Spotify's Q2 Results Disappoint, Shares Drop 12%, and Price Hike Announced

Spotify shares dropped 12% following Q2 results, including a net loss and missed growth expectations. The company subsequently announced price increases as a temporary solution.

Spotify (NYSE:SPOT) shares dropped nearly 12% in response to its Q2 results, which included a surprising return to net loss and failed to meet growth expectations. The company subsequently announced price increases, and shares recovered to pre-earnings levels fairly quickly. While Spotify’s core subscription business remains strong, concerns persist about stagnating margins, struggles in ads, and market share losses to YouTube (GOOG).

The quarterly results showed a decent slowdown in growth, with Spotify adding 18 million monthly active users (MAUs) to reach 696 million, up 11% year-over-year (YoY). Premium subscribers grew to 276 million, up 3% quarter-over-quarter (QoQ) and 12% YoY. Revenue was at €4.2 billion, missing guidance due to incremental FX headwinds. Premium revenues rose by 12%, while ad-supported revenues declined by 1%.

Spotify’s gross margin declined for the second consecutive quarter, dropping to 20%-23% of revenues. The company expects a slowdown in MAU additions to 14 million in Q3 and another quarter of 5 million premium adds. Revenue is expected to be roughly flat QoQ, reflecting the lowest year-over-year growth in years, even excluding FX headwinds. Gross margins of 31.1% would mark the first quarter in a few years that gross margins do not improve on a YoY basis. Operating income is expected to increase by a single-digit percentage from last year.

Price increases are seen as a temporary measure to offset these challenges. Spotify’s current valuation is viewed as stretched, with the stock trading at 110 times forward earnings and 53 times next year’s estimates. This is at a time when revenue growth is the slowest it has ever been, and the concerning areas of the business, in advertising and video, have yet to demonstrate meaningful optimism. Spotify trades at a significant premium compared to Netflix (NFLX), which trades at 39 times next year’s estimates, more than a 20% discount.

The company’s ability to maintain subscriber growth at a 10% premium over competitors is a key factor. However, the question remains whether Spotify can sustain this premium as it continues to raise prices. Additionally, the company has yet to add significant value to its core offering to justify higher prices.

In conclusion, while Spotify’s subscription business remains strong, the company faces significant challenges in its ad-based business and market share losses to YouTube. Price increases are seen as a temporary solution, and the company's valuation appears stretched. As such, investors should consider the potential for downside risk.