Investing.com -- Wolfe Research downgraded Spotify Technology (NYSE:SPOT) to Peer Perform from Outperform on Friday, citing concerns over its valuation and the limited profitability of its core music streaming business.
The firm noted that while Spotify is "pacing towards 1B+ global users" and has successfully broadened its offerings to include audiobooks and video, future growth will require more than just music share gains and pricing.
Wolfe Research highlighted that the company’s "valuation looks reasonable," but the "renters' economics in music" constrain margins, necessitating additional investments in new verticals to achieve long-term gross margins of 35-40%.
The firm expressed concerns about Spotify's "developed markets saturating" and the company’s services becoming "9-18% more expensive than other DSPs."
The downgrade follows a strong 2024 for Spotify, driven by price increases and ongoing share gains with "minimal churn."
However, Wolfe Research warned that future revenue forecasts appear "full" after frequent price hikes, steady user growth in developed markets, and modest tiering benefits.
Wolfe stated, "We now think forecasting risk for key KPIs skews negatively."
Additionally, Wolfe Research pointed out that "music renter economics necessitate further investment in new verticals."
Despite a robust gross margin expansion in 2024, the firm sees limited near-term opportunities for margin growth, as "65% of music revenue" is paid to creators. The report expects rising costs from audiobooks, AI investments, and changes in advertising revenue from select vodcasts.
Wolfe Research concluded that while Spotify's "highly durable growth story" remains intact, the path to further upside is less clear, warranting a downgrade to Peer Perform.