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Not so long ago, if you wanted to listen to your favourite music, you had to go to a store and buy a CD. You then put the CD or cassette in a CD player at home. Depending on whether you bought a ‘single’, i.e. a single music track, or a compilation CD, you could listen to up to 20 tracks from one CD.
Does that sound antiquated? Yet the company that has played a major role in the shift from buying to streaming music is not even 20 years old. We are talking about Spotify Technology, which comes from Sweden and was founded in 2006. In April 2018, twelve years after its founding, it went public – and what followed is a success story.
(Source: Spotify stock chart)
The first day of trading ended with a premium of more than 10% on the issue price of $132. Since then, the share price has more than quadrupled. Driven by continuous user growth and rising global spending on streaming, Spotify is currently riding a wave of success. According to the latest figures, the share price rose again by more than 10%.
The positive share price performance also has a significant impact on the valuation. Spotify is now valued at 7 times sales and almost 50 times free cash flow. These are very high valuations – and yet one of the few pure-play streaming providers, Netflix, is valued significantly higher.
(Source: Spotify vs. Netflix valuation)
On the basis of free cash flow, Netflix is also valued significantly higher, at a multiple of over 60. For shareholders, the crucial question is therefore: Is Spotify stock expensive now or does it still have room to rise? What does the future hold for the company in the face of growing competition? And what are the analysts saying? We will try to answer these questions in the following article:
Today, almost everyone in Europe is familiar with the name Spotify. The company has revolutionised the way we consume music. In the past, we used to listen to classic radio stations, then cassettes and CDs, and finally music via ITunes. With the beginning of the Spotify era, however, not only the medium we use to listen to music has changed, but also the business model of music providers. Previously, access to music was transaction-based, i.e. a consumer had to carry out a transaction, i.e. buy or rent a track, in order to listen to music. Spotify itself calls the new model ‘access-based’, i.e. it is basically possible to listen to music from the company's own library of over 100 million tracks with your own account.
Spotify has gradually expanded its original music-only business model. The company has now built up an extensive catalogue of podcasts and live audio content, as well as audiobooks, through various acquisitions in 2021 and 2022. In total, the company made five major acquisitions in these two years, with purchase prices ranging from $45 million to $113 million, spending a total of $395 million. Spotify has thus established a leading position for itself in the booming podcast market in particular. By the end of 2023, its portfolio here will include 5 million podcasts and 350,000 audiobooks.
However, Spotify does not own the music library here, but is, strictly speaking, ‘only’ a marketplace that brings supply and demand together. The company buys from the major music studios itself. Spotify has signed multi-year contracts with the three largest music studios in the world, Universal, Sony and Warner, which represent the biggest and most famous artists. The contracts do not renew automatically and must therefore be renewed upon expiration. The contracts include so-called royalties, i.e. variable payments (usually a percentage of the revenue from the respective studio's titles), as well as other obligations in the areas of marketing, finance and data. In addition to the three major studios, Spotify has contracts with over 100 independent, smaller labels. These are usually valid worldwide and are automatically renewed, but there are exceptions.
In contrast to streaming providers that are active in the film industry, Spotify is much more dependent on external content, which also represents a major risk. Spotify itself writes that existing contracts may not be renewable under certain circumstances. Netflix and other providers also buy films and series externally, but they are increasingly producing their own content, which helps the company to differentiate itself and thus become more independent. Spotify is trying a similar model in the podcast sector, also relying on its own productions. To this end, studios and podcast hosts (the ‘hosts’ of the podcasts) are hired and paid either a fixed or variable share of the revenue. However, around three-quarters of the content streamed is currently music, which is why Spotify is likely to have only limited success in breaking away from these external dependencies.
But back to Spotify's business model: the company offers consumers a freemium model for access to its library. Users can choose whether they want to take out a subscription and pay a monthly fee or whether they want to use the free, ad-supported version of Spotify. If you opt for a monthly fee, you can choose between a standard subscription, a shared subscription as ‘Spotify Duo’ or a ‘Spotify Family’ subscription, where up to 5 devices within a subscription and a household can be registered with Spotify. There is also a cheaper option for students than the above subscriptions. Subscriptions can also be taken out via the end user's contractual partner. They are integrated, for example, into mobile phone or internet contracts or into multi-subscriptions with Netflix, Amazon Prime, etc. In this case, it is not the consumers who are Spotify's direct contractual partners, but the providers of these subscriptions.
