If you read my articles, you know that I’m bullish on a lot of big growth tech names.
But one big growth tech stock I can’t get behind is Spotify Technology SA (NYSE:SPOT).
Investors and analysts are pumping up the music streaming giant as the next Netflix, Inc. (NASDAQ:NFLX). I just don’t see that comparison. Spotify will never have the one thing that put Netflix over the hump — original content. And without that, secular growth in the music streaming industry will be overshadowed by competition.
All in all, Spotify stock just doesn’t make any sense to me trading above $170.
Here’s a deeper look:
Why Spotify Isn’t Netflix
The one thing that put Netflix over the hump was original content. It wasn’t until Stranger Things landed in the summer of 2016 that Netflix stock broke out like a rocket ship. Before that, this was a stock stuck in a sideways trading pattern below $100. Since then, Netflix stock has broken above $100, $200, $300, and is now closing in on $400.
Spotify, though, will never have original content.
Perhaps the company can try to become its own record label, much like Netflix become its own content producer. But that is a far reach.
For starter’s, movies have never been free, and there has never really been a place where you can legally stream full-length movies and TV shows at zero cost. Because of that, Netflix had an easy time locking original content behind a paywall.
But that isn’t the case in the music industry. Music has always been largely free, and is now more free than ever thanks to ad-supported platforms like YouTube and SoundCloud. Because of this, Spotify will have a hard time convincing artists to lock their content behind a paywall and limit distribution to a single platform.
And even if Spotify does do that, which is highly unlikely, music piracy is much easier than movie piracy, and those “original” songs will inevitably find their way all over the internet. And even if that doesn’t happen, Apple Inc (NASDAQ:AAPL) will likely follow suit in the original music production game. It has far more resources to develop music content, so Spotify will likely lose that battle.
In the big picture, then, investors shouldn’t count on original content. The problem here is that without original content, Spotify is just a commoditized business that will inevitably fall victim to price wars.
Take me for example. I’m a subscriber to Spotify. But if Apple comes around and offers its music streaming service at $8.99 versus the $9.99 I’m paying for Spotify, I’ll quit Spotify and join Apple Music.
In other words, there is nothing really keeping subscribers on Spotify other than price.
What Is Spotify Stock Worth?
Due to the aforementioned risks, I think there is a strong argument that Spotify is a bubble, and the stock is worth a whole let less than its present market value.
But even in an “everything goes right” scenario, I still think fundamentals barely support today’s valuation.
Spotify has 75 million paying subscribers. Apple Music has 50 million subscribers. That is a close 1-2 race in the music streaming industry. It’s even closer in the U.S., where both Spotify and Apple Music are reported to have around 20-25 million subscribers.
In other words, in the most developed music streaming market, Spotify and Apple Music are neck-and-neck.
Let’s extrapolate this out. There are roughly 1.6 billion internet households in the world. How many of them need a music streaming subscription like Spotify? Not many. After all, you can listen to essentially any song you want for free on SoundCloud or YouTube. Therefore, I peg music streaming’s global penetration rate among internet households at 25%.
Therefore, the global market is 400 million subscribers. Assuming Spotify and Apple Music are the only players and split the market, that implies 200 million subscribers for Spotify. At roughly $7.50 per month, that equates to $18 billion in subscriber revenues. Add in about $1 billion for advertising revenues, and Spotify could hit $19 billion in revenues.
Assuming gross margins trend towards management’s long-term target of 35% and the opex rate moderates towards 15%, then Spotify could reasonably net around $12.50 in earnings per share at 200 million subscribers. A big-growth 25-times forward multiple on that implies a price target of just over $310.
But how long will it take Spotify to get there? A long time. Assuming user growth of somewhere around 15%, then 200 million users is seven to eight years down the road. That means the $310 price target is six to seven years down the road. Discounted back by 10% per year, that equates to a present-day value of around $160 to $175.
Bottom Line on Spotify Stock
Even in a best-case scenario that Spotify grows to 200 million users over the next five to 10 years, Spotify stock is worth no more than $180. But there are plenty of risks to that best-case scenario, the largest of which is price erosion due to a lack of original content as a differentiating factor.
As such, I can’t reasonably justify paying for $170 and up for Spotify stock today. It is worth that only in a best-case scenario, and that best-case scenario has a low likelihood of materializing.
As of this writing, Luke Lango was long AAPL.