New Beach Pick for 2025: Q1 earnings reports - Part 2
Portfolio: Beachman's take on recent earnings reports
With about 40% of SP500 companies reporting their Q1 performance this week itself, we have received many informative clues on how the US economy and our stocks could perform over the next 12-15 months…the biggest clue being that…
…hyperscalers continue to spend on building out their AI infrastructure in a race to capture as much marketshare as they can…as fast as they can.
This was confirmed by GOOG, MSFT and META and most AI stocks zoomed higher.
While the knee jerk reaction could be to buy more AI stocks, to buy the dip in tech…I am more focused on 2026 and extrapolating backwards from there. I continue to ask myself which stocks are likely to perform better than the broader market when the US economy hits the upcoming potholes due to more serious structural issues like the growing US deficit, refinancing of about $9T of US debt and possible stagflation-related macro pressures.
Given what we learned from this year’s macro and earnings reports, I think the MAG-7 are a good place to “hide out” when the shit hits the fan. These large companies have massive economies of scale - markets, customers, balance sheets, margins and pricing power to weather any potential storm. They did so in 2022 and they will do it again.
That said, I keep screening for other companies and sectors that could also do well in 2025.
I believe that Spotify SPOT is one such company and today I am adding SPOT to my Beach Picks list for 2025.
Let’s dive deeper to understand why…
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Table of contents
Introduction to Spotify SPOT
From its founding to the current state
The business model
SPOT’s Q1 earnings report
Risks to consider
Valuations
Investment thesis - Why add it to Beach Picks 2025?
Beachman’s plan
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Introduction
Spotify SPOT is dominant in the global digital music streaming industry, fundamentally altering how people consume audio content. By offering instant access to a vast online library of music, podcasts and audiobooks, they have become synonymous with digital listening. While some view it as simply another streaming service, others see it as a singular platform for audio creators worldwide. Its journey from a nascent idea in Sweden to a publicly traded company with hundreds of millions of users highlights its impact and evolving business strategy.
From its founding to the current state
The genesis of SPOT can be traced back to Sweden around 2006. It was founded by Daniel Ek and Martin Lorentzon with a clear vision: to provide a legal and accessible alternative to music piracy, ensuring artists could be compensated while making music freely available to everyone. The streaming service officially launched on October 7th 2008. In its initial phase, access to free services was limited and invite-only. Spotify then expanded its reach, launching in the UK in 2010 and in the USA in 2011. The company's founding mission was driven by the belief that a legal and affordable platform could protect musicians' rights and offer listeners a seamless experience…a win win for both cohorts. Facing early challenges like deep skepticism from and securing licensing agreements with the record labels, Spotify leveraged its freemium model to attract users and over time they have slowly but surely gained mass adoption that neither the artists nor the record companies could ignore.
Today, SPOT operates on a global scale in more than 180 countries. As of Q1 2025, the platform boasted 678M monthly active users (MAUs), reflecting +10% yoy growth. Premium subscribers reached 268M in the same quarter, growing +12% yoy and marking the highest Q1 net additions since 2020. While MAU growth has been consistently strong and trending upwards, 2024 was the year when they reached sustainable profitability and cash flows.
The business model
SPOT's business model is primarily built on a multi-tiered "freemium" approach and has evolved over time. The core offerings are the ad supported free tier and the premium paid subscription. The free tier attracts a large user base by offering access to the music catalog with advertisements, serving as a funnel to convert users into paying subscribers. Premium subscribers enjoy an ad-free experience, higher audio quality, unlimited skips (this is a key feature for many MAUs, btw) and offline listening. Spotify caters to various demographics with different premium tiers: individual, student, duo and family plans, often with varied pricing based on geography. The company generates revenue through advertising on the free tier, leveraging user data for targeted ads and through subscription fees from its premium users. Beyond these core streams, they also bring in revenue through partnerships and collaborations with brands, artists and creators. Spotify invests in and aims to monetize new segments like podcasting and audiobooks, which offer opportunities for different business and margin structures as compared to just music streaming. A large portion of music profits is paid back to labels and artists, as Spotify does not own most of the music it streams. One of the key attractions to me as an investor is that SPOT does not spend as much on content as other streaming companies like Netflix, Warner Bros etc. I am not a fan of high capex business models because they are susceptible to margin risk, cash flow contraction and higher debt to cash ratios leading to balance sheet deterioration.
