Ray Dalio (Trades, Portfolio) is a billionaire investor and the founder of Bridgewater Associates, the world's largest hedge fund. In the second quarter, the firm loaded up on a number of stocks, including Spotify Technology SA (SPOT, Financial).
In this overview, I will break down Spotify's financial report for the second and review its valuation metrics. Let’s dive in.
Leading market position
Spotify is the market-leading music streaming service provider with approximately 30% of the global market share, according to data from Statista.
The Swedish company had a first-mover advantage as it was founded in 2006, many years before Apple Music (2015) and one year before Amazon Music (2007).
However, Spotify’s behemoth rivals did have access to huge resources and distribution, which has enabled them to capture more market share in recent years. Apple Music has 13.7% market share and Amazon Music has 13.3% market share. YouTube is also a popular place for music lovers. Its music service has around 8.9% market share, according to Statista and IMS data.
I believe much of Spotify’s continued success has come from the business providing a purpose-built music streaming service, as opposed to just an add-on service offered by a large tech giant.
The company has also continued to lean into hugely popular trends such as Podcasts, with the rights to Joe Rogan’s podcast, which was purchased for an estimated $200 million, according to the New York Times.
Many people also are not aware that Spotify has expanded into video podcasts, which effectively makes it a competitor to YouTube.
Solid financials
Spotify reported revenue of $3.51 billion, which rose by 11% year over year and on a foreign exchange-neutral basis, it increased by a solid 14%.
Relative to prior quarters, this represented a reacceleration in growth. For example, in the second quarter of 2022, Spotify reported year-over-year growth of just 8.54%. In the first quarter of 2023, year-over-year growth was just 12.09%.
The top line was driven by a 27% increase to 551 million users, which was 21 million above its guidance. The company added 36 million net new users, which was its largest quarterly addition in history.
This growth was solid across all regions, driven by improved marketing efforts, retention as well as the addition of new podcasts.
Spotify utilizes product-led growth, in which it offers users the ability to use the service for “free” via an ad-supported tier. However, this is usually shortly followed by a signup to the paid service.
The number of Premium Subscribers rose by 17% year over year to 220 million, which surpassed guidance by 3 million.
New features and content
The company has launched a range of new features, including an “AI DJ,” which basically acts as a personalized radio station that helps users discover new songs. This was based on user feedback that said while they enjoyed playlists, they also wanted to discover new songs.
Spotify also launched a new podcast with Trevor Noah, the former host of "The Daily Show."
In addition, the business launched Spotify Ad Analytics, which is a free tool for advertisers.
Margins, cash flow and balance sheet
Moving on to margins, the company reported a 24.1% gross margin, which did compress by 47 basis points. This was driven by $48.08 million in net charges, which was related to the shutdown of various podcast shows.
On an adjusted basis, the gross margin did improve by 22 basis points year over year, driven by an improvement in the popularity of podcasts.
Spotify did report an eye-watering operating loss of 247 million euros ($269.93 million), according to its second-quarter shareholder deck. This was substantially worse than the 156 million-euro loss reported in the prior quarter. This was driven by costs related to its real estate reduction, thanks to its work from anywhere policy. This is expected to result in a positive outcome in the long term as the business will likely attract the best talent.
Spotify reported free cash flow of 9 million euros in the second quarter, which represented a substantial decline from 57 million euros reported in the prior year. In the earnings call, management blamed this reduction on the “timing” of certain payments in the second quarter. On a trailing 12-month basis, over the past three years, Spotify has averaged 200 million euros in free cash flow, which is solid.
Moving on to the balance sheet, the company reported 3.5 billion euros in cash, cash equivalents and short-term investments. In addition, it has total debt of 1.73 billion euros.
Valuation
Spotify trades with a price-sales ratio of 1.98, which is lower than its five-year average.
Based on historical ratios, past financial performance and analysts' future earnings projections, the GF Value Line indicates a fair value of $193 per share. Therefore, the stock is modestly undervalued at the time of writing.
Guru interest
Bridgewater Associates purchased 68,847 shares of Spotify during the second quarter. The stock traded for an average price of $144 per share during the quarter, which means the stock is trading slightly cheaper than this level at the time of writing.
Final thoughts
Spotify continues to prove the critics wrong and still holds the market-leading position over its big tech giant peers. I believe its platform has retention built in thanks to its custom playlists and tailored user interface. The company also has huge potential to expand into audiobooks. Its stock looks to be undervalued at the time of writing, and thus could be a great long-term investment.
