Spotify: Look Past Currency Headwinds

Summary

• Spotify reported fantastic Q1 numbers that were hit by currency headwinds.
• The company continues to expand non-music options and drive innovation in the music industry.
• The stock valuation remains compelling for a company generating substantial recurring revenues.

The first quarterly report after a company goes public is always dramatic for shareholders and the stock. Different management teams present and guide in different manners and the quarterly report provides the initial opportunity for investors to react to the presented data. In this scenario, the market isn't appreciating the guidance from Spotify (NYSE:SPOT) due in part to over extrapolation of the currency impacts on the results.

Source: Spotify

Currency Headwinds

In the third sentence of the shareholders letter, Spotify summed up the quarterly results without much further research needed.

Total revenue was €1,139 million growing 26% Y/Y, and 37% Y/Y after adjusting for the negative impact from changes in foreign exchange rates.

The stock ended up dipping 6% on the day following earnings that probably wouldn't have occurred if the reported earnings growth was 37%. So basically, the company is located in Stockholm, Sweden, and reports in euros, so the translation with the U.S. dollars impacted revenues. The euro strengthened significantly against the U.S. dollar in the 2H'17 so the comparison to last Q1 is skewed.

Source: XE currency charts

The company only has 40% of subs in Europe so currency impacts could go far beyond the U.S. as well.

Source: Spotify Q'18 shareholder letter

So despite these currency headwinds and knowing that Spotify originally guided towards a €280 million impact for the year, the market just wasn't prepared for the Q2 guidance that revenues might only grow a meager 10%. The currency headwind is alleviated in the 2H based on where the euro trades now. As well, guidance sees €195 million of the impact in the 1H and only €85 million in the 2H.

The overreaction is clearly and likely based on the market not being familiar with Spotify. Very few tech stocks on the U.S. markets report in a foreign currency with the majority of revenues not generated in U.S. dollars.

Where To Focus

The better focus is on the surging subs that continue to help grow the music industry. As expected, Spotify reached 75 million subs last quarter and forecasts another jump to 79 to 83 million this quarter. The company expects to ultimately reach around 94 million at the end of the year.

Spotify continues to crush Apple (AAPL) that ended Q1 with only 40 million subs. Other players in the streaming music industry remain a threat, but Spotify continues to expand business opportunities like all good companies. The integration into auto infotainment systems, the use of scale to work with exclusive content from artists, and non-music products like the podcast partnerships set up the company to be more than just a streaming music service.

The key to the story similar to Netflix (NFLX) and other subscription services is once a customer subscribes to the services the business model only requires fine tuning to make a successful business, whether the margins are under pressure currently or not. The recurring revenues eventually reach the scale to make the business highly profitable.

Spotify has the added benefit of nearly 100 million MAUs on the ad-supported model. The business has plenty of future customers already on the platform and some of these new partnerships will benefit from access to nearly 200 million users.

My original research on Spotify still supports a $150 price as the low-end valuation. The stock only trades at roughly 4x sales at those levels and far below where Netflix trades with a similar video streaming business no matter how many comments that the businesses can't be compared.

Takeaway

The key investor takeaway is that Spotify was hit by irrational fears due to currency impacts. Reuters recently detailed the impact to other European companies and the benefits these corporations will see if the euro dips to the €1.15 level as predicted.

The stock will magically return to substantial reported growth come the second half of the year and the market will praise the innovation of the music-streaming service. Use the weakness in the stock as an opportunity before the market catches on to the obvious.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SPOT over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock, you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.