Spotify Incorporation

Spotify is a technology company that deals with sharing of music through its streaming platform. The company was founded on 27th December 2006 on the belief that music is listened to globally and thus important to connect the music producers with their fans. The company has grown exponentially and is among the leaders in the industry. It offers both premium and ad-supported services to its users. As the name suggests, the premium service is more expensive as compared to the ad-supported segment since it does not have advertising as a way of selling audio and video content. The premium service has different subscriptions, such as student plans, family plans, and standard plans, all of which offer a commercial-free online and offline streaming experience to its users. The ad-supported service is for the customers who cannot afford to pay for the premium services. Due to the company’s recent sale of its shares to an unnamed acquirer, a complete valuation of the company was necessary to ensure that the sale matched the percentage being bought. As a result of this decision, a comparable company analysis was conducted on the company using the data from the third quarter of 2018. The comparable companies used were picked from the Spotify’s competitors depending on their strength and area of specialization.


The Spotify connect feature enables users to control playback and connect to other devices such as televisions, car speakers, computers, smart watches, and other receivers, thus enabling the users to play the digital content from whichever output device they are using. The Spotify for artists feature, on the other hand, enables the artists to distribute their contents, such as songs and albums, to the target audience. This feature also helps the artists to enhance their brand images and become strategically placed in the market. According to Reuters (2018), the company was present in at least 65 countries as of March 2018, through its subsidiaries such as Spotify USA, Spotify Ltd, and Spotify AB.

Since its inception, the company has had its fair share of competition from other reputable companies in the industry such as Google, Apple through iTunes, iHeartMedia and Last.FM Limited. Based on the competitors’ abilities, three groups can be formed, including the big cap, which consists mainly of Google. Speciality to music streaming business can include Apple, iHeartMedia or Last.FM since they all specialize in this field. Lastly, the small cap, Last.FM is the smallest among the four. Due to the unavailability of information on Last.FM, it could not be used on the comparable company analysis. Conducting Spotify’s valuation using the comparable company’s analysis begins by establishing companies that can be compared to the subject firm. Although companies cannot be perfectly alike, through effective judgment, it is possible to select the businesses that have the most similarity to the subject firm and extract information from them (Hampson, Hecht & Rolnick, 2015). For this paper, the focus will be put on the rival companies such as Apple and Google. However, this method is disadvantageous mainly because some companies operate from different parameters, and thus hard to compare. Although Apple does have a streaming site, it continues to produce other products such as iPhone and iPad, which are not produced by Spotify. To effectively conduct a valuation using the comparable company method, there are four steps involved. The first process is determining the peer group, then determining the multiples to measure and collecting data, and lastly spreading the comps (“Comparable Company Analysis | Valuation University | Investment Banking & Financial Modeling Guides”, 2018).


Determining the Peer Group


As previously stated, the peers as determined from the Reuters website are Apple, Google, Last.FM, and iHeartMedia. Of these four, Apple and Google are the strongest, and thus they form the basis of the chosen peer group. This choice is in addition to the companies operating in similar geographical areas.


Determining the Multiples to Measure


In order to create company multiples, it is advisable to divide the measures of a company’s value by its performance. Measures of a company’s value include market capitalization and enterprise value. Notably, three types of multiples can be used in this case, and they include equity value multiples, enterprise value multiples, and industry-specific multiples. A keen analysis will be put in all these multiples and further detail regarding why they were chosen provided. All the data obtained in this analysis is as at the third quarter of 2018.


Equity Value Multiples


These multiples focus only on the equity part in the capital structure by placing price as the numerator in the multiples. As such, to create these multiples, denominators such as earnings per share and book value per share are used alongside price as the numerator to determine the appropriate equity values. In creating the denominators, it is important to consider only the metric that is specific to the company’s shareholders. Price-earnings ratio is simply the amount an investor is willing to part with to get one dollar of profit. The price/ earnings ratio offers one of the simplest ways to value a company’s stock on a speculative basis (“Comparable Company Analysis | Valuation University | Investment Banking & Financial Modeling Guides”, 2018). Looking at Google and Apple’s financials, it is possible to compute the price-earnings ratio based on the most recent data as shown in Table 1.
Table 1:

. Google P/E ratio Apple P/E ratio iHeartMedia P/E ratio
Stock price 1037.61 Stock price 176.78 Stock price 0.41
Earnings per share 18 Earnings per share 9.27 Earnings per share 9.27

P/E ratio 57.645 P/E ratio 19.07011866 P/E ratio 0.044228695

Taking an average of the two ratios gives 38.194, which can be adopted as the industry average. The P/E ratio will not be a suitable basis for comparison as it shows the companies to have a varying ratio although they are operating in the same market. Introducing a new entrant (iHeartMedia) smoothens the variance and gives the price earnings ratio the needed strength, and thus ideal for this exercise. 

