Spotify's stock (SPOT 1.10%) hit an all-time high of $387.44 last February. But it subsequently lost more than half of its market value amid concerns about the competition, its lack of profits, and rising interest rates.
Spotify might seem cheap after that sell-off at less than three times next year's sales. But if you're thinking about buying this beaten-down growth stock, you should review these three red flags for its future first.
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1. Spotify is producing weak bottom-line growth
Spotify's revenue rose 16% to 7.6 billion euros ($8.8 billion) in 2020, then grew 22% year over year to 7.0 billion euros ($7.8 billion) in the first nine months of 2021. Its monthly active users (MAUs) rose 27% to 345 million in 2020, then improved 19% year over year to 381 million in the third quarter.
For the full year, Spotify expects its revenue to grow 21% to 23% and its MAUs to increase 16% to 18%. Those robust growth rates should reinforce its position as the world's largest premium streaming music platform.
But Spotify's profits are still nearly nonexistent. Its net loss widened from 186 million euros in 2019 to 581 million euros ($649 million) in 2020, and it barely squeezed out a slim net profit of 5 million euros ($5.6 million) in the first nine months of 2021. But on a fully diluted basis, that net profit still trickled down to a net loss of 0.85 euros ($0.95) per share.
Spotify is trying to improve its profitability by shifting toward higher-margin podcasts while reining in its marketing expenses. However, analysts still expect it to post net losses in the fourth quarter as well as the full year. That lack of stable profits makes Spotify a tough stock to recommend as higher interest rates boost borrowing costs for unprofitable companies.
2. Spotify has a growing dependence on podcasts
Spotify is trying to differentiate itself by aggressively expanding its podcast platform through acquisitions and exclusive podcasts.
In the past three years alone, Spotify acquired the podcast studio Gimlet Media, the Ringer podcasting network, the podcast technology companies Megaphone and Whooshkaa, and the podcast discovery platform Podz. It also bought the exclusive rights to Joe Rogan's podcast, The Joe Rogan Experience, for more than $100 million in 2020.
This strategy is divisive. The bulls believe it will ultimately boost Spotify's margins by reducing its dependence on expensive licensed music, but the bears believe the costs and risks of securing some of those exclusive podcasts are too high.
For example, Joe Rogan is facing criticism for having guests on his show making misleading comments that spread misinformation regarding vaccines. In response, Neil Young, Joni Mitchell, and other music artists are pulling their music from Spotify's catalog -- and more popular musicians could potentially follow suit. Rogan on Sunday apologized for the controversy and promised to provide some balance of opinion on shows that feature controversial guests. Spotify said that it had no plans to censor Rogan's podcast, but that it would provide content advisories on any podcasts with discussions about COVID-19 in the future.
But Spotify's big bet on podcasts also suggests it's evolved into a social platform -- which will likely involve it in the same types of controversies that have plagued leading social networks like Meta Platforms' Facebook and Twitter in recent years. If Spotify's other exclusive podcasts spark similar debates in the future, we could see more musicians refuse to share the streaming stage with those podcasters.
3. Enemies at the gates
Meanwhile, major competitors like Apple (AAPL 0.38%) continue to grow at an alarming rate. In its latest quarter, Apple said that it had locked in more than 785 million paid subscribers across all its services -- including Apple Music, Apple TV+, Fitness+, Apple Arcade, and the iCloud. That marked a gain of 165 million subscribers in the past 12 months alone.
Apple didn't reveal its exact number of Apple Music subscribers, but MIDiA's latest estimates suggest it has about 78 million paid listeners. It's still a lot smaller than Spotify, but Apple can easily leverage the strength of its other services to pull subscribers -- and musicians -- away from Spotify.
But that's not all. Amazon Music, which is bundled with Prime, is another passive competitor with tens of millions of listeners. Alphabet's YouTube is also trying to leverage the popularity of YouTube to expand YouTube Music.
Those competitors haven't throttled Spotify's growth yet. However, Spotify's recent controversies and its lack of long-term pricing power against those big tech rivals could gradually weaken its defenses.
Is Spotify worth buying?
Rising inflation, higher interest rates, and the recent Joe Rogan controversy will all likely cause investors to shun Spotify in this tough market for growth stocks. The market might warm up to Spotify again if it stabilizes its bottom-line growth and cools off its spree of podcast-related acquisitions -- but it will likely remain in the penalty box for at least a few more quarters.