According to Spotify, the two services operate completely independently of each other and also have a different revenue base. While subscribers of the premium services generate the revenue for Spotify themselves, advertisers pay Spotify a fee for advertising-based use. In this case, payment is not made monthly, but based on the cost per thousand consumers reached.
Currently, Spotify has around 675 million monthly active users, making it the largest audio streaming service in the world, although it is closely followed by Tencent Music Entertainment. Premium subscriptions account for 263 million monthly users, or around 40 per cent. Conversely, users of the ad-supported version (425 million) account for around 60 per cent. For Spotify, growth in the number of users on the advertising-based platform is crucial, as this is the primary acquisition channel for premium subscriptions.
What are the current data and trends in the streaming market? According to the statistics platform Statista, revenues from music streaming will continue to grow slightly in the coming years. The undisputed market leader in this category is Spotify, with a global market share of around 32 per cent in paid subscriptions. It is followed by Tencent Music, which is mainly active in China, a country where Spotify is not active, and has a global market share of 14 per cent. Apple Music has a market share of 13 per cent.
It is also interesting to note that Spotify's users are regionally very diverse. Europe accounts for around 27% of users, America for around 17%, Latin America for 22% and the rest of the world for 34%. However, the share of paying subscribers is significantly higher in Europe and the US, at 32% and 26% respectively, while Latin America (22%) and the rest of the world (14%) together account for just 36%. Nevertheless, Spotify has built a leading global brand and is relatively immune to local (trade) conflicts.
And it will need to be, because despite its market leadership, Spotify has numerous and well-known competitors. Apple Music, Amazon Music, Youtube Music and Deezer are among Spotify's biggest competitors, along with traditional radio. At the same time, Spotify itself names the platforms of Meta and TikTok as competitors for live audio content and podcasts. In the audiobook segment, Amazon with Audible, Apple with Apple Books and Google with Google Books are also mentioned as competitors. Quite a lot of competition with high budgets and deep pockets. It will be all the more important for Spotify to stand out from the competition by offering its own content and to continue to grow. But what do the current figures look like? Is Spotify still generating growth?
Spotify's share price rose by 13% on the day the quarterly figures were released – so investors were clearly enthusiastic about the numbers. And rightly so. Spotify was able to increase its monthly active users by 12% – with advertising-based users rising by 11%, almost as much as premium users (12%). This is important for Spotify because a large proportion of its premium users are acquired from users of the advertising-based version.
Although ad-based users currently account for almost 40% of all users, Spotify only generates 13% of all revenues with them. Conversely, premium users are therefore significantly more valuable to Spotify than ad-based users. It will therefore continue to be important for the company to convert ad-based users into premium users.
It is also noteworthy that Spotify was able to increase revenues in the premium segment by 17 per cent, which is significantly higher than the increase in the number of users. This means that Spotify has raised its prices in recent months. The fact that the number of premium users has nevertheless increased by 12 per cent shows that customer loyalty is high and price increases are being accepted.
On the other hand, advertising revenues only increased by 7% and thus weaker than user numbers. This means that the revenue share is likely to drift further apart in the coming quarters.
Partly due to the price increase, Spotify was able to increase revenue growth again in the last quarters after it almost came to a standstill in 2023. Based on the last 12 months, this results in a growth rate of 18%.
Spotify's gross profit rose by 39%, and thus significantly faster than revenues. This is a good sign because it means that Spotify can generate more revenue with lower costs – another sign of a sustainable competitive advantage. With the exception of 2024, Spotify has been able to continuously increase its gross margin in recent years.
(Source: StocksGuide)
It will be interesting to see whether Spotify can continue to accelerate revenue growth by raising prices or whether users will no longer tolerate further price increases.
The profitability indicators EBITDA and EBIT as well as net profit have also risen sharply. This shows that Spotify is still in the scaling phase and that profits are likely to continue to rise disproportionately in the coming quarters. Here is an overview of the complete profit and loss statement:
(Source: Profit and loss statement December 2024 Spotify)
In addition, Spotify has a very healthy balance sheet. It is true that the company is disproportionately financed by debt rather than equity. However, since the liquid funds are easily sufficient to cover all liabilities, this does not pose a major problem. In addition to the high level of liquid funds, the level of intangible assets is striking. These consist almost exclusively of goodwill.
