Spotify Stock: Poised to Soar as Price, Regrouping Adjustment Hit Earnings (NYSE:SPOT)

Like Spotify (New York Stock Exchange: SPOT) is set to release its second-quarter 2024 results on July 23 before the market opens, several indicators point to a strong performance that should exceed analyst consensus expectations on both revenue and operating income. Spotify’s strategic initiatives are a crucial factor in its positive outlook for the second quarter. As another positive catalyst, I highlight that during the first half of 2024, Spotify has been proactive in improving monetization and expanding its service offering.

This includes the introduction of new pricing tiers and the scaling of audiobook services, which provide additional revenue streams and help maintain user engagement. While most of the benefits of the monetization push will likely only materialize in the second half of 2024, the second-quarter reports could surprise investors with stronger-than-expected guidance for the remainder of the year. On the valuation front, I am raising my 2030 ARPU estimate for Spotify by 10% to $44, while I am I am reducing my cost of equity assumption by 50 basis points to 8.5%. This brings my price target for Spotify stock to around $453.

As a reminder: Spotify stock has significantly outperformed the broader stock market this year. Year-to-date, Spotify shares are up about 61%, compared to a gain of about 18% for the S&P 500 (SP500).

Price increases are bullish…

In a previous article on Spotify stock, I noted that I was very bullish on Spotify’s ability to raise prices. However, I have to admit that I didn’t expect the music streaming leader to impose higher prices so soon. But it’s a pleasant surprise. On June 3, Spotify announced that the company was planning price adjustments in the United States, following successful price increases in the United Kingdom and Australia. Overall, the price increases range from $1 to $3 per subscriber per month, which should have a significant impact on the company’s financial performance.

In fact, Deutsche Bank analysts estimate that the U.S. price hike alone could contribute about €70 million to third-quarter 2024 revenue, assuming the changes go into effect in mid-July. On an annualized basis, the revenue impact is expected to exceed €300 million by 2025 (Source: Deutsche Bank research note on Spotify, dated June 4: The price seems right).

While the date of the price update is not yet known, I expect the adjustments to take effect as early as July of this year. Interestingly, this is the second time in a year that Spotify has increased its prices, which speaks to the company’s confidence in its strategic position and its ability to capitalize on the strong demand and perceived value of its services. The previous round of price increases, implemented in May in countries like the UK and Australia, appear to have been well-received, setting a positive precedent for the upcoming adjustments in the US.

…While the consolidation strategy contributes to the increase in margins

In addition to the price increase, Spotify has also made some notable changes to its bundling strategy. Notably, Spotify recently launched a more expensive audio bundle that includes music, podcasts, and audiobooks. This bundling strategy, now available in markets representing approximately 50% of Spotify’s user base, is designed to capitalize on the growing consumption of diverse audio content and maximize user engagement.

In my view, the bundling strategy is not just a short-term revenue driver, but also a long-term growth driver. By offering a comprehensive audio experience, Spotify is taking an important step toward the company’s broader goal of becoming the world’s leading audio platform. At the same time, the strategic introduction of new pricing tiers, such as a music-only option, provides flexibility to users who may be price-sensitive, mitigating the risk of churn and preserving the stability of the subscriber base.

In terms of profitability, the new pricing structure is expected to support gross margin expansion. Analysts estimate that the majority of the additional revenue from these price increases will flow through to the income statement, with minimal participation from record labels. This is particularly relevant for the audiobook service, which is seen as one of the main drivers of the price adjustments. The introduction of a new base tier, excluding audiobooks, allows Spotify to segment its offerings and justify price increases as added value for improved services.

For example, Morgan Stanley’s analysis suggests that gross margin for plan users in the US could increase to 35.7%, up from 27.8% under the previous pricing model (​Source: Morgan Stanley research note on Spotify, dated July 7: The grouper). For further context, I would point out that the additional third-quarter revenue of €70 million could generate €50 million to €55 million in additional gross profit, according to Deutsche Bank’s projected estimates (Source: Deutsche Bank research note on Spotify, dated June 4: The price seems right).

Second Quarter Report and Third Quarter Forecast Overview

Spotify is expected to report its second-quarter results on July 23 before the market opens. As of July 14, analysts are forecasting revenue of €3.79 billion, which I think is very conservative. In fact, I would point out that Spotify’s own forecast is €3.8 billion, and the company has a good track record of beating its own forecasts. Similarly, Spotify’s forecast calls for operating profit of €250 million, compared to analyst consensus of €220 million, according to data collected by Refinitiv. As for user growth, I expect MAU and premium subscriber numbers to be in line with TTM growth expectations and trends, with a forecast of 15-17 million MAU net additions and 5-6 million premium subscriber net additions, reflecting annual growth of around 15% and 11%, respectively.

Also on the second quarter results, I am very optimistic about the company’s guidance for the third quarter. Highlighting the price increases and consolidation efforts discussed above, I believe we can expect a significant increase in gross profit, operating income and free cash flow compared to the prior quarter. In addition, I am optimistic about the likely announcement of a share repurchase program, after the company achieves a sustainable and strong free cash flow inflection, coupled with a cash position of $4.7 billion in the first quarter of 2024.

Assessment: TP increase to $453

Focusing on valuation, I update my 2030 ARPU assumption to $44, up 10% from my estimate of $40 3 months ago. The increase in ARPU expectations should reflect Spotify’s more aggressive than expected monetization and consolidation efforts. Additionally, I lower my cost of equity assumption by 50 basis points to 8.5%, primarily due to lower risk premiums in the equity asset class. Based on these adjustments, my baseline price target for Spotify rises to ~$453, suggesting nearly 50% upside to the company’s early July 2024 trading price.

Below I also share the updated sensitivity table. For context, the rows project ARPU, while the columns project user count (all data for 2030)

Key takeaways for investors

Spotify’s price increases and bundling strategy represent a well-calculated move to increase revenue and improve gross margins. In fact, the company’s ability to raise prices twice in one year in major markets like the U.S. and U.K. without significant churn loss demonstrates the strong consumer confidence and perceived value of Spotify’s offerings. In my view, investors should consider Spotify’s pricing power to be a testament to the company’s market leadership and ability to leverage its large user base to drive incremental revenue gains.

Looking ahead to the second quarter, I expect the upcoming earnings report to further validate Spotify’s strategic direction and ability to generate long-term shareholder value, with the announcement of a share repurchase program also in the pipeline. On the valuation front, I have increased my 2030 ARPU estimate for Spotify by 10% to $44. Additionally, I have lowered my cost of equity assumption by 50 basis points to 8.5%. As a result, my price target for Spotify stock now stands at around $453. Spotify remains my top investment pick.