Spotify’s Lack of Focus Is Hurting Shareholders
What will it take to turn around the price of Spotify (NYSE:SPOT) stock?
The music streaming giant has seen its stock fall 53% through five months of the year to trade at $110 at the start of June 7. SPOT stock is now 64% below its 52-week high of $305.60. The share price collapsed 33% in the month of April alone as the broader selloff in the market accelerated.
Part of the steep decline can be attributed to investors’ lack of appetite for highly valued technology stocks in a volatile market. However, the drop is also due to growing concerns about the company’s increasing investments in non-music ventures. With its stock sliding lower, we take a look at what’s ailing the Swedish audio streamer and what it might take to get the share price moving in the right direction again.
Troubling Signs for SPOT Stock
At the end of April, Spotify reported first quarter results that beat Wall Street forecasts. The Stockholm, Sweden-based company announced that it earned revenue of 2.66 billion EUR ($2.85 billion) and earnings of 0.21 EUR per share (22 cents) a share in Q1.
While the headline numbers were positive, analysts and investors continued to sell SPOT stock after parsing through the entire earnings report and finding some troubling signs. The big issue is Spotify’s margins, which appear to have stagnated. Gross margins in the first quarter came in at 25.2%, down slightly from 25.5% in the previous quarter.
However, executives at Spotify have promised to raise their gross margins to as high as 40%, a level they say will generate consistent net profits and cash flow. The lack of progress on margins is seen as a red flag for analysts and investors.
Additionally, Spotify’s advertising revenue softened during Q1, raising additional concerns. Between January and March, Spotify’s advertising revenue grew a tepid 31% year over year. The company blamed the slowdown in ad growth on the closure of its operations in Russia due to that country’s invasion of Ukraine.
However, analysts expect advertising to comprise more of Spotify’s revenue, especially after the company invested $1 billion into new podcast content since the pandemic began in 2020. The podcasts are expected to attract new advertising dollars. A continued decline in the growth of ad revenues could be a disaster for Spotify and its stock.
New Content
As mentioned, Spotify is increasingly branching out into new ventures that aren’t necessarily aligned with its core music streaming business. Analysts have taken issue with the amount of money the company has invested in podcasts.
Some have also questioned Spotify’s move into audiobooks through its acquisition of privately held Findaway. And other industry observers were left rolling their eyes at news that Spotify is experimenting with non-fungible tokens (NFTs), often referred to as digital art and widely associated with blockchain technology and cryptocurrencies.
The main criticism is that these new investments are distracting Spotify from its subscription-based streaming platform.
If there’s some good news related to Spotify, it is that the company continues to be the global market leader in audio streaming with 422 million monthly active users. Currently, Spotify boasts a leading 31% market share, according to MIDiA research. That is more than double second place Apple’s (NASDAQ:AAPL) Apple Music, which has a 15% share of the $17 billion worldwide industry.
Also, SPOT stock looks to be extremely cheap at current levels. The company’s price-to-sales (P/S) ratio currently sits at 1.9 times forward sales, down from around 5.4 a year ago. The average stock in the S&P 500 index trades at a P/S multiple of 2.6. The combination of a severely beaten down share price and low P/S ratio put Spotify in undervalued territory.
Wait on SPOT Stock
While there are reasons to like Spotify and believe in the company’s long-term prospects, there are also reasons to be concerned. Stalled margins, slowing ad growth and an unfocused business plan are reasons for investors to be cautious when its comes to the audio streamer. While the company retains a leading market share, competition is only growing and competitors are getting more innovative.
And although the stock is cheap, there are no indications that it has hit a bottom yet. Further declines could be coming. For these reasons, investors would be smart to wait on Spotify and see if the company can overcome current challenges. SPOT stock is not a buy.
On the date of publication, Joel Baglole held a long position in AAPL. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