(Source: Intangible assets Spotify)
A look at the history shows that these have risen sharply at the same time as the numerous acquisitions in 2020 and 2021 and are currently tending to fall again.
This is a sign that Spotify has not made any potentially overpriced acquisitions, at least not in the past two years. The overall balance sheet reads as follows.
(Source: Spotify balance sheet 2024)
Spotify is still run by its founder, Daniel Ek. Daniel Ek is one of the co-founders of Spotify, but not the sole founder. He founded the company in 2006 together with Martin Lorentzon, another Swedish entrepreneur. Ek has served as CEO from the outset and played a central role in the development of the streaming platform. The fact that Ek continues to steer Spotify's fortunes can therefore be seen as a promising sign for the future.
The Spotify company is currently a top scorer according to the Levermann criteria. In addition to the positive price momentum, which also includes the positive reaction of investors after the quarterly figures, Spotify stands out above all with a high return on equity. The high profit growth of 30% and the profit outlook raised by the company's own management are also positively reflected in the score.
(Source: Spotify analysis according to Levermann)
However, the share price increase in recent months also has a downside - the valuation. It is true that Spotify's valuation has risen in recent months due to the re-acceleration in revenue growth. Nevertheless, the valuation is at least ambitious for a company with revenue growth of less than 20%, with an EV/Sales of just under 7, a P/E ratio of 100 and an EV/Free Cashflow of just under 50. The chart clearly shows that the valuation has increased significantly in recent quarters despite only a slight acceleration in revenue.
(Source: Development of EV/Sales Spotify)
It is clear that Spotify is currently trading at the upper end of its historical valuation.
Interestingly, however, this does not apply to free cash flow. On a six-year basis, the company is rather at the lower end of the valuation here. This is certainly also due to the fact that Spotify is currently able to significantly increase its cash flow. Despite the strong share price increase, Spotify became cheaper in the last year on the basis of EV/FCF.
(Source: EV/FCF development Spotify last 12 months)
In addition, a high EV/FCF can quickly be relativised for companies that have invested heavily in growth in recent years when the focus is on profitability. A good example of this is Netflix, where the situation was similar in the past.
In view of the contradictory charts, it is all the more interesting to see how analysts assess Spotify. In any case, they expect profitability to continue to rise in the coming years, which can be a good indicator of increasing cash flow.
(Source: EBITDA and net margin forecast Spotify)
So it is quite possible that the enterprise value to cash flow ratio will continue to trend downwards and that the share price will continue to trend positively.
(Source: Forecast Spotify Analysts)
Analysts also see it that way, with the majority recommending Spotify shares as a buy. However, they see the upside potential as very limited at just under 10% at present, paying tribute to the - in absolute terms - optically high valuation.
Spotify has established a very good competitive position for itself, particularly in the music streaming market. The company has a real asset in the form of contracts with all the major music studios and podcast hosts, coupled with a wealth of data from more than half a billion monthly users. Spotify is the undisputed market leader, clearly beating well-known competitors such as Apple and Amazon.
On the other hand, Spotify – unlike Netflix, for example – is much more dependent on its contracts with the studios. Although customer loyalty is currently very high, there is a significant risk of a massive exodus should Spotify fail to renew its contract with a major music studio. The major music studios are also aware of this negotiating position. So it is not a given that Spotify can continue to increase its margins indefinitely without the music creators wanting a piece of the action.
In this respect, too, the valuation does not currently appear favourable, at least not cheap. However, Spotify has impressively demonstrated in the past that it can increase its user base and develop into a cash-flow machine despite price increases. If this development continues seamlessly, shareholders will continue to enjoy the stock in the future. In any case, Spotify is currently one of the hottest stocks on the market and is particularly interesting for potential newcomers when it is weak. Cautious investors can set themselves an EV/FCF alert at 35 and be notified when the stock reaches a more favourable valuation again.
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The author and/or persons or companies associated with the StocksGuide own or may own shares in Spotify. This article represents an expression of opinion and not investment advice. Please note the legal information.