Spotify: Q4 Results Confirm The Company’s Investment Attractiveness (NYSE:SPOT)

Background

In my previous article, I noted the undervaluation of Spotify Technology S.A. (NYSE:SPOT) shares and their attractiveness for the long-term investors. To be honest, I didn’t expect SPOT’s share price to grow so quickly, and focused more on the growth in the long-term period. However, since the previous article, Spotify’s shares have risen by 57%. The S&P 500 index (SP500) over the same period rose by only 8%.

Following the release of the 4Q2022 report, the stock is up by 12%. Let’s consider what was interesting in the 4Q2022 results and what to expect from the company’s shares dynamic in the next quarters. Looking ahead, I will note that I keep my bullish view on Spotify Technology S.A. shares. While the company’s margin leaves much to be desired, double-digit revenue growth and a record MAU (monthly active users) addition in 4Q2022 are certainly encouraging.

Revenue

The company’s quarterly revenue totaled 3.16 billion euros (+17.5% YoY, +4% QoQ), 1% worse than the consensus forecast. Excluding the F/X impact, year-over-year revenue growth was at 13%. MAU totaled 489 million (+21% YoY, +7% QoQ), adding 33 million monthly active users (the best 4Q result in the company’s history). The result was 2% better than the consensus forecast and 10 million better than management’s forecast. The main contribution to the growth of MAU was from the Rest of the World (+18 million, mainly India and Indonesia) and Europe (+6 million) regions. I will note a double-digit revenue growth rate, even with excluding the F/X impact.

Margin

4Q Gross profit totaled 801 million euros (25.3% margin), +13% YoY and 7% QoQ. The gross margin result beat management’s forecast by 0.8 percentage points, mainly due to the lower investment in new podcasts. However, the same item caused a 1.2 p.p. gross margin deterioration YoY.

Operating profit was at the level of (-231) million euros (margin (-7%)), while it was at -7 million euros (margin 0%) last year. A quarter earlier, operating loss was at (-228) million euros (-8% margin). The consensus expected an operating loss of $284 million. Operating costs rose 44% YoY (+36% constant currency). The reasons for the increase in operating expenses were a 32% year-over-year headcount increase (+2.4 thousand employees) and an increase in advertising spending.

Free cash flow (“FCF”) loss amounted to 73 million euros (margin (-2)%). A year earlier, FCF was at +103 million euros (margin 4%). A quarter earlier, it was at +35 million euros (margin 1%).

Negative margin certainly can draw criticism from some investors who have questioned the margin of music streaming business models in the past. However, it’s worth recalling that 2022 was a year of spending growth for Spotify, driven by the high growth rates of new hires. In 2023, I expect the company’s margin to improve, thanks in part to the 6% headcount reduction that was announced recently.

Subscription revenue

Subscription revenue grew 18% YoY (+13% constant currency) to €2.7 billion (+2% QoQ). The result was 2% worse than consensus expected. The number of subscribers increased by 10 million QoQ to 205 million (+14% YoY, +5% QoQ), 2% better than consensus and 3 million better than SPOT’s management expected. The main subscriber growth contributor was the Latin America region. Average revenue per subscriber increased 3% YoY to €4.55 (-2% QoQ). Excluding the F/X impact, the indicator decreased by 1% YoY. The share of subscribers in MAU was 42% in 4Q2022 (-2 p.p. YoY, -1 p.p. QoQ). The subscription revenue gross margin was at 28.6%, implying a decrease of 0.6 p.p. YoY.

Advertising revenue

Company’s advertising revenue totaled 449 million euros (+14% YoY, +17% QoQ), 7% better than consensus expected. Excluding the F/X impact, the YoY growth amounted to +4%. The share of advertising revenue of total revenue increased to 14%. The number of ad-supported users was at 284 million (+26% YoY, +9% QoQ). Advertising ARPU was at €0.55 (-8% YoY, +8% QoQ). Spotify’s global music ad revenue grew by about 5% with a double-digit rate of growth in ad impressions sold. Advertising revenue gross margin was 5.1% (-5.5 p.p. YoY). I would like to note an increase in the share of advertising revenue in total revenue, which should help Spotify Technology S.A. reach a higher profitability level in the long-term period.

Management’s guidance

Management’s guidance for 1Q2023 assumes revenues of €3.1 billion, implying 16% YoY growth. The consensus 1Q2023 revenue forecast was at €3.05 billion. Total MAUs are projected at 500 million (+20% YoY, +11 million QoQ) and the number of subscribers is expected at 207 million (+14% YoY, +2 million QoQ). The MAU forecast was 2% better than the consensus forecast, while the subscriber forecast was 1% higher than the consensus expected. Gross margin is projected at 24.9%. Operating loss is expected by management at the level of 194 million euros. At the same time, the margin forecast was worse than the consensus forecast, which forecast an operating loss of $123 million.

Final thoughts

Undoubtedly, Spotify Technology S.A.’s quarterly reporting was very positive. Yes, there are some drawbacks in the form of negative margins, which the company is unlikely to improve substantially in the next three months. Nevertheless, there are some opportunities for this. The company’s podcast business is in a very solid condition. The weakness of the global advertising market is currently a headwind to faster advertising revenue growth, but the double-digit MAU growth creates a foundation for more rapid advertising revenue growth in the future. As a result, I maintain my positive view on Spotify Technology S.A. shares.