Equity Report – Spotify

Date: 25/04/2018 Current Price: $155.07 Target Price: $118 (-21%)

Ticker: SPOT Market Cap.: $27,434Mn Recommendation: Sell

Figure 1- Market Profile

Business Description
Market Profile
Launched in 2008, Spotify is the global market leader in the streaming segment of the
Closing Price ($) 155.07
music industry, with 42% market share; nearly double the scale of its closest
52 Week H/L ($) 135.51/169.00 competitor, Apple Music. Present in 61 countries, the platform attracts 159Mn MAUs,
Average Volume of which 71Mn (44.5% of users) are Premium subscribers as of 2017YE. The
1.84
(Mn) remaining 55.5% of users are Free subscribers, monetized via advertisement
Shares
176.98 revenue. Premium subscriber growth has reached a 59% CAGR from 2015 to 2017,
Outstanding
with Free subscribers reaching a 18% CAGR in the same period. Currently, the
Free Float 64%
subscription business represents 90% of the firm’s revenue. Recent operating trends
PBV 16.1x include a declining ARPU from the introduction of cheaper packs, a decline in
premium churn, increasing hour consumption and a declining acquisition cost per
Price/Subscriber 145.9x
customer. In 2017YE, Spotify generated $5,182Mn in revenue, a 45% CAGR from
Figure 1-Share Price and Value 2015 to 2017, with the operating margin climbing from -12% in 2015 to -9% in 2017.

15 200 Spotify’s competitive advantages lie in scale, which provides it unique data that
10 150 enables a personalized experience to its users, in superior user experience and in
5 122,95 100
playlists building a two-sided music marketplace for users and artists, powered by
0 50
data, analytics, and software. In the medium-term Spotify, main challenge is to
continue growing its subscriber base without further price reductions.
Volume Spot share price
Price target Sources: Reuters, Yahoo Finance and Team Analysis

2018E 2019F 2020F 2021F 2022F 2023F 2024F 2025F 2026F 2027F
Revenues growth 29.5% 33.4% 33.8% 29.7% 22.2% 14.1% 7.8% 4.4% 3.2% 3.0%
Gross margin 23.1% 25.4% 27.7% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0%
EBIT margin 1.8% 4.3% 6.6% 8.9% 10.3% 11.0% 11.3% 11.4% 11.5% 12.7%
Profit margin -3.5% 0.8% 3.1% 5.1% 6.4% 7.1% 7.4% 7.5% 7.6% 8.5%
Sales to capital 3.0 3.9 4.5 4.5 4.0 3.5 3.4 3.3 3.2 3.0
ROC 3.9% 12.1% 21.6% 29.0% 30.3% 28.0% 27.8% 27.1% 26.8% 28.1%
FCFF (% of revenues) -1.9% 5.9% 7.6% 6.7% 7.4% 5.8% 4.0% 3.3% 2.9% 3.7%
EVA (€Mn) - 95.6 314.7 614.8 875.3 1043.3 1151.6 1202.6 1240.9 1432.7

Investment Analysis
We issue a SELL recommendation for Spotify based on a 2018 year-end target price
Figure 2- Operating Metrics
of $122.95 per share, implying a downside potential of 20.7%, based on a DCF (FCFF
2015 2017 based) model. The target price and consequent recommendation result mainly from
the following key catalysts: 1) favourable industry dynamics, with streaming
ARPU (€) 6.8 5.3 growing at 10.6% CAGR from 2017 to 2029; 2) strong competitive positioning based
User acq. on data mining ability, consistent increases in loyalty, churn reduction and
20 17
Cost (€) subscriber acquisition cost savings; 3) leading operating metrics, with controlled
Premium
7.7% 5.5% content costs (79% of revenues in 2017) and a more profitable revenue mix
churn
expanding the gross margin to 30% by 2021, while lower user acquisition costs and
Hours/user 191 250 benefits of scale drive the operating margin to 12.7% by 2027, and 4) low capital
Source: Team Analysis intensity, with little need for capital reinvestment except for R&D (sales to capital
ratio averages around 3.6x). Return on capital is forecasted at 29% by 2021, with
the strong bargaining power of content owners exerting downward pressure on this
number.

Corporate Finance Department | www.fepfinanceclub.org

 Figure 3- Sensitivity Analysis
P&L
$ Growth rate
Value 31% 36% 41%
Gr. Margin

($Mn) 2018E 2019F 2020F 2021F 2022F 2023F

25% 61 73 89
Revenue 5298 7067 9456 12625 14994 17012
30% 102 123 147
COGS 4076 5273 9837 8586 10496 11971
35% 144 173 206 R&D 371 495 663 860 1051 1199
Source: Team Analysis SG&A 734 980 1311 1700 1869 2132
EBIT -239 -155 11 298 573 795
Figure 4-Relative Valuation
Interest 278 226 226 226 226 226
Bull Bear Taxes -5 -3 -2 19 94 154
Netflix Pandora Net Income -512 -378 -213 52 254 415
EV/User 1165x 15x Source: Team Analysis
EV/Revenue 12x 1x
EV/Gross
profit
34x 2x
Spot price
($)
325.8 4.4
Source: Team Analysis
Balance Sheet
($Mn) 2018E 2019F 2020F 2021F 2022F 2023F
Figure 5-DCF valuation
Fixed Assets 824 1083 1509 1915 2344 2691
Intrinsic Value
Working
EV ($Mn) 23349 Capital
-1709 -2372 -3259 -4101 -5071 -5799
Options and Non Operating
warrants ($)
-1567 1951 1977 2225 2713 3508 4304
Assets
Equity value Equity 1066 688 475 528 781 1197
21782
($Mn)
Debt 0 0 0 0 0 0
Shares
outstanding
177168 Source: Team Analysis

Share value $122.95

Source: Team Analysis

Cash Flow Statement

Figure 6-Cost of Capital

2018- ($Mn) 2018E 2019F 2020F 2021F 2022F 2023F

∞
2027 Adjusted EBIT 133 340 674 1158 1625 1994
Risk-free
rate
0.55% 1.48% Taxes 36 92 182 313 439 538
Equity CAPEX+R&D 371 495 663 860 1051 1199
risk 5.08% 5.08% Investment in WC -173 -663 -887 -842 -971 -727
premium
FCFF -101 416 716 827 1105 984
Beta 1.27 1.27
Country Change in Debt 0 0 0 0 0 0
risk 1.59% 1.59% Interest 226 226 226 226 226 226
premium FCFE -327 190 490 601 879 758
Cost of
equity
8.39% 9.50% Dividends/Buybacks 0 0 0 0 0 0
Cost of Issued Equity 0 0 0 0 0 0
debt
5.50% 3.67%
Change in Cash -327 190 490 601 879 758
WACC 8.39% 9.29% Source: Team Analysis

Source: Team Analysis,

Damodaran

Corporate Finance Department | www.fepfinanceclub.org

Analyst Email LinkedIn
Paulo Silva pauloj.c.silva95@gmail.com -
Director Email LinkedIn
Miguel Guimarães migftg95@gmail.com www.linkedin.com/in/miguelftguimaraes

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