Spotify expected stock price as of publication: $115 per share. 

Ten hours from now, Spotify stock will be available to investors to participate in a rare-direct type of public offerings. In a direct IPO, the company sells shares directly to investors without the need for an investment bank to act as a stabilizing agent if things went south on day one. This may be justified as the company, Spotify Technologies, is not getting any proceeds from this IPO. Instead, private Spotify stockholders are cashing out. The company is expected to be valued between $18 and $20 billion, however, there is no assurance that this might be the valuation due to the nature of this offering.

Spotify stock should not witness the increase that Twitter or Snap stocks had at their IPOs as there are no preferred buyers of this stock, again, due to the nature of this IPO (in a normal IPO, investment bankers would sell shares to preferred clients days before the IPO which would increase the price substantially, like in Twitter’s case, as the market opens).

This gives retail investors an equal opportunity to participate in Spotify’s IPO. We believe that SPOT valuation, at $18 to $20 billion, is an undervaluation to the company’s potential.

Not only the company had a highly respectable growth rate in MAU and Premium subscribers, its average revenue per user is close to that of Facebook. Per its F-1 filing, SPOT generated 63 euros ($77 at a current exchange rate of $1.23/Euro) from each of its 71 million premium subscribers last year, which is slightly lower than Facebook’s ARPU of $84 in its most prestigious market, North America.

We believe that subscription-based platforms with this kind of ARPU and growth (48% increase in premium subscribers and 29% growth in MAU in 2017) deserve much more than 5 times 2017 revenues.

By our estimates, we believe that Spotify stock should trade at 10x sales which is close to the current multiple of Netflix. We chose Netflix as a comparison due to the similarity in the business model, total addressable market, churn rates (5%-6% for both platforms) and growth rates. However, Spotify generated $109 and $71 million in 2017 and 2016, respectively. Compared to Netflix, which burned $2 billion last year, is a huge success in a low-margin business.

Bears would argue that 10x sales is a huge multiple for a Spotify at the time when its closest competitor, Pandora, is trading at less than 1x sales. We believe that this comparison is baseless and lacks proper evaluation of the situation as Spotify reported a 25% growth in revenues last year while Pandora barely reached the 1% mark. Also, Spotify has 2x the number of Pandora and Apple Music MAUs which makes the multiple more justified.

All that in a business where each additional users adds more value to the platform than the preceding user. For instance, a huge user base gives more leverage for the company with the singer/distributor, thus fewer royalties per stream. It’s also worth mentioning that Spotify has a sticky user base as it is not easy for them to change platforms given that their playlist is on the app and the improvement of AI recommendations by the company which gives users a better experience.  

We believe that Spotify at a $20 billion valuation is a one-time opportunity in an environment which appreciates growth, especially when accompanied with a subscription-based model. We are long Spotify with a price target of $226 per share, nearly double the expected IPO average price of $115 per share.

Disclaimer: Celeritas Investments will enter into a long-position in SPOT on April 3rd.