Spotify: What's Baked In at $150?
And what would a reasonable base case suggest the stock is worth?
I shared some qualitative thoughts about Spotify earlier this month in Spotify: A Compounding Effect. In this post, I’ll focus on the quantitative as it relates to valuation.
First, I’ll walk you through an update to my reverse DCF now that the stock has quietly more than doubled in the last five months. This tries to answer the question, “What’s baked in at $150?" or “What do we need to believe about Spotify’s future to earn average returns over time?”
Clearly, higher expectations are baked in at $150 per share than they were at $69 six months ago. But it would be hard to have a sense of what those expectations might be and how they’ve changed without running some numbers.
So here we go—what sort of future for Spotify is priced in at $150? I’ll share the model later in this post but here’s the gist of it:
Total MAUs grow from 515 million last quarter to 705 million in a decade and 815 million a decade beyond that. That’s a 2.6% average annual growth rate, sharply lower than the 20%+ growth rates of today.
Premium subs grow from 210 million last quarter to 285 million in a decade and 337 million a decade beyond that. That’s a 2.5% average annual growth rate. In both years, Premium sub penetration of total MAUs is about 41%, flat with today.
Premium ARPU grows at a 3.3% annual rate to reach €6.08 in a decade and €8.67 a decade beyond that. That implies a fairly modest amount of long-term pricing power—despite ad-free streaming music being clearly underpriced today—offset by some product and geographic mix shift to lower ARPU plans and regions.
Ad-Supported ARPU, which I define as ad revenue over average total MAUs, grows at a 4.5% average annual rate over time. I think the largest audio platform in the world should get an appropriate share of advertising revenue over time. This implies ad revenue gets up to about 16% of Spotify’s total revenue a couple decades out, which misses management’s 20%-40% long-term target range for ad revenue as a percent of total revenue.
With those assumptions, total revenue would grow from about €11.9 billion last year to €24.0 billion in a decade and €41.4 billion a decade beyond that. That’s a 6.4% average annual growth rate.
Incremental gross margins on the Premium side are 33.3% this year and then jumps to 38.0% next year and beyond partially due to a more favorable arrangement with the labels as it relates to sharing the upside from future price increases. That takes overall Premium gross margin into the low 30%s a decade out and mid-30%s another decade out.
Incremental gross margins on the Ad-Supported side are 30% this year, 40% next year, and 50% thereafter. That takes Ad-Supported gross margin into the high 20%s a decade out and into the high 30%s a decade beyond that.
Overall gross margin reaches 32.2% in a decade and 35.5% a decade beyond that. That is basically at or below the low end of the 35%-40% long-term gross margin range management has discussed.
Incremental R&D is 40% this year, drops to 8% next year, and 6% thereafter. As revenue grows, the R&D dollars would get silly if this line did not see leverage.
Incremental S&M is 13% this year, 7% next year, and 5% thereafter.
Incremental G&A is 3.0% this year and beyond.
With those assumptions, operating margin rises from slightly negative today to 8.3% in a decade and 15.8% another decade beyond that. With a 10% discount rate, a ~5% terminal year free cash flow yield, and a 1.073 EUR/USD exchange rate, and adjusting for the value of non-operating items, SPOT’s fair value is the current $150 stock price. I’ll let you be the judge of those assumptions and how achievable they might be for Spotify, but if that played out I’d expect SPOT holders would earn average long-term returns.
Base Case
Here are my base case assumptions in the same format: