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Spotify's Confusing Buyback Plans

By Adam Levy – Aug 25, 2021 at 9:21AM

Key Points

  • Spotify announced a new $1 billion share repurchase authorization.
  • It still needs to invest in podcasts and technology to stay ahead of the competition.
  • It may be able to balance both to the benefit of investors.

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Shouldn't an unprofitable growth stock be investing for the future?

Spotify (SPOT 0.60%) announced plans to buy back up to $1 billion worth of its stock last week with the authorization expiring in April 2026. Stock buybacks are often a tax-efficient way for businesses to return excess capital to shareholders.

The authorization is at the same time a vote of confidence in the future of the stock and an admission that Spotify might not have anywhere better to invest in the future growth of the business. That's a bit confusing for a growth stock like Spotify.

A reception desk with the Spotify logo on the walls.

Image source: Spotify.

Is Spotify done investing for growth?

Spotify has been spending heavily on acquisitions and investments focused primarily on the podcast industry. Spotify has paid up for exclusive distribution rights for popular podcasts, acquired entire production studios, created its own original content, acquired and developed monetization tools for creators, and acquired its own podcast hosting company. All told, its podcast spending topped $1 billion in the last couple years.

During Spotify's fourth-quarter earnings call, CEO Daniel Ek said it might not invest as much on outside acquisitions in the future. "Most of our strategy going forward, while we don't exclude any further acquisitions, it is about ramping the ability of our own production capabilities that we now have through all the studios that we have acquired."

In the meantime, however, competitors like Amazon have made several high-profile podcast acquisitions, including the studio Wondery, podcast technology company Art19, and the distribution rights to the popular podcast SmartLess. Apple is investing in more creator tools, including subscriptions in its popular Podcasts app. SiriusXM bought Stitcher last year, and it's been signing high-profile talent like Roman Mars from 99% Invisible and Seth Rogen.

Even if Spotify isn't going to invest in high-profile acquisitions as much as it has in the previous two years, it still needs to continue to spend on the content and technology it's developing in house. The podcast strategy just started paying off last quarter, and it's not the time for Spotify to take its foot off the pedal as the deep-pocketed competition doesn't appear to be letting up.

Indeed, Spotify probably doesn't plan to let up on its investments. Instead, it may be making a strategic change in its financial structure.

Liquidity on the balance sheet

Earlier this year, Spotify added $1.5 billion (about 1.28 billion euros) of debt to its balance sheet, and boosted its cash reserves to about 3.1 billion euros. At the same time, the company generates a modest amount of free cash flow despite still operating just below break-even profitability.

Over the last 12 months, free cash flow totaled 252 million euros. Even if Spotify failed to improve free cash flow somehow, and it kept its balance sheet stable by using the cash to buy back shares, it would blow through its entire authorization in less than four years.

It was an opportune time to take on debt earlier this year, as interest rates remain low. Using the buyback to replace a bit of equity with low-interest debt is a smart move.

By taking on some debt, Spotify gives itself the liquidity needed to keep investing in growth while taking advantage of what management thinks is a relatively low stock price. Spotify shares are over 40% off their high from earlier this year, and they were even cheaper when Spotify originally announced the share repurchase plan. The buyback can give investors more confidence in the stock, knowing management will step in and buy shares if the stock gets too cheap. Ultimately, however, if management sees a better use of cash than buying back its own shares, it's under no obligation to repurchase the stock.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Amazon and Apple. The Motley Fool owns shares of and recommends Amazon, Apple, and Spotify Technology. The Motley Fool recommends Sirius XM Holdings Inc. and recommends the following options: long January 2022 $1,920 calls on Amazon, long March 2023 $120 calls on Apple, short January 2022 $1,940 calls on Amazon, and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.

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