Spotify, the music streaming service, announced today that it will spend $1 billion to buy back its shares between now and April 21st 2026. Spotify's market capitalization is just 2.5%. Spotify shares rose 5.1% after the announcement.
In 2018, the company executed a similar buyback programme.
It is not unusual for a public company to use some of its cash in order to purchase its shares. There are many public companies like Microsoft, Alphabet, and Apple that have active share repurchase programmes. It is not uncommon for mature or near-mature companies to use a portion of their cash flow or a fraction of the balance sheet to buy back their equity.
These efforts are designed to return cash to shareholders. Companies can reward shareholders by using their wealth in buybacks and dividends. Companies can also increase the value of individual shares by purchasing their stock. Limiting the number of shares in circulation means that the share count of the company decreases. However, each share's value will rise because it represents a greater percentage of ownership in the corporation.
Spotify shares traded at $387.44 per share over the past 12 months but now are worth only $215.84 after today's gains. Spotify's decision to use cash to repurchase its equity makes perfect sense.
However, buybacks aren't usually the answer when you ask recently listed companies what they plan to do with their excess cash. TechCrunch asked Alex Timm, CEO of Root Insurance, if he intended to use his cash reserves to buy equity following the Q2 2021 earnings report. The Root share price has fallen in recent months making it an appealing time to buyback shareholders. Timm resisted the idea and said that his company was building for the long-term. This means that the cash is being used for growth and not shareholder returns.
Spotify is a growth company, but what about Spotify? Spotify is not valued based on its profit margins. Spotify, for instance, posted a net profit of just 3 million on revenue of 4.5 billion in the first half 2021.
Spotify should not lose its capital if it is still growing-focused. It should invest in exclusive podcasts, and similar efforts that could grant it pricing power in future and increase its revenue growth.
We will need to look at the balance sheet of the company in order to answer that question. Here are the key numbers from Q2 2021 earnings:
Spotify ended the second quarter with 3.1 million in cash and cash equivalents. It also had restricted cash and short-term investments.
Spotify also generated 34 million in free cash flow during the second quarter. This figure was 7 million higher than a year ago, despite higher working capital requirements arising from podcast-related payments and delayed Q1 licensor payments.
Simply put, Spotify is still wasting cash despite spending money on efforts that are widely understood to be crucial to its long-term ability and profitability to increase its gross margins. Spotify uses a large portion of its cash to buy back stock, despite a huge bank account that is earning very little due to global low prices for cash.
Spotify will not suffer any material loss by spending $1 billion in the next few years. It will still be extremely cash-rich. The move will help to protect its value and make itchy investors happy. Spotify's long-term trust in its business' value means that the company is purchasing its stock at a discount relative to its market price.
The better question isn't whether Spotify is an odd company that decides to split off some of its wealth for shareholders; rather, why aren't other breakeven tech companies with cash flows neutral and fat accounts doing so?
