Spotify’s Q1 2023 Earnings Pushes Volume Through the Roof. Is It a Buy?

Spotify (SPOT) reported Q1 2023 earnings Tuesday before the markets opened. While they weren't great, investors didn't care, sending their share and options volumes through the roof.

However, just because volume jumped on the news, it doesn't mean the audio streaming platform is a buy. Up 5% on the day and a little more than halfway through Tuesday's trading, the analysts seem to like SPOT, but that doesn’t mean it’s an automatic buy. 

Here’s why. 

The Earnings Specifically

Like most earnings reports, there are always positives and negatives about a quarter. Spotify is no exception. So, in this first section, I'll highlight what I see to be the three most significant positives and negatives in Q1 2023.

The three positives: 

1) Monthly Active Users (MAUs) were 515 million, 22% higher than last year and 5% higher than Q4 2022. 

2) Ad-Supported MAUs were 317 million, 26% higher than a year ago, and a 7% increase from the previous quarter, and

3) MAU net additions in the quarter were 26 million, 15 million higher than management guidance. 

The three negatives:

1) Its revenue fell sequentially by 4% to 3.04 billion euros ($3.33 billion).

2) Its ad-supported revenue fell sequentially by 27%, to 329 million euros ($360.8 million), from 449 million euros ($492.40 million) in Q4 2022. 

3) Its gross margin was 25.2% in the quarter, flat to both Q4 2022 and Q1 2022. 

I won’t get into Spotify’s operating loss other than to say that it was 156 million euros ($171.1 million), down from  231 million euros ($253.33 million) in Q4 2022, but substantially higher than its Q1 2022 operating loss of just 6.0 million euros ($6.58 million).

The volume of 6.35 million suggests a tug-of-war is happening between Spotify bulls and bears. I thought tech investors were focusing more on profits than revenue growth. Unfortunately, the trading for SPOT today says not so fast with that opinion.  

What Does It All Mean?

Netflix (NFLX) reported Q1 2023 earnings on April 18. One thing that stood out was that its ad-supported plan ($6.99 per month) in the U.S. earned more average revenue per membership than its $15.99 monthly plan. 

That’s what you want to see with ad-supported streaming. Just as Costco (COST) memberships generate the lion’s share of its profits, Netflix wants to reach the point where its premium plans pay its operating expenses while the ad-supported plan delivers the profits. 

Spotify is in the same boat. However, its Q1 2023 results are a long way from achieving this streaming nirvana. 

While total MAUs increased by 26 million in Q1 2023, relative to Q4 2022, the average revenue per premium subscriber was 12.92 euros ($14.17), 92% higher than the 1.04 euros ($1.14) average revenue per ad-supported subscriber.

Ideally, this number should be reversed. 

Why is that?

Video streaming of television and movies differs from audio streaming of music and podcasts. In part, that’s because we’re accustomed to linear TV and six minutes or so of ads each half hour. Now, you could say the same thing about radio. However, years ago, products such as the iPod trained consumers to be less interested in ad-supported radio. 

That doesn’t mean Spotify can’t push through the challenge in front of it. It just means it will be difficult to grow its premium subscriber MAUs by more than 4% sequentially each quarter. In the past four quarters, it's sequentially increased its premium subscriber MAUs by 3.3%, 3.7%, 5.1%, and 2.4% for a 3.6% average. However, as the MAUs grow, the ability to hit 4-5% every quarter will become more difficult. 

On the other hand, if it can move the needle for ad-supported MAUs by double digits each quarter, it could be to one billion in no time. The $1.14 average revenue per subscriber would add approximately $780 million in quarterly revenue. 

And let’s not kid ourselves; if it gets to one billion ad-supported MAUs, there’s almost zero chance the $1.14 figure doesn’t increase substantially. That is what will bring profitability. 

Bottom Line: Can It Get There?

I suppose anything is possible. 

Most media reports covering Spotify’s Q1 2023 results focused on adding 26 million users and hitting half a billion for the first time. That’s all good. 

However, it will take a Herculean effort by the company to get to the point where it’s making more average revenue per ad-supported subscriber than its premium subscribers. Netflix is already there. 

Call me crazy, but Spotify would be wise to beg Reed Hastings and Ted Sarandos for a merger between the two companies. That would seriously accelerate its pathway to profitability. 

Is Spotify a Buy? If you’re an aggressive investor, sure. If you’re at all risk-averse, the latest results should not be enough to get you to buy. It’s still a long way from eliminating its operating losses.       

 

On the date of publication, Will Ashworth did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.