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Delmaine Donson/E+ via Getty Images
overview
SpotifyNew York Stock Exchange: Spot) is a great business trading at a market cap of $24 billion or a price-to-sales ratio of 1.9. With nearly 500 million monthly active users and more than 200 million paying customers, Spotify is a leader in the music and podcast industry. Recently, they started expanding into audiobooks. Spotify is already profitable today and I believe over time he can achieve a 20% operating margin.
If I had $24 billion in my bank account and they offered me to buy the entire company, I would do it. However, there is one big problem: Spotify stock is a non-investment for me.
ownership structure
When Spotify went IPO in 2018, the founders were given a special voting stock that controlled most of the voting power, but now owns just 27.6% of the company.

20-F
Giving the majority of voting rights to the founders That in itself is necessarily bad. That means they can run the company as they wish and the remaining shareholders cannot influence management decisions.
problem
The problem is that Spotify is running very inefficiently and overstaffed. The number of employees is increasing rapidly year by year. If this business is an app, why should it hire over 1,000 new employees each year?She had less than 1,000 employees. I remember being able to listen freely.

Author’s spreadsheet sourced from 20-Fs post-2016, Statista.com prior to 2016.
Recently, there has been talk that Spotify will become more efficient after laying off 6% of its workforce in 2023 and streamlining its organizational structure. This is a positive step, but it may be overstated. The headcount reduction was necessary as operating expenses increased by 44% (36% at constant currency) in 2022, outpacing revenue growth of 18% (12% at constant currency). Despite the headcount cuts, Spotify’s current headcount remains about 9,200 above his 2022 average, a 65% increase from his 2020 average.
Finance
Revenues have almost quadrupled since 2016, but operating expenses have grown as fast as revenues. The whole point of investing in a software business is that revenue can grow faster than operating expenses, leading to high profitability. However, Spotify’s income statement looks more like a poorly run car company than a software business.

Author’s spreadsheet taken from 20-Fs
We are confident that Spotify will perform well with its 2018 cost structure and reach its growth targets. Already achieving a 13% operating margin on its 2022 revenue run rate, and with revenue and gross margins improving over time, Spotify believes he can achieve a 20% operating margin. increase.

Author’s spreadsheet taken from 20-Fs
Unfortunately, this is just my imagination, and there is no sign that management will turn around to initiate drastic cost-cutting and operational efficiency initiatives.
By the way, if management decides to operate in high-growth mode at break-even, I have no objection to that approach. We also recommend investing as much as possible if you can find a solid investment with reasonable returns. The problem, however, is that it continues to increase the overall cost structure, making his long-term ROI significantly negative.
You might think that a big company like this with all the brains and resources can’t be overstaffed and that every employee must be vital to the business. Recently, Elon Musk acquired his Twitter, immediately laying off 50% of his 7,500 employees at the company. Since then, the number of employees has continued to decline, and now has about 2,300 employees, a 70% reduction in his workforce. Despite these cuts, Twitter continues to thrive, introducing new features at a record pace. Unfortunately, as organizations grow, they tend to become bogged down by bureaucracy, internal politics, non-essential employees, and excessive meetings, leading to lower overall productivity.
future growth opportunities
Spotify has made remarkable strides in the podcast industry, going from a minor player to a dominant market leader in just a few short years. The company’s next ambitious goal is to achieve similar success in the audiobook market. Audiobooks currently represent only 6-7% of his $140 billion book market worldwide, while market share in more mature markets is close to 50%. Spotify sees a potential market opportunity of $70 billion for him as the audiobook market continues to expand.
If they capture a significant market share, it could lead to $25 billion in revenue. Audiobook gross margin is expected to be 40% and net margin could be 15%. 15% of the $25 billion net profit is almost $4 billion profit. Multiply that by 20 PE, and Spotify’s audiobook business could be worth $80 billion in the future, or three times its current market cap.
It all sounds great. I wish them success. But so far it’s all speculation, and I feel management is trying to excite investors with a new growth story rather than focus on fixing the profitability of its core business. There is no guarantee that audiobook gross margins will remain at 40% in the long term, even after the volatility intensifies. Second, if management can’t run their music business efficiently, there’s no reason to believe they can manage their audiobook business better.
evaluation
With the current management, I think Spotify will be profitable in a few years, but it’s a low-margin business and long-term net profit margins are Five%We used the analyst consensus forecast of 11.1% CAGR over the next six years. CAGR then slows to 6.5% for him over the next five years, and then to low single digits after that. It will likely take several years for Spotify to become profitable, so we assume his first six years will be non-dividend. The dividend payout ratio was 80% for the next five years, and then the final payout ratio was 100%. At a discount rate of 10%, the net present value would be $10 billion, or 58% below the current market capitalization.

author’s spreadsheet
But if the company is run efficiently, I think in the long term we can achieve a 15% net profit margin. In that case, the net present value at a 10% discount rate would be $30 billion.

author’s spreadsheet
Suppose management achieves a revenue CAGR target of 20% over the next 10 years, then slows to 5%. Using a 15% net profit margin gives us a valuation of $92 billion.

author’s spreadsheet
Keep in mind that constant currency growth in 2022 is only 12%, and management’s goals are entirely dependent on its highly ambitious growth plans in the audiobook market.
Conclusion
So there’s definitely upside potential, and Spotify isn’t a stock to short at this low valuation. But I don’t trust management’s ability to control costs and achieve high profitability. Even in the black, Spotify will likely continue to be a low-margin business that doesn’t deserve a premium rating.
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