Thursday, June 16

Spotify: The Path To 1B Users

Spotify's stock is down ~75% from its all-time high. That means if Spotify reclaims that position, the stock will need to go up almost 300%.

How does that math work? Spotify's all-time high was $365. With the stock down 75%, the stock is currently trading near $98. Therefore to get back to $365 the stock must almost increase by 4x (aka 300%) in order to get back there.

So why are we even telling you this? It's because depressed stocks like Spotify are great places to go bargain-seeking if you're looking for a stock with limited downside and a ton of upside opportunity.

And in the case of Spotify, we believe they have that potential.

But why? Well, Spotify is not going to flame out during this pullback -- if anything it's quite the opposite.

Spotify's plan for "audio dominance" now seems more realistic than ever as they build a more scalable business.

That's why today we want to discuss Spotify's execution + long-term vision and why we believe they have the ability to more than double their stock price over the next few years.

Market Overview:

As with many investments right now, a large majority of them are down big in 2022. And as much as that may pain you to look at, this truly presents buying opportunities for long-term investors.

So as long-term investors, you need to understand that the market will bottom and reverse course at some point.

Predicting that exact bottom point is near impossible, so what smart investors are doing right now is not trying to time the market but rather buy stocks that they believe in over the long run at ridiculously cheap prices. So that when they rebound, the potential upside is massive relative to what it was just even several months ago.

And as we mentioned in the intro, we believe Spotify is one of those stocks. But let us be clear, there's a very good chance you buy this stock now and it continues to slide down.

But as we just mentioned timing the market is impossible so what we can do is get "close to the bottom" without trying to get "the dead bottom". So if and when Spotify returns back to $365, you capture a large chunk of that upside rather than try to time the bottom and miss it entirely.

This might seem counterintuitive, but the evidence is clear that calling the exact bottom is basically all but luck. So we'll ask you, would you rather get it close to the bottom now and get ~250% upside or try the impossible and get the exact bottom and get the full 300%. We hope the answer is clear enough.

 

Spotify Top-Down Case:

So with all of this out of the way, let's finally review why we believe Spotify is a great investment now. And this is largely due to two main areas. One area is focused on what Spotify is doing specifically and the other area is focused on what market forces are helping Spotify's stock. Let's focus on the latter now and we'll dive into the former below.

So the latter's thesis is focused on the "market forces". This view is largely shaped by the fact that over the last decade, growth investing dominated value-based investing.

While that can be interpreted in many different ways, the takeaway here is that investors cared less about the traditional financial metrics and more about the growth potential of the companies they were investing in.

So for example, if a company was growing revenues over 40% annually, even if they were losing money, investors were fine with this and figured these companies would become profitable further down the line.

And that's why companies like Snowflake, Coinbase, and others ripped higher over the last few years. And it's not that they're not great companies, but their short-term business models had them burning cash while the stocks were insanely overvalued.

But during the most recent market correction, value-based investing started to make a comeback. Investors started finally caring about sustainable growth and not just a company growing at all costs.

So why are we telling you this? Well in the case of Spotify, they fit in that second bucket. They're a company that is growing fast but is doing it at a sustainable pace while becoming more and more efficient.

And in today's markets, the ability to grow efficiently is more important than its been over the last 10+ years.

So while we've liked Spotify for a while, in the current conditions, Spotify looks like a great long-term hold.

And that's because their model fits what's popular now (e.g. profitability, valuation, etc.) as it becomes center stage for investors. But while their business bodes well in the current macro environment, it's what they're doing internally that has us so excited.

 

Spotify Bottoms Up Case:

This is the part you won't want to miss.

While the above section can be a bit dry, it's very important to realize how stocks are behaving right now. But at the end of the day, Spotify's roadmap and execution are allowing them to even fit in that bucket described above. So with all this anticipation built up, what is it?

Spotify is doing a few things really well right now:

  1. Spotify is growing its gross margins quickly which means its gross profit is anticipated to grow to 20% annually over the next 5 years.  At this given growth rate, it appears that the market is only valuing its revenue at 1.5x. That's insane. Over the last decade, most major tech companies in their cohort were valued at a minimum of 6-8x and Spotify is at 1.5x -- which signals that they're at a major discount relative to their financials.

  2. Spotify's user growth and churn metrics are far above their peers. This is because, during a recessionary period, users usually consolidate their spending. And with a wide array of video platforms, the churn there is likely to increase with growth to slow. While on audio-based platforms, if anything churn decreases and Spotify can gain more market share. With over 30% of their members on bundled plans, a wide cohort of their users are likely to stay with them.

  3. The two items above speak to Spotify's execution today. But what about their roadmap for tomorrow? Spotify is betting its future on expanding into other audio genres -- specifically podcasting. But podcasting is still young for them as 15% of their ad revenues come from podcasting while only 7% of their total listening hours come from there. But of that 7%, only 14% were even monetizable which means that the revenue generated from ads ($200M) represents under 2% of the total on which they can generate. Long story short, not only can Spotify get more users, but they also can get more revenue per user on their platform.

And remember when we discussed efficiency above? The fact that they can increase each user's worth, while also growing their user base profitability, is key to our investment in them.

 

Spotify Summary:

This is just the tip of the iceberg when it comes to Spotify but these three points are what reconfirms our overweight rating on them.

Add in the fact that they're also monetizing their user data, and growing margins across all business units, and the upside for their stock is clear over the long run.

However in the short run, outside of the macro risks, we do need to note that most of their revenue comes from selling advertisements.

With a recession looming, their short term revenue stream may take a hit.

However, like most of our investments, this is a long term play and we are comfortable with the short term risks!

While this is longer than most investors time horzion, Spotify has a real plan to get to 1B users and $100B of revenue in the next decade.

Paired with a combination across all audio formats (e.g. music, podcastting, events, audiobooks, etc.) Spotify has a good chance of hitting these benchmarks.


Price Target: $150 (55% upside)

Current Price: $97

Target Date: 1 Year

Rating: Overweight

Ticker: SPOT

Risk/Reward: High/Very High

Market Cap: $18.7B

Dividend Yield: 0%