Spotify: Q1 2022 Guidance Not Enticing Enough (NYSE:SPOT)

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Investment Thesis

Spotify (SPOT) is a leading music subscription service, that’s looking to move beyond this label, to encompass all things audio.

Spotify is one of those stocks that has fiercely bullish and bearish investors on both sides of the story. The bulls point to the stock’s low multiple and sticky subscribers, while the bears contend that the business will never be meaningfully profitable.

Its Q4 2021 results didn’t tilt the argument one way or another. The battle continues.

Investor Sentiment Remains Sour

Spotify share performance

Spotify share performance

Investing in mid and small caps has been seriously tough the past 3 months. And yesterday’s 10% slide after-hours as a reaction to Spotify’s results once again is once again a reminder of just how testing and exasperating investing has become of late.

Everyone wants to buy stocks at a discount. But nobody wants stocks to stay at a discount.

Revenue Growth Rates Slow Down

Spotify revenue growth rates, FX neutral

Spotify revenue growth rates, FX neutral

Spotify’s Q1 2022 is pointing towards 13% y/y growth. Keep in mind that Q1 of last year is Spotify’s easiest quarterly comparison.

Meanwhile, for the remainder of 2022 Spotify comes up against increasingly tougher quarterly comparisons. Consequently, investors are going to have to knuckle down for a wild ride ahead.

While I acknowledge that readers are going to proclaim that Spotify is lowballing its revenue estimates to allow for easy beats, yet looking back over the past number of quarters, the results show that Spotify is just as likely to beat estimates as it is to miss consensus.

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A further aspect to keep in mind is that Spotify reports its results in euros. Thus, its Q1 2022 guidance includes just over 3% tailwinds from F/X movements.

Meanwhile, for their part, Spotify declares that over the long term it should continue to grow its revenues at approximately 20% CAGR, thus even if this upcoming quarter looks somewhat light, investors should not be unduly troubled.

Next, let’s dig further into Spotify’s near-term prospects.

Spotify’s Near-Term Prospects

Spotify’s Q1 2022 total MAU guided figures did come in ever-so-slightly lighter than analysts expected at 418 million compared against 422 million, thus 1% shy of the consensus.

Furthermore, consider this, given how badly investors reacted to Netflix’s (NFLX) own Q1 2022 subscriber numbers coming short, I expected that any miss on the MAU guidance would lead to a dramatic sell-off after hours, particularly given that the market was already primed for a sell-off.

Indeed, there are several topics that investors are acutely focused on right now:

  • Will Spotify struggle against tougher comps pulled forward since the onset of COVID?
  • Would the number one podcaster lead to an enhanced churn?

Accordingly, as you would expect, during the earnings call Spotify paid perfunctory lip service to the Joe Rogan misinformation topic, and said,

We believe we have a critical role to play in supporting creator expression while balancing it with the safety of our users.

Then, during the Q&A section of the call, more questions emerged from the investment community which was met with the same reply. Further noting that any potential fallout from Joe Rogan’s churn has not been factored into its upcoming Q1 MAU figures.

Bearish Consideration: Profitability Profile

Spotify saw its free cash flow increase 39% y/y, which is clearly very satisfying for shareholders.

Q4 2021 results

Q4 2021 results

On the other hand, Spotify’s free cash flow margins stood at 3%, consistent with the same period a year ago.

Spotify contends that at its upcoming investor day in Q2 2022, it will lay out its path to expanding its gross margins to approximately 30% to 40%.

Given that the highest it has achieved of late has been 28.4% gross margins, with Q4 2021 reporting just under 26.5%, any commentary around getting Spotify’s gross margins to go above 30% would be clearly welcome, particularly if it gets backed with a few quarters of evidence, that would be a game-changer for the bull thesis.

SPOT Stock Valuation – On The Cheap Side

Spotify is priced at 2.4x forward sales. On the one hand, this looks seriously cheap, particularly when you consider that Spotify carries approximately EUR2.4 billion of net cash on its balance sheet.

Indeed, presently, more than 6% of its market cap is made up of cash.

Data by YCharts

Furthermore, as you can see above, right now, Spotify’s P/Sales multiple is towards the lowest it’s been for more than 18 months.

On the other hand, Spotify is a business with very thin free cash flow margins of just 3%.

And most crucially, as discussed, the business is clearly not growing at such a rapid rate.

The Bottom Line

Spotify continues to invest to move the business beyond its reliance on advertising into multiple revenue streams. There’s little doubt that the stock right now is priced towards the low end of its valuation range.

But does that mean that there’s enough value in the stock? Objectively, I remain on the fence.

I believe that there are much better investments out there right now. This is a buyers’ market and Spotify isn’t that compelling from my perspective. Whatever you decide, good luck and happy investing.

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