NOTE: PERSONAL OPINION ONLY, numbers in $USD

INTRODUCTION:

SPOT has become the largest music streaming platform in the market even outperforming platforms backed by giants such as Apple or Amazon. SPOT users swear by the personalized selection given by SPOT and how seamless their music listening experience is with spotify connect. But, the path to capitalizing on all this for SPOT is a murky one which I’m skeptical SPOT is capable of reaching.

As a general guideline for my forecast, I followed what management laid out in the 2022 investor day where SPOT expects to continue investing in podcasting and audio books, in the short run focus on improving Monthly Active Users(MAUs) rather than Average Revenue Per User(ARPU). The end goal by 2030 should be 1 Billion MAUs and $100 ARPU.

REVENUE:

The main concern I have with SPOT is their piracy issue. Piracy is still very easily conducted, it could be as simple as turning on an ad blocker or installing the “Cracked” version of SPOT on Android (SOURCE)

Piracy is an ailment of every service, it cannot be eradicated completely. For SPOT to put a meaningful end to Piracy the benefit (Convenience) and cost of SPOT (Legality, Financially and Restrictions) has to far outweigh the cost of Piracy (Risk, Time and Effort).

To quote Gabe Newell the founder of Steam, a platform that distributes video games.

“Piracy is almost always a service problem and not a pricing problem. If a pirate offers a product anywhere in the world, 24 x 7, purchasable from the convenience of your personal computer, and the legal provider says the product is region-locked, will come to your country 3 months after the US release, and can only be purchased at a brick and mortar store, then the pirate's service is more valuable."

I believe that SPOT is cheap enough for a monthly subscription and the value of the service far outweighs the cost of piracy. So, when forecasting revenue I’ll assume that Piracy is not a significant factor/consideration that will affect MAU and in turn affect revenue.

When forecasting MAU, I’ll assume churn is not a significant factor based on management's statement, “Year-over-year churn, though, was pretty consistent with where it was at this point last year. So even with the strong growth, we're not seeing any uptick in churn at all.” - Q4 2022 Earnings conference. As SPOT is in the process of rolling out and expanding on their new offerings like Audiobook and Podcast, I’ll assume MAU grows at historic rates as there are a lot of low hanging fruits to pick off at the start of the implementation. Based on 2022 Investor Day, SPOT is expecting a CAGR of 9.4% for the next 7 years.

When forecasting MAU conversion rate, I’ll assume that users have to try the service for a bit before deciding whether to take up SPOT’s services or not. So the conversion rate climbs steadily before holding constant at perpetuity, as there is always a group of consumers whose needs/situation makes subscribing to SPOT not attractive enough.

When forecasting ARPU, the rationale for the first few years of forecast is slow and meager Y/Y growth based on management’s statement, “we're mostly focused on growth. So that's our general approach.” - Q4 2022 Earnings Conference. During the high growth period, as SPOT is more focused on gaining new MAU they will raise prices at very meager rates before switching to monetizing mode when new features are fully established. But because SPOT is very careful about raising prices too much as they are worried that will drive MAU towards rival products, the overall CAGR is held at about 2% for my entire forecast period.

When forecasting Advertising revenue, SPOT plans on using Audiobooks, Podcast to increase advertising spend to improve advertising revenue. Rationale for this is that by giving larger audio offerings means MAU spends longer on the platform allowing for SPOT to earn more advertising revenue. But, as these offerings are quite new there isn’t much reliable historic data to base the Y/Y growth rate off. So, opting for less granularity. The growth rate of advertising revenue is pegged to growth rate of ad-supported MAU as management showed in 2022 investor presentation that Ad-supported MAU had a direct correlation with Ad revenue. Overall, it had a CAGR of about 6%.

COST:

Cost of revenue is mainly consisting of Royalty and Distribution cost. I doubt that SPOT has much room to reduce Royalty as the terms set up by record labels against SPOT are predatory in nature. With monthly payment of royalty from SPOT, certain of these royalty payments are required to be paid upfront in advance or SPOT has to give them a guaranteed minimum royalty. On top of that, certain licensors have a “Most Favored Nation” Clause which is a clause stating that if other licensors perform better than the licensor with the clause, SPOT has to make up the difference. All these Predatory terms ensure that SPOT will always have to burn a hole in its pocket first before it can even start paying downwards to other aspects of the business e.g. R&D. SPOT can’t do anything about it as the big 3 music licensing can just refuse to license their music to SPOT.

“increase in Premium cost of revenue was driven primarily by increases in new Premium Subscribers, publishing licensing rates”.

When forecasting cost of revenue, some drag on gross margin is experienced as SPOT recently started investing in podcasts which they expect drag to be lifted by 2023 as per 2022 Q4 Earnings Conference. However, as licensing agencies have SPOT at a chokehold, I’ll assume that the needle doesn't shift very much. Cost of revenue holds at historical rates.

When forecasting Marketing and R&D, as it’s unpredictable how management will make operating decisions and what to invest in moving forward. I’ll use historic to avoid being overly granular.

When forecasting G&A, as management recently had a layoff I’ll assume that G&A spend remains at historic levels before tapering downwards.

CHANGE IN NWC:

When forecasting change in NWC, I made sure to take the historic of the past 4 years. Only the past 4 years was used as SPOT intrinsically changed since 2018, moving past just being a music only business into Audiobooks and Podcasts which may affect Day Receivables and Payables.

CAPEX & D&A:

CapEX only took into account purchase of physical buildings which I thought was not meaningful in helping to expand SPOT. So, opting for less granularity I assumed historic CapEX and D&A.

WACC:

Cost of Equity

RFR (1M Avg) = 2.81%

Beta (SOURCE) = 1.73

ERP = Unable to find any reliable analyst’s forecast for ERP, the next best alternative is to take US stable market ERP.

ERP = 6.48%

COE = 9.16%

Cost of Debt

SPOT has no bond rating so the next best thing to take is a synthetic rating. But SPOT has been mostly EBIT negative for the past 5 years so we’re unable to take a synthetic rating. As SPOT has no actual bond yield, the next best thing we can do is to take book yield.

Book Interest Expense = 132M + 53M = 185M

Book Debt = 1683M

Book Yield = 11.0%

Marginal Tax Rate = 20.6%

AT Book Yield = 8.73%

Weightage

Price (5D Avg) = $157.56

Shares O/S = 193M

Market Value of Equity = 30409M

%Equity = 94.8%

%Debt = 5.2%

WACC = 9.14%

CONCLUSION:

At base case, I value SPOT at $164.55. I believe that SPOT's future is determined by how much they can break free from the music licensors or whether competitors will find any way to regain the upper hand against SPOT. The advantage that SPOT has is personalized music and spotify connect which competitors could make use of existing AI technology to replicate or create an interchangeable system that allows for cross play on different platforms. The future of SPOT is very volatile with my worst case at $39.47 and best case at $357.93 as their future is very reliant on external unpredictable factors. Due to how volatile it is and with negative earnings historically even a sanity check to find ROIC may not add much to accuracy.

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