Spotify (SPOT -0.48%) has the potential to greatly increase its free cash flow generation as the music streaming leader boosts prices and better monetizes its users. That's the view of analysts at Pivotal Research, who maintained a buy rating on the stock and boosted their price target from $330 to $390 on Friday. That new price target represents a potential upside of about 26%.
Pricing is on the rise
While Spotify's user base is split between premium subscribers and ad-supported users, the premium subscription service generates the bulk of the company's revenue. Of the 3.67 billion euros in total revenue Spotify reported for the fourth quarter of 2023, premium subscriptions accounted for 3.17 billion euros.
It's the potential for Spotify to wring out more revenue from its premium subscribers that has Pivotal Research excited about the stock. Average revenue per premium user was just 4.60 euros in the fourth quarter.
Pivotal Research expects Spotify to accelerate its efforts to boost revenue per user this year, which should then drive higher free cash flow. Spotify is reportedly planning to raise prices in multiple markets this year, including the U.S., partly to account for the costs of the company's audiobook service.
Is Spotify stock a buy?
While Spotify's free cash flow is rising rapidly, the company is still not profitable. Net income was a loss of 532 million euros in 2023, slightly worse compared to 2022.
Spotify's business model involves paying royalties that it has little control over to the owners of the music on its platform. Gross margin for the premium service hovers below 30%, while gross margin for the ad-supported service is currently around 12%.
While free cash flow totaled 2 billion euros in 2023, Spotify is now valued at about $62 billion, resulting in a lofty valuation based on cash profits. Free cash flow certainly has some room to rise, but Pivotal Research may be a bit too optimistic.
