Spotify: Price Increase Failure, Can High Valuation Still Hold?

$Spotify(SPOT.US) The Q2 2025 earnings report was released before the U.S. stock market opened on July 29, and the report again fell short of expectations. In addition to external factors such as exchange rates, the guidance for endogenous growth was also disappointing.

Specifically:

1. Revenue Weak in Guidance: The revenue growth rate for the second quarter was only 10%, falling short of guidance and market expectations. However, there was a 5ppt headwind from foreign exchange, and after excluding this, the endogenous growth rate was 15%, higher than the original guidance of 14.2%, which is actually not bad.

In comparison, the company's revenue guidance for the third quarter appears somewhat weak. Even after adding back the 5-point foreign exchange headwind, the actual growth rate of 10% still falls short of the market expectation of 12%. This may be the main point of dissatisfaction for the market, as there were more optimistic growth expectations driven by a new round of price increases in Europe (initially tested in Benelux and planned to expand the price increase range in the summer).

2. Steady User Penetration: From the breakdown of subscription revenue by volume and price, the key reason for revenue falling short of expectations is the low ARPPU per user. The increase in payments from emerging market users with low ARPPU and foreign exchange impact are the main reasons. Additionally, we speculate that a new version was launched in the second quarter to promote third-party payment channels, accompanied by some promotional offers, which may have also affected short-term customer unit prices, ultimately offsetting the pull from price increases.

However, the core competitive advantage, from the perspective of user growth, has not been affected. The strategic direction expressed by management recently is to prioritize user penetration as the current primary goal, so the impact on ARPPU should not be overly concerned.

3. Gross Margin Improvement (Temporarily) Stalled: The gross margin continued to slow down to 31.5% in the second quarter, affected by audio content investment, foreign exchange headwinds, etc. Although it meets company guidance and market expectations, it seems that the effect of price increases on gross margin has ended.

Low gross margin is the biggest key hindering Spotify's profitability. Over the past year, Spotify has made considerable efforts to actively seek cost optimization opportunities. In addition to price increases, the method of changing bundled content sharing mentioned by Dolphin Research earlier seems to be temporarily suppressed.

This is related to the hidden price-uplift share rule when renewing agreements with top labels in the past two years, which will be discussed in detail below. Simply put, the optimization space for copyright costs from price increases has been compressed in the short term (within 12-18 months after the price increase), and the improvement effect on gross margin is discounted.

4. Efficiency Improvement Ended? Expenses Return to Growth: Operating expenses in the second quarter all increased year-on-year, partly due to the end of the efficiency improvement cycle, and partly due to the short-term impact of new version releases + promotional offers + employee incentives (including Social Charges) driven by rising market value.

However, with the release of the new version, reduced payment friction, and potential improvements in user payment conversion rates and churn rates, it is worth continuing to pay attention. Ultimately, Q2 achieved operating profit under dual pressure from revenue and expenses, only achieving 410 million euros, a year-on-year increase of 53%, significantly slowing down from the previous quarter, with the profit margin weakening to 9.7% quarter-on-quarter.

5. Cash Flow Increased Against the Trend, Due to Seasonal Mismatch: Despite poor profitability in the second quarter, cash flow temporarily increased significantly due to seasonal mismatch effects (Q2 and Q4 are the concentrated subscription periods for annual packages, only accrued but unpaid social security taxes, and unpaid operating-related debts). Q2 free cash flow net amount was 700 million euros, a year-on-year increase of 43%, accounting for 17% of revenue, seasonally high.

As of the end of Q2, the company had accumulated nearly 8.3 billion euros in cash + short-term investments. Last quarter, management stated that after external investments, the remaining funds would be considered for shareholder returns, and the progress can be monitored in the conference call.

6. Performance Overview

Dolphin Research Viewpoint

As a streaming media with certain competitive advantages, high valuation is the norm, and streaming media during a price increase cycle is even more attractive. However, each earnings report is the alchemy stone for valuation testing, and high valuation means performance evaluation will be stricter.

After the brief "shock" from last quarter's earnings report, with the "content bundled" price increase (20% increase in April in the Benelux region, expected to expand the price increase range in the summer), and the benefits from Apple App Store rectification (discussed in detail below), Spotify directly reached a new market value high of ~160 billion, with a GAAP P/E valuation of 57x in 2026, implying very optimistic expectations (25-27 three-year operating profit CAGR growth rate of about 40-45%, at PEG=1 level, reasonable valuation is around 120-140 billion, compared to last quarter's Dolphin Research valuation expectation increased by 10%).

And until July, as the earnings report disclosure approached, with the downward adjustment of institutional expectations (foreign exchange headwinds, SBC and social security tax expense growth), Spotify's stock price adjusted 15% from the highest point, still in a valuation state that is not considered cheap. Therefore, even if the second quarter achieves an inline performance, the market is estimated not to give a good face.

But from a long-term perspective, price increases are not always effective.

