Spotify: Minor flaws don't change the big trend, high valuation faces emotional kill

$Spotify(SPOT.US) The Q1 2025 earnings report was released before the US market opened on April 29. Due to revenue and profit guidance falling short of expectations and already high valuations, the earnings miss triggered a sharp drop in the stock price.

Key highlights from the earnings report:

1. Is the 20% revenue growth trend unsustainable?: The main reason for the sharp decline was that Q1 revenue itself fell short of expectations, and the company's Q2 revenue guidance of €4.2 billion was also below market expectations of €4.38 billion.

According to the guidance, Q2 revenue growth is only 13%, which is far below management's previous short-to-medium-term guidance of maintaining 20% annual growth, naturally raising market concerns.

The revenue miss also led to an operating profit miss, but from a margin perspective, Q2 profitability was better than the market had anticipated.

2. Which matters more: volume or price?: Breaking down subscription revenue by volume and price, the key reason for the revenue miss was lower-than-expected ARPPU (average revenue per paying user). Since the price hikes began in 2023, ARPPU growth has become one of the core drivers of Spotify's revenue growth and a key factor in market expectations for future growth.

Q1 subscription user growth mainly came from Latin America and Europe. While ARPPU still grew YoY, the increase was only 3.9%, below the market's expected 5%. In terms of subscriber numbers, Q1 saw a net increase of 5 million, exceeding both guidance and expectations.

The volume-price dynamic was primarily due to Spotify's Q1 focus on penetrating emerging markets like Latin America (leveraging the Wrapped 10th-anniversary campaign). Users in these markets naturally have lower payment capacity. Spotify's country-specific pricing strategy prioritized user conversion but sacrificed short-term ARPPU growth.

Management's reluctance to raise prices further during the earnings call confirmed the current strategy: prioritizing user penetration and long-term customer lifetime value over short-term profit expansion from monetization.

3. Impact of podcast partnerships: By segment, Q1 saw significant growth in ad-supported users, with ad revenue driving gross margin improvement. Subscription growth, however, was concentrated in lower-monetizing emerging markets. Expanding member benefits (e.g., adding video and podcasts) in certain regions also pressured margins.

Additionally, Spotify's January renewals with Universal and Warner included stricter requirements on traffic allocation (e.g., preventing fake streams for long-tail songs), which may temporarily slow subscription margin optimization. Dolphin Research estimates Q1 copyright costs rose ~0.5pp QoQ, but the long-term trend of copyright cost optimization remains intact.

4. Continued operational efficiency gains: Excluding costs, Q1 R&D and sales expenses continued to decline YoY. The call highlighted AI's dual role in enhancing user experience (e.g., personalization) and internal efficiency (e.g., code cost optimization, faster product development). G&A expenses rose slightly YoY, mainly due to SBC-related social charges.

Q1 operating profit reached €510 million (+203% YoY), with margins expanding to 12%, reflecting the high-growth phase post-breakeven.

5. Rising cash reserves prioritize investments: Improved profitability naturally boosted cash flow. Spotify's prepaid business model is inherently advantageous, especially as its market position stabilizes with reduced heavy investments in software/hardware/content, leading to more pronounced cash flow expansion.

Q1 free cash flow doubled YoY to €534 million (13% of revenue), seasonally lower. By end-Q1, cash + short-term investments reached ~€8 billion. Management stated they will actively seek investment opportunities, with potential shareholder returns if excess cash remains.

6. Performance snapshot

Dolphin Research's View

Spotify's valuation has long relied on its reiterated medium-term 20% growth outlook during investor days and market expectations for long-term margin expansion, particularly in gross margins.

Thus, despite premium valuations relative to growth, the market has generally been willing to assign >30x forward EV/EBITDA multiples given this cash flow certainty. However, the pre-earnings market cap exceeding $120 billion implied ~40x 2026E EV/EBITDA—a level pricing in substantial growth optimism.

To Dolphin Research, Q1 results aren't a fundamental issue but reflect shifting strategic priorities affecting profit timing. Management noted earnings are typically back-half weighted, with Q4 being strongest. Long-term positives—competitive positioning (growing penetration/share in core/emerging markets) and strengthening industry leverage (platform's traffic centrality driving copyright cost reductions)—remain intact, keeping Spotify a high-quality long-term tracking target.

But even great companies need the right price. Netflix, another quality streamer, trades at <30x 2026E EV/EBITDA for ~20% profit growth. While Spotify's cash flows are more stable, it lacks Netflix's dominant streaming position.

Applying Netflix's "valuation/growth" premium (which Dolphin Research already views as elevated), if Spotify's 2026E profit growth slows to 20-25% (with sub-20% revenue growth and tempered profit leverage amid investment prioritization), neutral valuation would likely be 30x-38x.

For margin of safety, assuming a midpoint 35x and 2026E EBITDA of ~€3 billion implies a neutral-to-positive valuation range of $100-120 billion. While not bubbly, higher levels invite greater short-term earnings volatility.

Spotify's key performance charts below