Enterprise Value Multiples


This is a preferred method of analysis as it looks at the whole capital structure of the company, inclusive of both debt and equity. In order to create this multiple, one must use a denominator that captures the whole capital structure of the company such as Earnings before interest, tax, depreciation, and amortization (EBITDA). Other common denominators that can similarly be used include earnings before interest and tax (EBIT) and Sales and Unlevered free cash flow.


EV/EBITDA


To calculate the enterprise value, we add preferred shares to the market capitalization and minority interest and later deduct the total cash. According to Yahoo Finance, Google’s enterprise value is 635.8 billion with an EBITDA of 39.33 billion (“Alphabet Inc. (GOOG)”, 2018). The value of EV/EBITDA is 16.16 for Google Company. Still, on this ratio, Apple’s enterprise value is 966.56 billion with an EBITDA of 81.8 billion, translating to an EV/EBITDA value of 11.82 for (“Apple Inc. (AAPL)”, 2018). Lastly, iHeartMedia is the smallest company among these giants and has an enterprise value of 37.29 million. The same company registers an EBITDA of 1.56 billion, and this gives a ratio of 12.94 (“iHeartMedia, Inc. (IHRTQ)”, 2018). On average, the ratio is 13.64 for the industry, and of this, Apple has the best figure since it is the least among the three.


Industry Specific Multiples


Depending on the industry being valued, such multiples provide a more accurate and reliable measure. For instance, in the oil and gas industry, we take the total reserve divided by annual production. For the retail industry, the multiple is obtained by dividing the sales by the total square footage. In the transport and airline industry, we generate the industry-specific multiple by dividing the total revenue obtained from passengers by the available seat miles. It is important to first understand the industry being valued before choosing a relevant multiple. As much as the price-earnings ratio and the EV/EBITDA are widely used in a variety of industries, others may need that one multiple is preferred over the other. To project where the companies would close at, CY18E, the three-quarter data, is multiplied by 4/3 to estimate the four-quarter data. The 2019’s data is projected by assuming the same growth experienced in 2018 from 2017 will persist into the future.


Data Collection


Three types of data will be collected from sources such as yahoo finance, morning star, company 10-k reports, and guru focus. The three categories include forecasted data, historical data, and current data. The importance of having a forecasted data is for the valuation done for the future. From the data in the excel sheet, current data includes the earnings per share and enterprise value data, and so is the historical data.


Spreading the Comps


This is usually the longest and most tedious process as it involves cleaning up the company’s balance sheet and arranging the data in a way that each column has the same value. Table 1 (in the excel) shows a wide variety of data that is filtered out at this stage, such as the compound annual growth rate and the last twelve-month data, last year’s data, and projected closing place for the current year, in addition to the future projection based on the current year’s growth rate.


Analysis and Interpretation


The graph attached displays a range of valuation multiples obtained by taking the price earnings ratio multiples and the EV/EBITDA multiples, and multiplying it with the target company. The company being targeted is Spotify Inc., and the multiples are taken in the first, median, and third quartile sequence. The implied share price for the first quartile shows the product of the comparable companies’ 1st quartile price earnings ratio and the net income of Spotify Inc., then dividing the product by the shares outstanding of Spotify Inc. Breaking this down shows the earnings per share. To get the firm’s value that is attributed specifically to the common stockholders, commonly known as price per share, we first calculate the net debt by deducting cash and its equivalents from the total debt after which we deduct the net debt from the enterprise value. To get Spotify Inc.’s enterprise value, we multiply one of the multiples: Min, 1st Quartile, Median, 3rd Quartile, or Max values with Spotify’s EBITDA. The number gives 12.37 x $ (228,330,000.0) to get an enterprise value of $(2,825,084,175.24). The price per share for Spotify can be obtained by taking the enterprise value less the difference between total debt and cash equivalents. The enterprise value for Spotify is equal to Spotify’s value attributed to stockholders is 0 – $ 1,950,000,000.0 = – $ 1,950,000,000.0, which is deducted from the enterprise value: 2,825,084,175.24 – 1,950,000,000 = 875,084,175.24. Dividing this number by outstanding shares gives the price per shares, for this case 4.83 dollars each. It is clear that the price-earnings ratio gives a clearer picture that is close to the current state of the company than EV/ EBITDA ratio. The price-earnings ratio values the company at $ 21,070,139,059.61 by multiplying the 1st quartile P/E ratio to its net income.
The comparable company model of valuation has some challenges despite being widely used by investors. For example, since we are using public data from public companies, it is difficult to get it especially when the peers to our target firms are private companies. Additionally, when the company being valued is new and a pioneer in the industry, it might be hard to get peer companies, such as the case when Facebook was being launched. Also, comps valuations are rapidly influenced by sentiments and market conditions, thus moved by short-term market swings. The CCA method offers the best and closest valuation estimates as compared to other models. However, the discounted cash flow valuation could also do better in the absence of this model. According to time.com, some private companies estimate the streaming giant to be worth approximately 20 billion dollars, which is within range with our estimate of 21 billion dollars. The site continues to state that the chairman owns around 10% of the stock and he is worth approximately1.6 billion dollars.

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