Spotify Stock’s Rally: Too Far Too Fast?

Spotify Stock’s Rally: Too Far Too Fast?
Cheyne Gateley/VIP

We may be in the midst of a global pandemic and economic recession, but that hasn’t stopped Spotify stock from soaring to all-time highs this year. Shares of the audio streaming platform have retreated a bit from record levels hit in late July, but it has been an eye-popping run by any stretch of the imagination. 

Despite a slew of justifications for the impressive performance thus far, could the stock be grossly overvalued?

So far in 2020, Spotify stock is up nearly 70% and more than 100% since the March lows. Meanwhile, the S&P 500 gained 4% this year and more than 50% from the market bottom. 

There are a couple key reasons for Spotify stock’s surge in the face of such challenging macroeconomic conditions. First, the stay-at-home culture has breathed new life into streaming, whether it’s audio or video. 

The COVID-19 pandemic forced the world’s population to shelter in place for months, and companies such as Spotify and Netflix saw user growth jump as a result.

Spotify reported that monthly active users (MAUs), a key industry metric, soared 29% to 299 million during its second quarter ended June 30. Paid subscribers of Spotify Premium jumped 27% from last year to 138 million. 

According to the company, global consumption hours are essentially back to pre-COVID levels, and it sees user growth continuing to climb through the rest of this year.

Talk about user-engagement wins. This brings us to the second big reason Spotify has been on a tear — podcasts. Not just any podcasts but exclusive ones with high-profile people like Kim Kardashian West, Joe Rogan and former First Lady Michelle Obama.

Cofounder and CEO Daniel Ek knows whether controversial or not, all three of those public figures have loyal followers. Rogan may have signed with Spotify in mid-May, but West signed her deal in mid-June and Obama inked hers less than a month ago. 

That means investors have yet to see the user boost created by these deals. Those results will be revealed in the coming quarterly results. However, markets are forward looking, so the massive rally in Spotify stock has a lot of these growth drivers priced into it already. Then that begs the question: Is there more room to run?

Some have said Spotify’s recent focus on beefing up its content library is reminiscent of Netflix’s strategy in the streaming wars. It’s true that Spotify’s penchant for aggressively spending money on content is right up Netflix’s alley, but here’s where things are different — audio isn’t video. 

Music streaming is a tough business because distributors like Spotify still have to relinquish the power. Most of the revenue Spotify generates from music streaming ends up back in the hands of artists and labels. 

That’s why the company is pivoting to shift some focus to podcasts. With podcasts, Spotify doesn’t have to work with labels and can pocket most of the money it brings in, especially through ads. The company currently boasts roughly 1.5 million podcasts on its platform.

Makes sense, right? But it’s not cheap. Spotify reportedly paid Rogan $100 million for his exclusive deal, and it’s unclear how much money he’s going to make for the company. Plus, while podcast consumption on the platform is growing, it is still rather low. About 21% of total MAUs listen to podcasts as of the second quarter.

That said, one advantage for Spotify is it does have advertising as a channel for revenue. Whether you’re a free or paid user, ads run in all podcasts on Spotify. Ad revenue only represents about 10% of total revenue for the service, but management has previously said it plans to grow that into a bigger part of its business. 

Here’s why that could be problematic. As we’ve seen throughout the pandemic, subscription-based revenue is more resilient to economic turmoil and volatility than ad revenue. Companies that bring in recurring revenue from subscriptions have been richly rewarded, whereas significant pullbacks in spending have punished those that rely on advertising revenue.

Spotify has been a growth story with a visionary founder, and it is taking aggressive steps to ensure it not only survives but ultimately thrives in a highly competitive environment. Wall Street tends to favor companies that are growing rapidly, and even though there is a lot of potential surrounding the podcast growth story, it could be argued that the stock may have run a little too far too fast.

With a market cap of nearly $50 billion, the valuation is sky high. Will Spotify lean more heavily into the subscription-based model or the ad-revenue model? It remains a critical question that will determine the future direction of the stock.