Share prices of Spotify Technology (SPOT -0.01%) have been crushed over the past year, falling 56% from their 2021 highs. The stock has been hurt by the overall decline in growth stocks and a reversal of some of the pandemic winners, like Spotify's music and podcast streaming business.
But should investors really be selling a company that's growing users and revenue by double-digit percentages and expanding margins? I think there's a lot to like about Spotify, especially at a more reasonable price than it traded at a year ago.
Focus on the business, not the stock
Long-term, it's business results that will drive investment gains, not short-term stock movements. And Spotify's business is performing pretty well.
The company reports fourth-quarter 2021 results Wednesday after the markets close, but we already know that third-quarter 2021 revenue was up 27% versus a year earlier to $2.50 billion, and monthly active users jumped 19% to 381 million users. Gross profit jumped 37% as advertising revenue began contributing better margins, and free cash flow was an impressive $99 million.
Results may be showing growth slowing from earlier in the pandemic, but it's clear that the business is improving at a very rapid rate. And that's what we should look for in any investment.
Advertising is Spotify's future
Spotify is known for music, but most of the company's investments have been in podcasts in recent years. If the company can become a go-to podcast service for users, it will be able to attract more podcast talent and advertising dollars.
It's this advertising business that I think is Spotify's real future, especially in podcasting. Spotify doesn't break out music versus podcast advertising numbers, but ads are a natural way to monetize podcasts if a company can build a big enough ad network. In the third quarter, the company said ad-supported revenue jumped 75% from a year earlier to $323 million, and ad-supported gross margin jumped from 1.6% a year ago to 10.5%, with more room for improvement.
Music is controlled by big music labels, but podcasts can be produced by almost anyone. The challenge is monetizing podcasts by matching listeners with relevant ads. If Spotify can get this business right, it'll be a juggernaut in the podcasting business.
Of course, enabling anyone on the platform has downsides. Over the past week, we have seen Spotify lose access to music from Neil Young and potentially Joni Mitchell and Nils Lofgren because of the company's refusal to remove Joe Rogan's podcast over a controversy regarding COVID-19 misinformation it contained. But unless advertisers or users leave in droves, I don't see this impacting Spotify's bottom line.
A value in technology stocks
After dropping over the past year, Spotify's stock is a solid value by many metrics. Shares only trade for about three times revenue, which is a steal compared to most technology stocks.
Spotify is also cash-flow positive, although it's still reporting a small net loss, as you can see above.
I think the real upside for Spotify is if it can build a large advertising business for music and podcasts. If it can, it will have a moat in podcasting because it will have a monetization model for even the smallest podcasts. The company is taking important steps in that direction, but continued revenue and margin growth will make this a great stock long-term.
Shares may be down over the past year, but operations are improving, and I like where Spotify is heading over the next decade.