Industry Tailwinds, Increased Monetization and Changing Cost Structure Will Lead To Higher Cash Flows

Vastly exceeding my conservative expectations, and even their own guidance.

https://newsroom.spotify.com/2025-02-04/spotify-reports-fourth-quarter-2024-earnings/

https://s29.q4cdn.com/175625835/files/doc_financials/2024/q4/Q4-2024-Shareholder-Deck-FINAL.pdf

To read all the details of the company's performance, please check out the links above. My update below will focus purely on how my narrative is tracking, and what I've changed.

As mentioned in most of my other narratives, I’d prefer to be conservative and wrong to the upside, than overly optimistic and wrong to the downside. This gives room to the upside if the best case scenario occurs, but protects me from the downside and helps prevent me from overpaying for something. Spotify is a perfect example of that.

Spotify continues to smash it out of the park, and while I expected it to do well, I made sure I paid a price where it didn’t need to smash it out of the park to generate a good return. My valuation made sure that it only needed to have performed moderately well to pass my hurdle rate of 10% return p.a.

While it seems my narrative has been directionally right, the company has exceeded my conservative expectations considerably, which is fantastic. The biggest part here for my narrative is that my valuation estimated much more conservative FCF margin that what it has been able to achieve. Given that, and many other aspects that have grown faster than I expected, a valuation update is warranted, which I will explain further down.

To explain context around the valuation update, here are my assumptions from my narrative, and how they’re tracking.

1. Retain Dominant Market Share Position In Paid Music Streaming
   1. This assumptions appears to be tracking well and ahead of my conservative estimates.
   2. I estimated 8% growth per year in MAU and premium subscribers, and the company clocked in 12% and 11% respectively.
   3. This means they’re at 675m MAU, and 263m premium subscribers. If it can just continue to grow it’s MAU’s at 8%, as per my original estimate, that would translate to 991m MAU by January 2030, which is higher than my latest estimate of 860m MAU by Q2 of 2029. As for premium subscribers, if they were to grow at 8% from here, they would reach 386m by January 20230, higher than my Q2 2029 estimate of 362m.
   4. I think the company can grow these MAU and premium subscriber numbers from here at an average of 8% per year for the next 5 years. This will increase the valuation due to the higher user base, which I’ll lay out further down.
2. ARPU to Climb From Price Increases And New Revenue Streams
   1. Premium Average Revenue Per User (ARPU) is also moving in the right direction. Premium ARPU increased 5% Y/Y to €4.85 thanks to “price increase benefits, partially offset by product/market mix”. I still expect this to increase to €7 per month (€84 per year) by 2030. This would be a 7.5% annual increase, and seems doable, considering the company said if we exclude FX headwinds, then the ARPU Y/Y increase for Q4 was 7%.
   2. This would result in Premium revenue of €32.42bn by January 2030.
   3. As for the ad-supported ARPU, it is currently sitting much lower at €5.05 per YEAR, which is €0.42 per month. This makes sense for now, since video and text platforms have received the largest portion of ad dollars for the last decade or so now. But I believe Spotify can grow this significantly due to it having historically under-monetized this segment. I believe it will eventually providing better economics (less bidding competition) than the highly competitive other channels available today.
   4. When advertisers start to see that they can get better value for money over on the audio space, I believe ad dollars will go towards Spotify. Ad-supported revenue currently sits at 12.7% of total revenue for Q4 2024 (€537m / €4.424bn). I expect this split to remain largely the same going forward. Meaning, if annual Premium Subscriber revenue is €32.42bn by January 2030, then I expect Ad-supported revenue to reach €4.84bn, up from the €2.15bn today (which is an annualised Q4 figure). Given I expect MAUs to be 991m, and Premium subscribers to be 386m, I expect Ad-supported MAUs to be around 605m, up from 425m today. This revenue estimate and ad-supported MAU figure would equal €8 per year (€0.67 per month) in ARPU, up 58% from the €0.42 per month currently.
   5. Combining premium subscriber revenue and ad-supported revenue, we get a total revenue estimate of €37.2bn Euros (which is an annual growth rate of 18.8% from the latest total revenue of €15.67bn).
3. Gross Margins to Rise From New Deals And Revenue Sources
   1. Gross margins were 29.2% in Q2 of 2024, and as of Q4 they’ve reached 32.2%. They are already higher than my original 30% estimate for Q2 of 2029.
   2. The company noted these as the reasons for the improved margins:
      1. Premium gains driven by audiobooks and music;
      2. Ad-Supported gains driven by music and podcasts (partially offset by real estate impairment activity);
      3. Other Costs of Revenue favorability, which benefited both the Premium and Ad-Supported segments
   3. Again, it seems like I’ve been too conservative on my gross profit estimates. As we head towards 2030, I’m going to assume these trends continue. The company has proven that it can increase price without risking churn. Plus, it’s increasing it’s leverage in negotiations with the labels as it continues to grow in influence in the music and audio industry.
   4. Therefore, for 2030, I’m going to assume it can reach gross margins of 35% based on continued trends that I mentioned in my original narrative (improvements in cost structure of non-music content listened to, price increases, new negotiations with the labels, and new revenue streams from the marketplace and ads).
   5. This would deliver gross profits of €13.2bn by 2030.
4. Net Cash Flow Margins To Improve Dramatically
   1. Here’s where Spotify has really knocked it out of the park.
   2. I was conservative on purpose with my FCF margin estimates because that reduced of paying too high of a price, but now that we have hard evidence that it can produce much higher FCF margins than before, I’ll be updating my estimates accordingly.
   3. For Q4 2024, the company managed to generate FCF margins of 20.7%, which is incredible.
   4. While I always expected FCF margins to improve dramatically thanks to favourable cost structure changes, better operating expense control, less aggressive capex, and operating leverage achieved from scale, I only expected free cash flow margins to reach 9% by Jan 2030. Considering they’re already at 20.6% for the latest quarter, and 14.5% for this year, I’m going to increase my Jan 2030 FCF margins as well.
   5. If Q4 is a sign of what’s to come, which I believe it is, I expect the company to be able to generate FCF margins of 20% by 2030, which should roughly translate to net profit margins of 15%.
   6. With that being the case, the company should generate Free cash flow of €7.44bn, and net profit of €5.58bn by Jan 2030.

With all that in mind, here’s my update valuation based on forecasts out to January 2030.

New valuation for January 2030:

• Revenue: €37.2bn
• FCF margin: 20%
• Free cash flow: €7.44bn
• Net Profit: €5.58bn
• PE multiple: 40x
• 2030 Market Capitalization = €223bn
• Shares outstanding: 235m (3% increase per year)
• 2030 value per share estimate = €948
• Discount rate: 8%
• 2025 € value per share = €625
• 2025 $USD value per share = $648

If the company can slow down its issuance of stock, or even decrease the shares outstanding by buying back stock with it's excess cash flow, which I think is likely in a few years, then the value per share could be even higher than this. But again, I don't want to rely on that. I want to be conservative to the upside to avoid overpaying should that not occur.