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3 Reasons to Dump Spotify Stock While You Still Can

These trends should keep investors away from Spotify stock

After a rough 2018, Spotify (NYSE: SPOT) stock has come back to life in 2019, gaining 25% year-to-date. There’s no questioning Spotify’s impressive growth numbers and music streaming market share. But the company’s underlying business model leaves people who invest in Spotify stock extremely vulnerable.

Spotify Stock spot stock
Source: Spotify

Unfortunately, the there are simply too many obstacles for Spotify to overcome in the long-term to make the stock a buy at these levels. Music streaming is here to stay, but that doesn’t mean Spotify is the best way to play it.

Here are three reasons investors should take profits in Spotify stock while they can.

Expectations Are Too High

Spotify stock is not the only growth stock plagued by the curse of unrealistic expectations. The most recent quarter is a perfect example. Spotify reported 30% year-over year revenue growth in the fourth quarter of 2018.

The company grew its revenue from $1.36 billion a year ago to $1.70 billion in Q4. The problem? The consensus analyst revenue estimate was $1.71 billion. Spotify gained $350 million in revenue, but the market zeroed in on that tiny $10 million miss. The stock initially dropped 4%.

When it comes to disruptive businesses like streaming music, investors always seem to go a little nuts with the expectations. Credit Suisse analyst Brian Russo addresses these unrealistic expectations in a new research note.

Much like streaming video disruptor Netflix (NASDAQ: NFLX), analysts and investors are obsessed with subscriber numbers. Consensus analyst estimates are calling for Spotify to reach 241 million total subscribers by 2023. Russo is predicting just 232 million subscribers.

“Our view is based on our belief that long-term consensus subscriber estimates are too high, and margins will be challenged to meet consensus expectations,” Russo said.

It’s important to keep in mind that Credit Suisse is forecasting Spotify’s subscriber count to more than double from 2018 to 2023. That’s an extremely impressive accomplishment. But much like that $10 million Q4 miss, it likely won’t be good enough for the market.

Competition Is Fierce

Almost every company out there has competitors breathing down its neck. Unfortunately, Spotify’s competitors are some of the biggest and baddest tech companies on the planet. Apple (NASDAQ: AAPL), Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) and Amazon (NASDAQ: AMZN) have nearly unlimited resources and massive user bases. They each have plenty of content and services to create bundles and incentivize customers. Perhaps most importantly, they have stellar balance sheets and tremendous cash flows.

Morningstar analyst Ali Mogharabi recently discussed the reason why those competitors may be a major problem for Spotify.

“Unlike Spotify, these firms don’t rely solely on streaming music to drive profitability and can potentially run at break-even, or even as loss leaders, while monetizing users via other products and services,” Mogharabi said.

In other words, Amazon, Apple and Google don’t need the streaming music business to be viable on its own. As long as it helps support their other viable businesses, they are happy. They can undercut Spotify on pricing and simply eat the losses. That’s not a luxury Spotify can afford.

Anything Spotify does to differentiate its offerings, competitors can easily emulate. In fact, Mogharabi goes as far as to call Spotify a “no-moat company” that is in serious risk of losing market share to much larger competitors.

Spotify Stock Margins at Risk

The third thing about Spotify’s business that may be changing for the worse is content costs. Spotify’s business lives or dies based on its content library. Spotify doesn’t produce the music it offers, so it must rely on deals with the music industry.

“A debate around profit margins for Spotify is essentially a debate around gross margins, which are determined by content costs,” Russo said.

In addition to natural market competition for music content, regulators have taken steps to ensure content creators are protected and treated fairly by large tech companies. As a result, Credit Suisse projects U.S. streaming royalty rates will rise from 10.1 percent in 2017 to 15.1 percent by 2022.

Spotify has joined Amazon, Google and Pandora (NYSE: P) in pledging to challenge the recent royalty rate hike by the U.S. Copyright Royalty Board. The optics of trying to get a larger piece of the artists’ pie certainly aren’t great for these giant tech companies.

Russo says music content has essentially become commoditized. In that sense, owners will continue to have pricing leverage in a fiercely competitive distributor market.

Bottom Line on Spotify Stock

SPOT stock currently trades at about 3 times 2019 revenue estimates. That’s a perfectly reasonable valuation given its current growth rate, market share and margins.

However, there are major doubts Spotify will be able to maintain any of those three selling points in the years ahead. The streaming music industry may continue to boom. Just don’t expect Spotify stock to follow suit.

As of this writing, Wayne Duggan did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2019/04/3-reasons-to-dump-spotify-stock/.

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