Taking the North American market as an example, the current $11.99/month single standard package (including audio content) is equivalent to 70% of the price of Netflix's single no-ad package. A 60%-70% discount is generally the normal ratio of music and film content, and because listening to music itself is more private, the demand for scenarios similar to multi-person movie watching is relatively low, so for users, this payment burden is not considered low.

Compared to peers, Spotify's price is also higher than the two largest competitors Amazon Music and Apple Music (both $10.99/month), although the latter two have deficiencies in product function design and user reach, the core copyright content can be said to be on par. Therefore, from the above two perspectives, the potential resistance to Spotify's subsequent price increases is also not small.

The real long logic is what Dolphin Research repeatedly says, Spotify's "upward" power reduction—the copyright cost as high as 60%+ (recording copyright + distribution copyright), theoretically has a relatively large optimization space (compared to the general 40% content cost rate of content platforms). However, in the short term, the status of top labels cannot be shaken, and in the contract renewal at the beginning of the year, Spotify made additional concessions to the four major labels for the price increase part (discussed in detail below), making the company unable to fully benefit from the price increase, and the improvement in gross margin is not obvious.

In the short term, Spotify's performance and valuation may be disconnected, leading to distorted stock price fluctuations every earnings season—beat may not necessarily rise significantly, but miss will definitely fall first, only after the emotions are digested, the valuation will re-interpret the long-term logic.

Detailed Analysis Below

I. Steady User Penetration

The user metrics in the second quarter were the only highlight of Spotify's earnings report, with a net increase of 18 million monthly active users, approaching 700 million users. North America and other regions were the main growth drivers this quarter, possibly due to the launch of a new version in May (providing a smoother third-party payment method).

Paid subscription users also grew well, with a net increase of 8 million, exceeding the guidance and expectation of 5 million, with Europe, Latin America, and other regions being the main sources of growth.

For the third quarter guidance—net increase of 14 million monthly active users, net increase of 8 million subscription users, also represents the normal penetration and expansion trend of user scale.

II. Price Increase Fails to Drive Revenue Growth

Despite the price increase in North America in the second half of last year, the foreign exchange headwinds and growth in emerging regions lowered the customer unit price, and the price increase dividend was basically offset. The second quarter revenue growth was 10%, with a 5ppt impact from foreign exchange headwinds. Subscription revenue growth was 12%, and advertising declined by 1% year-on-year.

Excluding foreign exchange, the endogenous growth in the second quarter was not bad, but the third quarter guidance shows that the endogenous growth rate of 10% is significantly inferior to market expectations.

However, the company's original plan was to expand the range of price increase regions, from the experimental price increase in Belgium, Peru, Luxembourg in April, to more European, Latin American countries and regions. Therefore, the market had certain optimistic expectations, but from the actual guidance, it seems that the pace of price increases has been adjusted.

III. Profit Under Dual Pressure, Improvement Trend Paused

Profitability in the second quarter significantly deteriorated, with the profit margin falling to 9.7%. Under revenue pressure, operating expenses returned to growth, jointly squeezing the release of operating profit.

Expense breakdown:

1. Hidden Clauses Make Copyright Costs Still Rigid in the Short Term

Although there is a long-term optimization trend, the short-term sharing ratio is difficult to shake. Previously launched bundled audio subscription packages aimed at optimizing royalty fees in disguise, but under protests from the upstream music industry, Spotify made certain concessions, giving an additional 40-50% share to copyright holders for the price increase part.

For example, the U.S. standard package fee increased from $10.99 to $11.99, Spotify not only needs to pay approximately 52% share to top labels, $11.99*52%=$6.2 in copyright fees, but also needs to pay an additional 0.4-0.5 dollars for the price increase of 1 dollar. As a result, the overall share ratio increased from 52% to 55%.

In the second quarter, subscription costs fell from 33.5% to 33.1% quarter-on-quarter. The company's gross margin expectation for the third quarter is 31.1%, continuing to slow down compared to the second quarter's 31.5%.

2. Operating Expenses Return to Growth, Due to Cyclical Reasons and Short-term Factors.

Operating expenses in the second quarter returned to positive growth, with all three expenses reversing the downward trend. In addition to being at the end of the efficiency improvement cycle, short-term factors such as the release of the new version in May in the U.S. led to some concentrated R&D and sales expenses.

Additionally, due to the increase in market value, corresponding option expenses and employer social security taxes (Social charges) have seen significant growth. In the second quarter, Social charges reached 115 million, almost double the same period last year.

Why did Spotify launch a new version in the U.S. in May? This has to mention the major adjustments made by Apple App Store in the second quarter:

This point is also very crucial in Spotify's Q2 upward logic, although the short-term impact has not been seen, but from a long-term perspective, it is beneficial for improving Spotify's user payment conversion and churn rates.

