Three Months After Going Public, Is Spotify a 'Must-Buy' Stock? Analysts Weigh In

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Ahead of Spotify’s Q2 2018 earnings call this Thursday (July 26), more Wall Street investors are speaking up about their bullish stance on the streaming service’s stock performance, upgrading their rating to “buy” and raising end-of-year price targets to over $200 per share.

In a memo published early yesterday morning, BTIG Research managing director and media & technology analyst Richard Greenfield announced that his firm would be initiating its coverage of Spotify with a buy rating, with a one-year price target of $230 per share.

"We have remained on the sidelines since Spotify’s April 3rd direct listing, which has clearly been a mistake," wrote Greenfield. "Waiting for a better entry point into the stock has not worked and we believe the Spotify platform is simply too powerful/valuable to wait any longer to embrace SPOT."

The memo follows similarly bullish reports last Friday from Wall Street firms Buckingham Research and Raymond James, who raised their price target for SPOT from $195 to $201 and from $190 to $210, respectively. For comparison, SPOT ended its first day of trading on Apr. 3 at $149.01, a decline of $17 from its opening price of $165.90.

Music-industry experts have been impressed by Spotify​'s ability to maintain and increase its value during its first quarter as a public company. "Music-tech has historically been given such a hard time in the press, with Crowdmix and other struggling startups," Chris Carey, CEO of Media Insight Consulting, tells Billboard. "To see music not being undervalued by financial markets is both interesting and encouraging for the wider industry. It’s good to see Spotify, the market leader in streaming, being able to pull this off with a proven model and price point, and to make room for other services to follow even more successfully."

Indeed, over the past three weeks alone, an influx of music-tech companies have officially filed for IPOs of their own, including Sonos and Eventbrite. (Greenfield declined to comment on other music-tech IPOs.)

Analysts across the board agree that the the music-streaming sector is still in its relative infancy when it comes to global adoption -- marking a significant opportunity for Spotify both to gain more share in existing markets and to expand into new territories, particularly in Asia and Africa. While Apple Music may be biting into Spotify's market share in the U.S., "the potential market size over the coming decade [for subscription music globally] is hundreds of millions ex-China," as Greenfield claimed in his memo.

In the past, some analysts have argued that Spotify's churn might increase slightly as the company expands further into emerging markets that tout lower-value subscribers on average. But Spotify's consumer loyalty and impressive daily usage stats -- as of Dec. 2017, 44 percent of Spotify's user base used the service on a daily basis, according to the company’s pre-listing investor presentations -- are among the key mitigating factors against churn that make Spotify seem "far more like a social media/network app than a media/content app," wrote Greenfield.

Experts also point to the scale and high conversion rate of Spotify's freemium tier -- which has driven over 60 percent of Spotify's total gross-added Premium subscribers since 2014, according to the company's F-1 filing -- as the opportunity to build a strong advertising business and gain a significant advantage over Apple Music and other premium-only offerings.

"It's easier to steal someone else’s market than to do the hard work of growing a market on your own," says Carey. "Apple is going after the relatively easy market of people willing to pay, but there’s real value in Spotify going out and reaching to new people constantly. If they can continually prove that the longer users stay on their free service, the more likely and the more loyally they’ll convert to the paid tier, that creates a lot of long-term value and predictable income. That keeps their base strong and is will be good for their share price.”

Interestingly, many analysts agree that Spotify's status as a pureplay music service -- i.e. yet to demonstrate clear adjacent revenue streams in sectors like video, hardware, e-commerce or cloud storage & computing services, as rivals Apple, Amazon and Google have -- is actually an asset, rather than a handicap, on the public markets.

“The likes of Spotify and Pandora have much clearer propositions compared to, say, Apple Music in the context of Apple, or Facebook’s music offering in the context of Facebook,” Carey tells Billboard. Greenfield even added in his memo that BTIG remains "underwhelmed by YouTube Music, which has relaunched with little-to-no fanfare."

