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Here Come the SPOT Analysts

April 22, 2018

It’s still very early days for stock analysts to reach a consensus about Spotify except for one thing–royalties are too damn high.  We have, of course, heard this one before–remember Pandora?  When Tim Westergren was cashing out his stock to the tune of $1 million a month and the company was wasting money hand over fist, the problem, you see, was those greedy artists and songwriters.

Spotify has been making the same argument for years without much care for their overhead and executive compensation.  Daniel Ek, for example, traded a high base salary for a $1 million bonus if he hit four performance targets–he hit three of the four and got his bonus anyway.  (SPOT F-1 at p. 133: “In February 2018, our board of directors determined to pay Mr. Ek the full $1,000,000 bonus based on the Company’s 2017 performance though certain performance goals were not achieved…”)  You know, just like when you promise a club owner that you’ll draw 100 people and you only draw 75.  They always pay your guarantee anyway, right?

But the analysts are starting to crunch numbers and here’s a few infographics from Simply Wall Street, a site I like a lot that started its Spotify coverage.

SPOT Share Value

This graph suggests that a fair value for Spotify stock would be closer to $85 rather than the overvalued price point of $158.45 where the shares closed on Friday.  One implication  of the inflated share price is that the direct listing strategy Spotify devised to offer shares to the public may be artificially propping up the price since most of the sellers will be “insiders” broadly defined.  If it turns out that a meaningful number of shares in the very low volume of shares changing hands is automated trading, that could help to explain why volume is low and shares are trading in a narrow price range.

Price Value

Not surprising that SPOT is significantly overvalued based on the value of its assets by comparison to the Internet industry average as well as the market overall.

SPOT Debt Service

And then there’s the debt.  Red ink as far as the eye can see.

In fairness, analysts do project significant revenue growth from Spotify as in this chart:

SPOT Growth

But note that revenue doesn’t start to convert into earnings growth until about 2021.  Which is fine as long as the company makes it to 2021.

My hunch is that it is this inflection point that will be leverage for cramming down royalties.  One thing seems certain–the current downward trend in royalty rates from Spotify is not going to turn around.  If anything, it will probably accelerate.

So remember that Wall Street’s argument is that the lower the royalties, the better for Spotify.  Wall Street is unlikely to ever say the lower the rent, or the lower the executive compensation, or the fewer loss making country operations the better for Spotify.  It will be a while before we see the insider trades that will tell you how much Mr. Ek has profited from his money losing company that is filing mass NOIs by the tens of thousands of songs, but we will find out soon enough.  My bet is that it will put old “million a month” Tim Westergren to shame.

Of course, Amazon is also a poor value by these metrics, doesn’t pay a dividend, but also has significant growth expectation.  There’s another way that Spotify is similar to Amazon.  Jeff Bezos’s core business philosophy is “Your margin is my opportunity.”

So don’t be surprised if Mr. Ek is coming after your margin just like Amazon did in one of the great income transfers of commercial history.

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