Spotify stock drops after earnings: Why the Wall Street reaction is dead wrong
Stock market price of Spotify (NYSE: SPOT) fell as much as 10.9% in early trading on Wednesday after the company reported its first quarter results. Wall Street analysts were apparently disappointed with a monthly growth of just 24% in active users to 356 million users, which was enough to send weaker stocks despite otherwise impressive results.
It’s no surprise that Wall Street is focusing on short-term analyst estimates, but that approach may miss the company’s long-term story. And what I see in Spotify’s results is that a company is executing well on its long-term vision of being a growth stock for the next decade or more.
Creators and listeners come first
It is important to understand how Spotify plans to grow its business in the long term. There are really two sides of the market the company is building right now: the creators and the listeners. In both areas we are seeing signs of growth.
I’m going to focus primarily on the podcast industry below, as I see it as the biggest growth opportunity, and the one Spotify invests in the most. But some concepts like growing ad dollars also translate into the music business.
Creators come first …
First and foremost, Spotify is trying to create a platform that is the top choice for creators. This involves both creating tools to attract new podcasters and paying creators for exclusive content, like The Joe Rogan experience, which encourages more listeners to find other creators. Interestingly, Spotify did this with a fairly open platform rather than locking creators into the Spotify platform. Podcasts created using Spotify’s free Anchor platform, for example, can be listed on other podcast players, and podcasters can even create subscription business models elsewhere and use Spotify as a player. This is intended to increase the number of creators on Spotify.
To this end, management reported that the number of podcasts on the platform increased from 2.2 million at the end of the fourth quarter to 2.6 million at the end of the first quarter of 2021. Growth of creators? Check.
These investments in creators come at a cost, however. Management stated that “non-music costs continue to grow at a slightly faster rate, which is slightly dampening our gross margin.” I’ll get to this gross margin number below.
… but listeners matter too
A large list of creators would be nothing without listeners, but here too Spotify is growing. Monthly active users are up 24% from a year ago to 356 million users, and premium subscribers are up 21% to 158 million users.
Spotify does not break down the hours of podcast listening by its users, but it did indicate that the audience was on the rise, saying this in the publication of the results: âFrom a consumption perspective, we have seen a big increase of podcast consumption hours in the first quarter compared to the fourth quarter, March activity generated an all-time high in terms of podcast share in the platform’s overall consumption hours. ”
The number of listeners is increasing and the number of hours of podcast listening is increasing. This is the key to the business network effect in podcasting.
The platform of choice
Spotify relies on a more open and flexible podcast platform than a company like Apple (NASDAQ: AAPL) because he bet he can win on the bottom. In other words, Spotify believes creators will want to host podcasts on its platform because they can find more listeners there and monetize better than on any other platform. Here are the steps to look for in the strategy:
- Open the platform to more creators and listeners.
- Attract a large number of creators and listeners.
- Create tools to effectively match listeners and creators.
- Create a monetization platform to make podcasts more profitable for creators than on other podcast platforms, whether they choose subscriptions or ad-supported content.
After the recent changes to the podcast app, Spotify is more and more open to creators, so # 1 is happening. For # 2, the number of listeners and podcasts are increasing. And Spotify is creating tools like Podcast Topic Finder and Navigation Upgrades that should more easily match creators and listeners (# 3).
If these three things keep happening, Spotify is establishing itself as the authoring and listening platform of choice, which will help boost the effectiveness of ad-supported monetization, or # 4. Now that Apple offers subscriptions through its podcast app, it’s this side of monetization where Spotify must prove itself.
Advertising is the key to unleashing Spotify’s growth
Spotify’s long-term thesis is that it will create a market of creators and listeners that will be extremely attractive to advertisers, who will ultimately fund the economy of podcast creators. Think of it like the strategy Alphabetof (NASDAQ: GOOG) (NASDAQ: GOOGL) Google used when searching increasing.
Google wasn’t the only search engine that came out 10-15 years ago, but it bet it was so much more effective at matching users with information (and advertisers) that its main focus was simply to develop the use of the Internet. Free or cheap computers went to schools, email was made free, fiber was built around the United States, anything Google could do to get more people online would be good for the bottom line. long term, even if users were not locked into a Google Platform.
As the Internet has grown, Google has become the search engine of choice. It was also the most effective advertising tool for businesses trying to reach their customers, which increased their ad revenue. Being on an open platform increases the opportunity, and if Spotify wins on the merits, it can lock in creators, as the best podcasters make it their platform of choice.
Spotify has the creators and the listeners, as already noted. What can be difficult is developing the advertising ecosystem and giving advertisers a boost. But there seems to be some progress. In particular, I noticed this quote in the earnings announcement: âAd-funded gross margin was 4.4% in the first quarter, up 1,100 bps year-on-year. As a reminder, all the content costs associated with the podcast investment are included in the activity with advertising. for current and historical periods. “
A 4.4% gross margin sounds ridiculously low, but note that all podcast investments are included in that number. The implication is that the investments made in software or proprietary content are relatively fixed while the incremental growth in ad revenue should be a high margin. This is why we are seeing an improvement of 1,100 basis points in the gross margin of the advertising-supported businesses on revenue growth of 46% compared to a year ago.
If ad revenue continues to grow at a rate like this, we could see Spotify’s margins increase rapidly, and that would be great news for investors.
Optionality for future growth
If Spotify is successful in attracting the best podcast creators in the world, it has plenty of options for expanding the medium. Anchor adds tools such as text to audio as part of a partnership with WordPress. Video podcasts continue to grow and creators are just starting to learn how to use this medium. These are just two of the growth opportunities Spotify can tap into by creating more tools for creators.
Notice the theme here: Spotify is innovative tools for its creators. And if it succeeds in doing so, it will attract listeners and ultimately advertisers, increasing revenue and margins along the way.
Spotify may have missed the guesses of Wall Street users during the quarter, but the company is implementing its long-term strategy to make podcasts a huge business. And as long as we see the number of available podcasts increase, listening hours increase, and ad-supported revenue and margins increase, the company is on the right track. That’s why I’m not panicked by Spotify’s stock drop on Wednesday.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.