Apple’s Great Quarter Is Bad News For Spotify Stock

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SPOT stock - Apple’s Great Quarter Is Bad News For Spotify Stock

Source: Spotify

Technology giant Apple (NASDAQ:AAPL) just reported robust third-quarter numbers that are propelling the stock closer than ever to the trillion-dollar mark. Meanwhile, streaming music company Spotify (NYSE:SPOT) is in the red on a day when tech stocks are largely rallying. As of this writing, SPOT stock is down 1%.

What is the connection here?

A big part of Apple’s strong quarter was continued robust growth in the Services segment, which grew 31% year-over-year. A big part of Services is Apple’s Spotify competitor, Apple Music. In the quarter, Apple Music revenues rose 50% year-over-year (versus 34% growth over at Spotify). Also, Apple Music has well over 50 million total subscribers, nearing Spotify’s 80 million base, and Apple management reported that Apple Music has taken a leadership position in multiple markets, including the U.S.

None of that is good news for Spotify. The music streaming race used to have one leader (Spotify) and two laggards (Apple and Pandora (NYSE:P)). Now, there are two leaders. And, if current trends persist, Apple Music will turn into the sole leader and Spotify will turn into a laggard.

This is all bad news for SPOT stock, which still trades at mega-rich valuation that doesn’t incorporate competitive risks. Consequently, I think SPOT stock could be a bubble that is ready to pop.

Here’s a deeper look.

Apple Music Is Beating Spotify

Everyone wants to call Spotify the Netflix (NASDAQ:NFLX) of music. After all, both are pioneering content subscription services with widespread popularity.

But Netflix hardly has any competition. Netflix has 130 million global members. Its biggest direct competitor, Hulu, has less than 20 million members. That is a wide gap.

On the other hand, Spotify has plenty of competition. Spotify has just over 80 million global paid subscribers. Apple Music just reported well over 50 million total subscribers. That is a narrow 60% gap, and it is only getting closer. At the end of 2016, Spotify was 150% larger than Apple Music (nearly 50 million subs versus 20 million).

Worse yet, Apple Music has taken leadership position in the U.S. and Japan, two countries where Apple Music has been around for a while. Thus, in countries where Apple Music has established solid footing, the music streaming service has also established leadership.

Long-term, that is a bad trend for Spotify. If this trend persists, then Spotify’s share of the global music streaming market will shrink, and that will inevitably weigh on user and profit growth, two things SPOT stock isn’t priced for.

Spotify Lacks A Competitive Advantage

I think Apple Music continuing to win and Spotify continuing to lose is exactly what will happen over the next several years.

At the end of the day, neither Apple Music nor Spotify has any original content to boost value like Netflix. Original content in music likely won’t become a thing because music is widely available for free everywhere, and it is so easy to pirate. Without original content, it is tough to see how Spotify differentiates itself in this market.

Apple Music can differentiate itself by being innately built into every iPhone in the world. It is a low-friction sign-up process that syncs with numerous other Apple services. No lengthy downloads are necessary. And the app button is already there when you get a phone.

In other words, Apple Music has a huge convenience advantage over Spotify when it comes to signing up new users. Spotify, meanwhile, doesn’t really have any advantage over Apple Music. Because of this, the current trend of Apple Music acquiring new users at a quicker rate than Spotify will likely persist.

Spotify Stock Is Unreasonably Valued

SPOT stock isn’t priced for this trend to persist. In fact, SPOT stock isn’t priced for any headwinds at all.

SPOT stock trades at 6X trailing sales without any profitability. Granted, I understand paying a huge premium for a company that has robust revenue growth potential and can scale profitability quickly on a big revenue base. But, SPOT stock doesn’t fit that description.

Revenue growth was just 34% last quarter, excluding currency fluctuations. That isn’t that big of a growth rate for a company with only a few billion in revenues. Plus, revenue growth is consistently slowing. In 2016, revenues jumped more than 50% higher. In 2017, revenue growth was narrowly under 40%. So far in 2018, revenues are up just 26%, and that is expected to slow even more in the back-half of 2018.

Overall, then, this isn’t that big of a revenue growth story. Now, consider that Apple Music is ramping and stealing market share, and it becomes obvious that Spotify’s revenue growth won’t be massive going forward.

Thus, in order to justify the current valuation on SPOT stock, you need a huge profitability ramp. That is possible. But, because all the subscriber growth is from lower price Family Plans, profit margins won’t soar enough to justify the current valuation.

All together, I think this company can do about $8 in earnings per share within the next five to 10 years. But even at the base, a hyper-growth 25X multiple on that implies a long-term price target of just $200. That makes SPOT stock’s present $180 price tag seem way too high.

Bottom Line on SPOT Stock

Apple Music is beating Spotify where it counts, and that will inevitably cause weakness in the richly valued SPOT stock.

As of this writing, Luke Lango was long AAPL. 


Article printed from InvestorPlace Media, https://investorplace.com/2018/08/apple-inc-aapl-stock-great-quarter-is-bad-news-for-spotify-stock/.

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