Unlike some analysts in the past, Greenfield tells Billboard that Spotify's continued success as a public company isn't necessarily predicated on the service competing with record labels or adopting an exclusive content-windowing strategy like Apple Music or Tidal do.

Instead, Spotify's long-term value proposition in the music business will come from its owned-and-operated playlists like RapCaviar, ¡Viva Latino! and Who We Be -- many of which have grown into "exclusive consumer brand[s]" with extensions into video series, live shows and other fan experiences. Spotify CMO Seth Farbman previously used similar terminology of playlists as "sub-brands" to describe the revenue potential of curation beyond the platform itself.

"We expect Spotify-curated playlists to continue to grow in importance, and would not be surprised for them to represent the majority of time spent listening over time," Greenfield wrote in his memo.

The one major thorn analysts still see in Spotify's side? "I’m still skeptical about their video strategy," Greenfield tells Billboard. “There’s clearly the synthetic bundling approach like their current deal with Hulu, but outside of just music videos and interviews, it’s still to be determined what video strategy makes sense for them."

"It’s not a value-proposition question, as there is clear demand for this type of content,” adds Carey. “The question is whether Spotify can package that content in the right way, and whether they can compete head-to-head with YouTube -- arguably the largest streaming service in the world -- on YouTube’s specialist subject. That said, Spotify has one of the deepest understandings of their audience of any media company, and I think that will serve them well."

In the short term, podcasting and other non-music audio content seem like a better fit. "There’s a whole range of audio content that Spotify has not focused on historically that has a far better margin profile, and in which consumers have a tremendous amount of interest," Greenfield tells Billboard. One potential competitive advantage that Spotify could cultivate against Apple, Google and other big-tech behemoths in the podcast space is moving beyond like-for-like music discovery and recommendation toward cross-media recommendations and consumer insights -- e.g. proactively recommending podcasts to users who listen to a particular group of artists.

If you're thinking about shelling out some money for Spotify stock, be wary that these analysts are making some assumptions in their conclusions that may not always hold true. For instance, Greenfield's earnings model for Spotify assumes that the service's monthly churn will fall by over 30 percent, monthly Premium streaming hours will grow by over 40 percent and ad-supported user will balloon by nearly 140 percent over the next five years.

Moreover, unlike in the video-streaming space, Spotify has little to no pureplay competition on the public markets.

"The single biggest issue with these bullish claims is that if you want to profit from the music streaming sector as an investor, there is virtually nowhere else to put your money," Mark Mulligan, managing director of MIDiA Research, tells Billboard. "The only two bets that are really big enough to make today are in Spotify or Vivendi [parent company of Universal Music Group, which may go public itself]. Demand for music streaming is accelerating, but supply is completely constrained. So naturally, people are going to be more bullish about Spotify’s prospects -- but we know Spotify isn’t going to turn a profit anytime soon, and other IPOs like Tencent Music could potentially really disrupt Spotify down the line."

Indeed, there is a cause in the mutual investment agreement that Spotify and Tencent signed in Dec. 2017 that not only permits Tencent to engage in directly competitive activity with Spotify’s current and potential partners, but also prohibits Spotify from reciprocating that competitive business -- essentially putting a contractual damper on the Swedish company's potential growth in China and neighboring markets.

Mulligan and other wary analysts have pointed to Pandora's stock -- which has declined by nearly 80 percent since its peak price of $37.42 per share in Feb. 2014 to just $8.19 yesterday -- as exemplary of the trajectory Spotify could take if Tencent or another international player delivered more effectively on the former's promises to artists, music execs and institutional investors.

"Look at how much damage was done to Pandora’s stock not because it was losing millions of users or because its ad business was going down, but because Spotify provided a new level of hope for the industry. That’s all it took," says Mulligan. "For investors, tech stocks have to deliver on their promise to change the world. As soon as that promise starts to fade, investors will jump ship."