Currently, Apple is still looking for opportunities to appeal or deny (for example, using Supreme Court regulations to deny the validity of judgments issued by local state courts nationwide), but the direction of this matter is very crucial for all app developers involved in in-app payments. Taking advantage of Spotify's earnings report this time, Dolphin Research will elaborate.

1. Cause: Old Case Revisited

Epic appealed to the Northern California court in April this year, requesting the enforcement of the 2021 court's injunction ruling against Apple for violating California's Unfair Competition Law—prohibiting Apple from restricting developers from informing users of other payment options in-app or through other means (often priced cheaper without the 15%-30% Apple tax).

Epic won with difficulty, but ultimately opened a gap in the Apple tax wall. However, iOS as a closed ecosystem, Apple's hegemony cannot be easily destroyed. The result is that Apple agreed to allow developers to introduce third-party payment links, but the cost is still "27% channel tax + link placement restrictions + danger warning pop-ups".

Actually, just the lower 27% channel tax is enough to make developers give up third-party payments, because introducing third-party payments, developers also have to pay a 3%-6% passage fee to the payment platform. Clearly intended to save money, but ultimately the overall cost did not decrease. And with the addition of "link placement restrictions" and "danger intimidation pop-ups", it actually increases purchase friction, reducing user payment conversion rates. In this way, introducing third-party payments is a big "loss outweighs the gain" for developers.

2. Progress: Hegemony Loosens

Therefore, Epic re-sued Apple for this "deceptive compliance" operation. The Northern California court ruled at the end of April that Apple violated the 2021 injunction, reissued the injunction and immediately took effect.

In early May, Spotify submitted a new version containing third-party payment methods to the Apple App Store, (temporarily) passed the review (Apple is still actively appealing). Since then, Spotify can at least provide users with other payment channels relatively smoothly in the U.S.

At the same time, the EU is also making efforts. In March 2024 and April this year, the EU respectively ruled that Apple violated DMA antitrust rules, fined 1.84 billion and 500 million euros, and required adjustments. In response, Apple's actions are only to make slight concessions by designing new payment excuses, the hegemony within the ecosystem remains, and Epic CEO also expressed protest against Apple's operations in the EU. As of now, the EU has not responded to Apple's operations. But it should be noted that facing American tech giants, EU regulation is always stricter, worth paying attention to.

(1) March 2024, launched new commercial rules for app developers—

a. Added Core Technology Fee (CTF, first annual installation fee), app installations exceeding 1 million times, need to pay an additional 0.5 euros per year, capped at 1 million euros.

b. IAP commission, reduced to 17% (10% for small developers), regardless of whether external payment links are used.

c. Payment processing fee 3%

(2) June 2025, launched new App Store service fee tier system—

The first tier (basic tier) service, although the commission is only 5%, developer functions are castrated, including automatic app updates, automatic app downloads, background data analysis, App Store recommendations, search tips, etc., not within the service scope.

3. Benefit for Spotify?—Reducing Payment Friction

But the Apple tax reform is not a direct improvement in gross margin for Spotify, but rather an increase in revenue, reducing customer acquisition and promotional expenses.

Unlike other app developers (especially game apps), Spotify can be said to have prepared early in dealing with the channel tax of Apple and Google.

As early as 2016 (Apple Music was just launched for a year), Spotify began to guide users to bypass the in-app payment (IAP) mode in the iOS system and subscribe to pay on its own website.

In terms of guidance, on the one hand, technically forced to close the in-app payment entrance, large-scale direct connection to the payment ecosystem (connecting low-rate online payments, signing fee deduction agreements with telecom operators), on the other hand, providing promotional means such as price discounts and free trial periods on the website.

Therefore, as of today, the overall payment channel cost in Spotify only accounts for 3% of subscription revenue. Therefore, the adjustment of the Apple tax has minimal impact on Spotify's payment cost optimization.

So why does Spotify, like Epic, actively urge regulators to intervene in breaking Apple's ecosystem monopoly?

—The reason is that Apple prohibits app developers from revealing other payment channel price information in-app, and after being forced to allow it, various pop-up security intimidation is also applied to jump links, these factors lead to a 20-30% decrease in Spotify's payment conversion rate, and the monthly churn rate on the iOS side is 0.4ppt higher than the Android side.

If according to the 70 million iOS subscription payment scale, assuming this churn gap can be leveled, it can recover more than 3 million subscription users a year, indirectly raising the gross margin by 1-2pct. In addition, the promotional expenses invested to attract user payments can also be saved, making the overall profit margin improvement very obvious.

IV. Cash Flow Instead Good? Just Seasonal Impact

Despite poor profitability in the second quarter, cash flow temporarily increased significantly due to seasonal mismatch effects (Q2 and Q4 are the concentrated subscription periods for annual packages, only accrued but unpaid social security taxes, and unpaid operating-related debts). Q2 free cash flow net amount was 700 million euros, a year-on-year increase of 43%, accounting for 17% of revenue, seasonally high.