Spotify Technology (NYSE: SPOT) reported terrific earnings, growing its revenue 20% year over year, posting its third straight quarter of positive operating profits, and returning to net profitability as well. The company also added 3 million paying subscribers during the quarter, or roughly 1 million per month.
Responding to the news, Benchmark analyst Matthew Harrigan on Wednesday added $50 to his price target, valuing the stock at $375 a share -- and Spotify's growing size was a primary reason.
Is Spotify stock a buy?
Quoted on StreetInsider Wednesday, Harrigan highlighted "meaningful music-only profitability" at the music-streaming specialist, with total gross profit margin approaching 28% in the first quarter and likely to hit that mark by Q2. As the analyst argues, Spotify's growing size gives the company "economic leverage with labels" that should help it to negotiate favorable royalty rates on music, as well as advantageous terms when paying for podcasts (and eventually audiobooks, too).
How much money might Spotify save through lower rates? Well, according to DittoMusic.com, Spotify currently pays royalties of $0.006 per stream -- or 6/10 of one penny. That doesn't sound like much, but Amazon, for example, pays only $0.004 per stream, and YouTube gets away with just $0.001!
Considering that Spotify has twice as many subscribers as Amazon Music does and 3 times that of YouTube Music, it seems strange it's paying relatively more. But this does suggest that Spotify has good grounds to negotiate cheaper streaming royalties as it gets even larger. In turn, this should continue to improve the company's operating margins, and almost certainly guarantees it reaches net profitability on an annual basis this year.
Make no mistake: After doubling in share price over the past year, at a valuation of 65 times trailing free cash flow and more than 90 times forward earnings, I find Spotify stock far too expensive to buy today. But as far as the business goes, it's firing on all cylinders and likely to continuing growing in value.
At the right price, I actually would be a buyer.
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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Spotify Technology. The Motley Fool has a disclosure policy.
