In April of 2018, global audio streaming company Spotify Technology (SPOT -4.62%) entered the public markets through a direct listing at $165.90 per share and a market cap of just under $30 billion. Since that point, Spotify has grown its total monthly active user count by 155%, steadily reduced its user churn, and more than tripled its annual gross profit.
Yet despite all these improvements, recent controversy has pushed Spotify's stock back down below its initial offering price for the first time since the start of the pandemic. With the company's stock now about 50% below its yearly highs, investors are likely asking themselves whether this recent volatility presents a good buying opportunity. Let's take a look.
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Recent headlines
As many people have probably heard, Spotify has been in the news a lot lately. Last month, popular artist Neil Young requested in a since-deleted letter to his record label that all his music be removed from Spotify's platform due to the company "spreading fake information about vaccines." This letter was particularly provoked by several controversial episodes from the world's most popular podcaster Joe Rogan, who is exclusive to Spotify. Following the news, two other artists followed suit and removed their content, citing the same reasons as Neil Young.
It's worth noting that Spotify has been dealing with artist boycotts for the majority of its existence. Bob Dylan, Taylor Swift, Jay Z, and Coldplay each tout more monthly listeners than Neil Young and have all temporarily pulled their content from Spotify at one point or another. Yet, amid each of those boycotts, Spotify saw little to no change in its subscriber growth. Nevertheless, this boycott seems to have many investors worried that Spotify could lose subscribers.
But so far the numbers don't seem to bear that out. In Spotify's latest quarterly conference call, CEO Daniel Ek said that the company's guidance for user growth isn't reflecting any churn from the Joe Rogan situation. And in fact, according to data from Sensor Tower, Spotify has been experiencing some of its strongest daily download activity in recent days.
Fourth-quarter earnings
In the middle of all of this news, Spotify also reported its fourth-quarter earnings on Feb. 2.
Led by strong adoption in international markets like India and Indonesia, Spotify added more total monthly active users (MAUs) than any other quarter in its history. By adding 25 million MAUs during the quarter, Spotify reached a total of 406 million -- 18% more than a year ago.
Thanks in part to this strong user growth, total revenue jumped 24% versus the same period a year prior and came in above the company's own guidance range. Within its premium segment, Spotify also increased prices across some of the plans in its more mature markets, which helped increase its average revenue per premium user by 3% year over year.
But perhaps the most exciting segment of the business was the ad-supported side. Revenue from advertising increased 40% versus the same period a year ago and accounted for 15% of overall revenue -- the highest percentage ever. The gross margins in this segment currently look much worse than they should over time since the company accounts for all podcast-related content costs in its cost-of-goods-sold line item.
CFO Paul Vogel alluded to the profit potential from this segment last quarter when he stated, "We think having a fixed-cost nature of the podcasting business and being able to grow that advertising will help margins." As advertising continues to become a bigger part of the business, Spotify should see its gross margins increase over time.
Is it time to buy?
Spotify is currently valued at a market cap to trailing 12-month gross profit multiple of just over 11 times -- the lowest gross profit multiple at any point in its history. While gross profit, in general, isn't really that great of a proxy for a company's true earnings, I believe Spotify's free cash flow growth should eventually follow the likely growth in gross profit. However, for the time being, the company continues to reinvest most of its excess cash back into the business primarily through content costs and acquisitions.
Between Spotify's steadily expanding subscriber base, its increasing revenue per user, and its rapidly growing advertising business, Spotify looks poised to grow its gross profit (and eventually cash flow) for the foreseeable future. As a Spotify shareholder, this looks like as good of a time as any to add some shares. And for those that aren't current shareholders, this could be an opportunity to add a new holding to a diverse portfolio.
