Spotify (SPOT) is trading lower after the company reported third quarter results and updated fourth quarter guidance this morning.
Third quarter revenue (+31%), users (+28%), and paid subscribers (+40%) were in-line with the company's forecast.
Operating profit exceeded guidance, and the company raised its profit forecast for the fourth quarter. However, the surprise Q3 profit came entirely because of a tax benefit. Also, the company noted that upside in operating profit stems from a shortfall in hiring. The company warned that it will accelerate investments in R&D and content in 2019, which will weigh on margins for the foreseeable future. So, near term upside in profit margins was more than offset by the longer-term warning on that front.
Spotify said it will issue formal guidance for fiscal 2019 next quarter.
Spotify skeptics are also concerned about declines in average revenue per user (ARPU). While the ARPU decline moderated sequentially to 6% from 12% in the second quarter, the company also warned about headwinds from lower-priced emerging markets like Latin America, Southeast Asia, and other newer markets, where Spotify is seeing most of its growth.
The streaming music leader also trimmed the high end of its fourth quarter outlook for users and subscribers. Spotify lowered its fourth quarter monthly active user (MAU) guidance to 199-206 mln from 199-207 mln and lowered its premium subscriber guidance to 93-96 mln from 93-97 mln. Management indicated this was done in prudence in order to not disappoint investors next quarter.
While this seems like a rather small reduction, those two metrics are arguably the key tenet in the Spotify investment thesis for growth investors.
While Spotify is the streaming market leader, it is a highly competitive space. Apple Music is number two and growing quickly with obvious competitive advantages. Meanwhile, Amazon, Google, and Pandora (being acquired by Sirius XM) are all going after the burgeoning streaming market. Therefore, any sign of weakness in Spotify's growth stokes fears over competition.
Spotify has a $25 billion market cap. The stock trades at just over 4x sales or 3x next year's sales. The valuation discount to other high-quality software subscription businesses reflects the company's poor margin profile given the hefty licensing fees paid to music labels.