After Spotify (SPOT 0.20%) reported its second-quarter results on July 25, the market didn't like what it saw. Following the reveal of its earnings before market open, the stock ended the day down 14%. That's quite the tumble, but it's also not representative of the whole picture.
Before the report, Spotify's stock was up 107% in 2023. With that complete picture in mind, was the sell-off warranted? Or is this a short-term reaction that long-term investors can take advantage of? Let's find out.
A price bump will help Spotify's finances
Spotify is the leading streaming service for music and podcasts worldwide. It boasts more than 550 million monthly active users, a figure that rose an astounding 27% year over year and 7% quarter over quarter. With an estimated global population of 8 billion people, that means one out of every 15 people uses the platform.
That kind of market share is what makes Spotify such an exciting investment. It has created a product that has captured a substantial part of its target audience: everyone who listens to music or podcasts.
About 40% of those users are premium subscribers (those who pay a monthly fee to avoid ads and gain access to downloaded music). However, Spotify will test that customer base's resilience soon. On July 24, Spotify announced a slight price increase on its offerings in most markets.
| Subscription | Previous Price | Current Price |
|---|---|---|
| Premium Individual | $9.99 | $10.99 |
| Premium Duo | $12.99 | $14.99 |
| Premium Family | $15.99 | $16.99 |
| Student | $4.99 | $5.99 |
Data source: Spotify.
Besides the Premium Duo subscription, the price hike represents a $1 increase across the board. That should represent about $660 million in new quarterly revenue starting in Q4 (some markets will be unaffected by the price increase, so this estimate is slightly high). This is assuming users don't cancel their subscriptions in response to the price hike.
With Spotify generating $3.2 billion in Q2 revenue, up 11% year over year, that $660 million boost will automatically increase Spotify's quarter-over-quarter revenue around 21% (this increase isn't expected to affect Q3 results due to the timing). That's an impressive boost and will help increase Spotify's margins since this revenue is expense-free.
Spotify's growth figures didn't cause the drop, as they were phenomenal. However, its profit margins could use the boost the price hike provides.
Spotify has some work to do on the bottom line
Although Spotify is seen as a tech company, its margins are far from it. Because it has to shell out lots of money for its content, its gross margins are poor compared to its tech brethren. In Q2, its gross margin was only 24.1%, showing Spotify has very little wiggle room to fund its operating expenses.
Spotify has struggled to break even as a public company, and its margins have even worsened in recent years.
Data by YCharts.
With the $660 million boost in hand, it should be enough to push Spotify into profitability as it posted an operating loss of $247 million in Q2. Additionally, as the advertising market recovers with a stronger economic outlook, it should also see its margins improve in that business segment.
So, yes, Spotify is a buy after its Q2 earnings drop. The immediate reaction was extremely short-sighted, plus Spotify still trades at a valuation level well below its historical average.
Data by YCharts.
Although it would have been better to purchase the stock at the start of 2023, this short-term pullback is a gift for investors, and anyone interested in the stock should consider adding to a position at these levels.
