Time to sell this great company as results loom?

hares in music streaming site Spotify Technology SA (NYSE:SPOT) have swung up and down like a soprano’s voice in a Puccini aria. They seem to have settled around middle C but it is not clear whether they can hit the high notes again.

Spotify was founded in Sweden in 2006 but is listed on the New York Stock Exchange. It offers a growing number of subscribers access to millions of songs and playlists. They pay less per month than it would cost them to buy just one CD or vinyl version, and the company earns revenue from a limited amount of advertising.

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The big problem is that a steady rise in subscribers from just over 200 million five years ago to more than 550 million now has not translated into profits. Rather, it has led to massive losses. Fewer than half of those who have signed up actually pay the monthly subscription that allows them to listen free of advertisements. Like many internet-based companies, Spotify has a free service, funded by advertising, to lure in frugal users who it hopes will eventually be persuaded to cough up for the real deal.

Meanwhile, it has to keep investing heavily to stay ahead of the game, particularly in artificial intelligence that divines what individual subscribers want and channels appropriate music to them so they remain engaged for as long as possible. A new feature called AI DJ not only selects songs that it thinks the subscriber will like but also provides an AI-generated voice that comments on the music, just like a real DJ. It could be a winner – or it could be intensely annoying.

Another new feature is Clips, which enables musicians to create short videos to try to win over new fans or engage with and retain existing ones. This type of video has been a hit on other social media platforms.

These features are designed to appeal to Generation Z, the young audience that currently accounts for most of the growth in subscriber numbers and, in theory, should provide a long-term audience. However, these tech-savvy youngsters are also the ones more likely to flit from one service to another as rival streamers try to outsmart each other at considerable cost.

It ought to be a recipe for success but there is intense competition, mainly from Apple Music and Amazon Music, and Spotify operates on thin margins. For every dollar that comes in from subscribers, 75 cents is spent on buying the music content.

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In the second quarter, the latest for which figures are available, Spotify ran up a net loss of $305 million, much worse than the $125 million net loss in the same quarter last year. Admittedly, this was partly because of a 34% rise in spending on research and development, but that demonstrates the spiralling cost of creating growth.

The shares bounced along just below their current level just above $150 before suddenly taking off in April 2020, when technology for use at home during Covid lockdowns really came into fashion. The peak of $365 came the following February but then followed a long slide to a low of $80.

Source: interactive investor. Past performance is not a guide to future performance.

Hobson’s choice: The near doubling of the share price in just under 12 months opens up a selling opportunity, either to take profits for those who made the right guess last year, or to cut losses for those who got sucked in when the bandwagon was racing ahead unrealistically.

Third-quarter results are due on 24 October and if, as is likely, they show another sizeable loss, then a continued downward lurch is to be expected. Spotify is potentially a great company, but investors never got rich buying into companies that always turn in a loss.

Rodney Hobson is a freelance contributor and not a direct employee of interactive investor.