SPOT’s Q1 earnings report
Spotify's Q1 2025 earnings report highlighted continued strong performance: key metrics were in line or ahead of guidance, but some numbers slightly missed analyst expectations. Total MAUs met guidance, while premium subscribers significantly outperformed, adding +5M net new subscribers, +3M above guidance. Total revenue was in-line with guidance, but was impacted by unfavorable currency movements. Gross margin came in slightly above guidance at +32%, reflecting a significant +4% yoy expansion driven by gains in both premium and ad supported tiers.
Note that SPOT reports their results in Euros €. Free cash flow (FCF) beat estimates at €534M. SPOT’s balance sheet remains strong with €8.0B in cash and short-term investments.
Margins are expanding. Cashflow margins are expanding. Cash on the balance sheet has doubled in one year even as debt ticked up very slightly. SBC expenses are very low, while institutional ownership continues to trend higher. Forward growth is expected to be in the mid-teens %s for the next 4-5 quarters with MAU growth in the low single digit %s during this timeframe.
Risks to consider
A significant challenge for SPOT is its dependence on major record labels for music inventory, which historically gives labels considerable negotiating leverage and limits SPOT's ability to expand music gross margins. Labels could seek a greater share of profits or impose unfavorable terms.
They operate in a highly competitive landscape with formidable competition from large, deep-pocketed technology companies like Apple, Amazon and Google (YouTube Music), which can integrate music services into broader ecosystems or bundles, potentially making their offerings more attractive. e.g. My family is in a perpetual debate whether we should subscribe to the Spotify family plan or Apple’s One family plan, which includes Apple TV (Ted Lasso & Severance!), expanded cloud storage and more.
In the face of an economic slowdown, Spotify's market dominance could wane or the broader audio streaming market's growth could slow. Pushback from consumers on price increases could also take some air out of the growth story.
We should also be aware that the co-founders of SPOT control over 70% of voting rights even with less than 30% ownership, leaving majority shareholders subject to their preferences.
Valuations
Morningstar rates SPOT’s fair market value at $500 factoring in a current PE of 100, a forward PE ratio of 56 and an EV to EBITDA multiple of 36. Taking into consideration forward growth, this is one of the most expensive stocks on my Beach Picks list.
The stock currently trades close to $600, which is 46x forward FCF.
That said, SPOT has always commanded a premium price for its shares. So it is not easy to get a “cheap” entry into the stock.
Investment thesis - Why add it to Beach Picks 2025?
With more than 678M MAUs and 268M premium subscribers, Spotify is clearly the music stream market leader on a global scale…operating in more than 180 countries. This is a highly profitable business that is generating consistent, strong cash flow on much lower capex spend as compared to its peers.
Their total addressable market (TAM) keeps expanding along with increasing global populations, broader smartphone adoption and more IoT devices in use. New segments like podcasts and audiobooks in different languages offer considerable growth potential and the ability to distance Spotify from music label dependency.
Spotify’s increasing focus on AI and leveraging vast user data allows for constant product tuning and improvement…this in turn gives them a competitive advantage in personalization…one of the most compelling reasons for user adoption and increased usage.
While large chunks of music profits go to labels, SPOT's growing scale gives it more power to negotiate over time. In the near future, there's the potential for Spotify to dominate the "car audio experience".
SPOT is a fundamentally strong company with consistent growth, expanding positive margins, expanding cash flow margins and a very healthy balance sheet.
SPOT has historically kept prices low and attuned to the local country and currency’s buying power. Therefore they do have the ability to increase prices in select geographies to bring in more revenues and higher profits.
We do need to be cognizant of some inherent risks as laid out above. While SPOT is expected to hold up well in a recession, growth could slow, some users might trade down to the free service and advertising revenue could soften.
Beachman’s plan
Bottomline…