Spotify Technology SA (SPOT  ) rallied in early trading on Thursday, despite the company reporting lower-than-expected third-quarter earnings.

While the company's third-quarter results were solid, management guided to higher-than-expected fourth-quarter margins despite concerns about elevated investment from the rollout of new products, according to BofA Securities.

The Spotify Technology Analyst: Analyst Jessica Reif Ehrlich maintained a Buy rating and price target of $685.

The Spotify Technology Thesis: The company's revenue grew 16% year-on-year to €4.969 billion (around $5.58 billion), driven by 17% growth in Premium revenue and 10% growth in ad-supported revenue, Ehrlich said in a note.

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She added that Spotify Technology's gross profit grew 21% year-on-year and its gross margin was better than anticipated, "with revenue growth outpacing music costs net of marketplace programs."

Monthly active users (MAUs) stood at 788 million, driven by broad-based regional growth, the analyst stated.

Spotify's fourth-quarter guidance calls for gross margin and operating income "above our estimates," Ehrlich wrote. She noted that management projected:

  • Revenue of €5.2 billion ($5.8 billion)
  • Total MAUs of 818 million, versus BofA estimate of 822 million
  • Premium subscribers reaching 316 million
  • Gross margins of 33.8%
  • Operating income of €820 million ($921 million)
"Given the recent rollout of new products there had been concern of an elevated investment period, as is typical with new product launches" the analyst stated. This is why the modestly better gross margin guidance should be "well received by investors," she added.

Spotify's longer-term profit growth and free cash flow generation depends on:

  • Deeper subscriber penetration
  • Price hikes
  • New pricing tiers
  • Advertising improvement on digital initiatives
  • New businesses
SPOT Price Action: Spotify shares rose by 9.69% to $575.74 at the time of publication on Thursday.