Why Spotify Stock Is on Track for $170 in 2019

SPOT stock is up big year-to-date, but SPOT's rally isn't over just yet

I used to be very bearish on Spotify (NYSE:SPOT) stock. Back in mid-2018, when SPOT stock was closing in on $200, I noted that its valuation was disconnected from reality. At that time, SPOT was riddled with competitive, growth, and profitability risks. Consequently, I called Spotify stock a bubble.

Why the Rally of Spotify (SPOT) Stock Isn't Over Yet
Source: Spotify

That bubble popped in late 2018. Spotify stock dropped from $200 to $100 in a hurry. That drop was overdone. Although SPOT is facing competitive, growth, and profitability risks, the continued robust growth of the platform’s popularity and new growth initiatives have significantly reduced those risks over the past few months. Likewise, the long-term bull thesis on SPOT stock has become clearer. That’s why I said that investors should buy the dip of SPOT stock in early 2019.

So far this year, SPOT stock is up nearly 30%. This rally is far from over.

Spotify’s growth outlook is gaining momentum as the platform is gaining international traction while building upon its domestic dominance. As its growth gains momentum, investors will flock back into the stock, since the optimistic long-term fundamental outlook of SPOT has paved a path for Spotify stock to reach $170 by the end of 2019.

Spotify stock trades under $150 today. Thus, the company’s fundamentals indicate that SPOT stock can rise 15% more from its current levels. Consequently, staying long Spotify stock remains the smart move.

Spotify’s Outlook Is Improving

When I was bearish on SPOT stock in mid-2018, I had three big concerns: competition, growth, and valuation. All three of those concerns have been significantly reduced by the company’s recent performance and its growth initiatives.

On the competition side, my chief concern was that a lack of original content on the platform would prevent SPOT from fending off competition from Apple Music unless SPOT lowered its prices. But Spotify is in the process of developing original podcast content. As a result, it looks like original podcast content will constitute part of Spotify’s content moat. Moreover, I believe that such content will be instrumental in helping SPOT keep users on its platform.

I was worried that Spotify’s growth would stall out due to rising competition from Apple Music and other services. That hasn’t happened. Instead, Spotify has leveraged its unique curation abilities, superior user interface, and various network effects to continue to increase both its premium subscriber and monthly active user bases at a robust rate over the past several quarters. Plus, the company is expanding internationally, and seeing great traction in its new overseas markets, too.

Meanwhile, the risk posed by the valuation of SPOT stock has been solved by the market. Back in mid-2018, SPOT stock was trading at six times its trailing sales. Today, the stock trades at a much more reasonable four times its trailing sales.

Overall, Spotify’s growth outlook has substantially improved since mid-2018. The company’s stock price has fallen over that same stretch. This disconnect presented an opportunity in late 2018. Spotify stock has risen by a large amount since then, but this rally isn’t over just yet.

Fundamentals Pave a Path to $170

My modeling assumptions for SPOT stock are pretty simple.

The global-streaming-music market is quite big, as it consists of essentially the 4 billion-plus internet users in the world. But, much like Netflix (NASDAQ:NFLX), multiple users can be bundled together under a single household subscription. So, the music-streaming market likely could potentially serve about 1 billion customers.

Not all of these customers will pay for music-streaming services. The free services out there are pretty good. But Spotify is currently converting about 50% of its monthly active users into paid subscribers. I believe that that conversion rate will remain stable over the long-term. Thus, at peak levels, there will probably be about 500 million customers who pay for music-streaming services.

Apple Music is the other big competitor in this space. But Spotify is almost twice as big as Apple Music globally. Thus, it’s fair to say that of the 500 million paying customers, Spotify will take home about 300 million of them. Spotify currently has just under 100 million subscribers, and its subscriber base is growing at a 35%-plus clip. Assuming a much slower 15%-20% compounded annual growth rate over the next several years, it should take SPOT about seven years to get to 300 million subscribers.

Thus, my big assumption is that Spotify can get to 300 million subscribers by fiscal 2025. My smaller assumptions are that its average revenue per user will grow over the next several years, its gross margins will gradually rise as its suscriber base grows, its operating spending rates will normalize lower, and its operating margins will stabilize around 15%.

Under those assumptions, I think Spotify’s earnings per share can reach about $11 by fiscal 2025. Based on a  forward price-earnings multiple of 25, which is average for internet stocks, that equates to a fiscal 2024 price target for SPOT stock of $275. Discounted back by 10% per year, that equates to a fiscal 2019 price target of $170.

The Bottom Line on SPOT Stock

Spotify has found a winning formula, thanks to its unique curation, original podcast content, and aggressive international expansion. As long as this formula continues to power robust subscriber and margin growth, the sentiment towards Spotify stock will remain bullish. That bullish sentiment will allow SPOT stock to rise up to and potentially even above $170 in 2019.

As of this writing, Luke Lango was long SPOT and NFLX. 

Article printed from InvestorPlace Media, https://investorplace.com/2019/03/why-spotify-stock-is-on-track-for-170-in-2019/.

©2020 InvestorPlace Media, LLC