on April 28, Swedish audio streamer Spotify (SPOT -4.22%) released its first-quarter earnings report. While revenue growth came in at the upper end of the company's previous guidance, monthly active users (MAUs) on the platform totaled 356 million, substantially lower than the consensus Wall Street estimate of 360 million. Spotify also revised its guidance for end-of-year MAUs, bringing the high end of its range down from 427 million to 422 million. Both of these factors were the main reasons why Spotify shares fell 14% following the report.

While such a decline hurts, long-term investors in Spotify shouldn't be concerned with these quarterly numbers. Here's why.

The Spotify media player on a laptop, tablet, and smartphone.

Image source: Getty Images.

Still growing quickly

Even though Spotify missed analyst estimates on MAU growth, it still grew total users by 24% year over year. Ad-supported MAUs (ones that don't subscribe to a premium plan) grew 27% to 208 million, and paying subscribers grew 21% to 158 million. This means that all three of Spotify's user growth metrics exceeded 20%, even with a tough year-over-year comparison when Spotify saw a bump last March due to the COVID-19 pandemic outbreak.

Taking the long view, Spotify still believes it can get to over one billion users on its platform. In February, the company announced it was expanding into over 80 new markets in 2021, including highly populated countries like Nigeria, Bangladesh, and Pakistan. It will take time to grow the Spotify service within each new market, so investors shouldn't expect a huge contribution to growth right away, but getting Spotify in every major market outside of China gives the company an opportunity to sustain a 20% user-growth rate over the next five years and beyond.

If Spotify can sustain a 20% MAU growth rate, it will close in on 900 million MAUs just five years from now. Historically, Spotify has converted around 40% of its total user base to paying subscribers, which is where the majority of its revenue comes from. If this conversion rate continues, Spotify will have significantly higher annual revenue five years from now.

Current earnings don't matter

A big knock on Spotify is that it doesn't make money. It currently runs at breakeven, plowing all gross profit into operating expenses and future investments. Gross margin is also low at only 25.5% last quarter due to the high payouts Spotify owes to music record labels and rights-holders. Within gross margin, ad-supported is currently at an abysmal 4.4%, but that is due to the heavy investments Spotify is making in podcast content and the advertising network that will support it. Management expects Spotify's gross margin to get to 35% or higher over time, which will likely come from better negotiating leverage with labels and the investments it is making into podcasts, live audio, and discovery.

Revenue growth was only 16% in the quarter, but if you adjust for foreign currency headwinds (Spotify is based in Europe), sales actually grew 22%, which is more in line with MAU and subscriber growth for the quarter. While Spotify doesn't currently have an impressive income statement, it is still growing revenue at a double-digit rate and has a path to improve the unit economics of its business within the next few years.

The global audio opportunity is still there

Spotify disrupted the music industry and is the largest music streaming service on earth. But now, it is looking to expand its offering by becoming a global audio platform. This includes making big bets on podcasts with its owned content like The Ringer and Gimlet studios, and building out a global advertising network to bring internet-level ads to the medium. It also means buying up Locker Room, a live audio app that has rebranded as Spotify Greenroom, to allow musicians, podcasters, and athletes to host live discussions with their fans. None of these investments are currently showing up on Spotify's income statement, but they represent big opportunities to enhance the value proposition for consumers on the platform.

As an investor, you have to remember that other shareholders may have different time horizons when owning a stock than you do. This is likely what happened with Spotify following its latest report. Shareholders with a short-term focus may have been disappointed by the slight deceleration in user growth, causing the stock to drop as sharply as it did. But if your investment thesis with Spotify is based on the company's potential to deliver 20% (or higher) user, revenue, and earnings growth over the next five years and beyond, there's no reason to panic about this single quarter of results. 

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