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Investors eye gross margin expansion, potential price hikes

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Spotify (SPOT) is set to report fourth quarter financial results before the bell on Tuesday as the music streaming giant grapples with fresh layoffs, declining margins, and a business struggling to turn a profit.

The stock, which lost more than two-thirds of its value in 2022, has climbed about 20% so far in 2023 but is still off roughly 40% from last year and more than than 65% below its record close of $364.59 in February 2021.

Here’s what Wall Street expects, according to Bloomberg consensus estimates:

Premium subscribers are expected to grow 7 million in the quarter to reach 202 million; ad-supported users are estimated to total 287 million, a 14 million jump compared to Q3.

Investors will likely remain hyper-focused on Spotify’s declining gross margins, which missed expectations in the third quarter and caused shares to crater 13% following the results.

Current estimates call for gross margins of 24.5%, roughly on par with the third quarter’s 24.7% result.

The company said it expects gross margins to come in between 30% to 35% over the long term amid plans to further scale its podcasting and ads business; however, execution remains murky amid macroeconomic challenges.

Free cash flow (FCF), another key metric for investors, is expected to be negative in the fourth quarter amid greater medium-to-long term investments. After reporting positive free cash flow of €35 million in Q3, analysts expect negative FCF of -€69 million in Q4.

Spotify CFO Paul Vogel, who previously categorized 2022 as a peak investment year, warned of the reversal during the company’s latest earnings call: “Given the timing within quarters, we may see free cash flow turn negative in Q4, but we still expect to be free cash flow positive for the year and moving forward.”

One of those heavily invested areas has been podcasts, where Spotify has spent more than $1 billion over the past four years.

Newly announced layoffs, coupled with a company reorganization focused on “efficiency,” suggest Spotify could be looking to pivot away from that strategy, especially with Dawn Ostroff out as chief content officer.

Under her leadership, Ostroff led pricey, A-list deals including a reported $200 million deal with Joe Rogan.

Wells Fargo analyst Steve Cahall wrote in a recent client note he expects gross margins estimate for the quarter to come in at 24.5%, down from an earlier forecast for 24.7%, given lower premium subscriber expectations.

Still, the analyst remained fairly bullish on the potential for margin expansion, writing gross margins “should be boosted by the recent headcount reductions (~6%) and the potential for a price increase in the near future.”

Spotify indicated the company is actively exploring raising prices on its U.S.-based tiers. Both Apple Music and YouTube Premium raised prices on their respective plans late last year.

“It is one of the things that we would like to do, and this is a conversation we will have in light of these recent developments with our label partners,” Ek told investors during Spotify’s latest earnings call. “I feel good about this upcoming year, and what it means about pricing for our service.”

Spotify CEO Daniel Ek speaks during a press event in New York May 20, 2015. Spotify, which provides free on-demand music or ad-free tunes for paying customers, said it will now also provide video content and podcasts. REUTERS/Shannon Stapleton

Alexandra is a Senior Entertainment and Media Reporter at Yahoo Finance. Follow her on Twitter @alliecanal8193 and email her at [email protected]

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