Many investors probably own shares of Spotify Technology (PLACE 3.85%) because they know his service. Streaming is gaining traction in the entertainment industry, so Spotify seems like a good bet. But with the stock price down 50% year-to-date, investors are likely wondering how resilient Spotify’s business might be in the face of an economic downturn.
The term “recession” has come up a lot lately. It is often associated with a period of weak gross domestic production (GDP). This has garnered more attention recently after the US posted its second straight quarter of GDP decline. When the economy is weak, it hits certain industries, including the one Spotify relies on: advertising. Its ad-supported streaming plan is used by more than half of monthly active users.
But even with the economic headwinds, Spotify stock surged after its second-quarter earnings report in July. The music streamer saw solid growth in monthly active users and revenue. This suggests that Spotify may be a more recession-proof company than market participants believe.
Why the Market Loved Spotify’s Neighborhood
Management said it doesn’t see a significant impact from the economy, but has recently taken preemptive action to reduce hiring in case market conditions worsen. CEO Daniel Ek said he noticed several markets were performing better than internal forecasts.
Spotify had reported a deceleration in monthly active user growth throughout 2021, which was a key factor that appeared to weigh on the stock’s performance. But that streak has come to an end. In Q1 and Q2, Spotify has now seen steady growth in monthly active users, up 19% in the first half of the year.
Still, Spotify’s outlook points to another drop in user growth. Q3 monthly active users are expected to reach 450 million, up 18% from a year earlier. But that’s hardly a concern.
It seems investors were just happy to see a subscription service post double-digit gains in users and revenue, especially after the streaming pioneer’s recent struggles. netflixwhich has struggled to grow its subscriber base over the past two quarters.
Indeed, Spotify’s 23% revenue increase over the prior year quarter looks very good next to the video streaming leader’s 9% growth.
Spotify’s results should come as no surprise given the huge tailwind at its back. After a roughly 15-year drought, US recorded music revenue growth is rapidly increasing thanks to streaming.
So far, Spotify appears to be a service users cannot live without, even in the face of a potential recession. Spotify said its churn levels, or cancellation rate, were in line with expectations in the second quarter and, crucially, down year-over-year.
Risks to watch out for with Spotify
While monthly active user growth remains steady, there are a few potential hurdles to watch out for.
First, management attributed the 14% increase in premium subscribers to an additional week of promotions during the quarter. This could pose a problem down the road if the economy continues to deteriorate and consumers who joined Spotify via a promotional offer are unwilling to pay for a subscription.
The 2022 Digital Consumer Sentiment Survey revealed why some subscription services are struggling to grow this year. The survey found that 43% of respondents in a sample of 1,054 American adults chose to cancel an online subscription this year because it was too expensive. This compares to 20% who cited a desire to consolidate services and 18% who canceled after a promotional rate offer ended.
Another risk to watch is the digital ad spend market. Social media companies have come under huge downward pressure on revenue this year as advertisers hold back spending amid an uncertain economic environment. Ad-supported users represent 59% of Spotify’s total monthly active users.
However, ad-supported revenue only accounted for 12.6% of total revenue last quarter, so it’s not a significant part of Spotify’s business. Additionally, the company posted a 31% year-over-year increase in advertising revenue, and management expects another solid quarter of growth in the third quarter.
While no company is completely recession proof, Spotify is in a stronger position than most other streaming services and is still a good long-term investment.
John Ballard holds positions at Netflix. The Motley Fool holds positions and recommends Netflix and Spotify Technology. The Motley Fool has a disclosure policy.