BREAKINGVIEWS-Spotify’s tippy valuation requires more top line

(The author is a Reuters Breakingviews columnist. The opinionsexpressed are her own.) By Jennifer Saba NEW YORK, March 2 (Reuters Breakingviews) - Spotify’s tippy valuation requires a hefty increase in its top line. The streaming-music firm may be worth $23 billion when it goes public – based on the highest price at which its privately held stock traded in the last couple of months. To justify that market capitalization, a back-of-the-envelope analysis suggests Spotify would need to double its revenue. Here’s how would-be investors can think about it. Spotify didn’t have any earnings last year – partly because it took a big loss on some convertible debt it had issued. But assume it can get into the black over the next couple of years. Once that happens, it will be possible to express Spotify’s valuation as a multiple of earnings. The peer group of rival online-radio service Pandora (P.N) and messaging-app unicorn Snap (SNAP.N) trades on an average of 25 times earnings, according to Eikon data. So at a market value of $23 billion, it’s fair to expect the company run by Daniel Ek to at some point muster a bottom line of close to $1 billion. From there, it’s possible to reverse out what kind of revenue Spotify would need to achieve. Adding back tax at 21 percent would get to $1.2 billion. Now say Spotify directs the same amount toward research, marketing and other general costs as it did in 2017. That gets to $2.7 billion of gross profit. The last piece to add back is Spotify’s “cost of revenue,” which is mostly the licensing fees it pays to record labels and the like. Right now that’s 80 percent of revenue. But it has been falling, so it’s reasonable to think it might fall further, say to 70 percent. In short, reaching $1 billion of earnings would mean Spotify had to create $9 billion of revenue – more than double what it got in 2017, and more than half of the global music industry’s revenue of some $16 billion. That seems like a stretch. Yes, Spotify increased sales around 40 percent year-over-year in 2017. But from here, rapid growth will have to come not from raising prices for its 71 million subscribers, but trying to crack the $28 billion global radio-ad market. It’s not impossible, but it’s a hard note to hit. On Twitter (https://twitter.com/jennifersaba) CONTEXT NEWS - Spotify filed a prospectus with the U.S. Securities and Exchange Commission on Feb. 28 for a direct listing of shares on the New York Stock Exchange. The music-streaming service said it had 71 million premium subscribers and about 159 million monthly average users as of the end of 2017. - Under a direct listing there is no underwriter and the price of shares is set by supply and demand, rather than being decided by the company beforehand. - - SIGN UP FOR BREAKINGVIEWS EMAIL ALERTS (http://bit.ly/BVsubscribe) Spotify S-1 (https://www.sec.gov/Archives/edgar/data/1639920/000119312518063434/d494294df1.htm#rom494294_14) BREAKINGVIEWS-Spotify sings out of tune on earnings, governance BREAKINGVIEWS-Spotify puts IPO bankers on “disruption” playlist BREAKINGVIEWS-Spotify business model is an unfinished symphony