Spotify has upside to consensus due to higher margin verticals – Wolfe Research

Wolfe Research initiated coverage of Spotify (NYSE:) with an Outperform rating and a $390 price target in a note Friday, with the new target representing a potential 28% upside.

Analysts at Wolfe Research believe Spotify is undervalued, trading at 26x CY25E P/FCF, despite its significant exposure to the faster-growing streaming market compared to Universal Music Group (UMG).

The firm notes that Spotify, holding approximately one-third of the global music streaming market, is more than twice the size of its closest rivals in the segment (Apple, Amazon, and YouTube).

According to Wolfe Research, “Spotify operates at the center of global audio consumption & discovery,” offering a pure-play exposure to music streaming without the variability and risks associated with artist negotiations faced by music labels.

The firm says this makes the company an attractive investment beyond just music, extending into higher growth verticals like podcasting, audiobooks, and live audio.

Analysts at Wolfe Research see potential for Spotify to exceed consensus estimates, driven by more frequent pricing adjustments and higher-margin verticals. They estimate that by the fourth quarter of 2024, around 7% of Spotify’s revenue will bypass label splits, up from 3% in 2023 and zero in 2018. This shift is expected to drive gross profit forecasts 4% above consensus in the second half of 2024.

Additionally, Wolfe Research highlights the potential for Spotify to increase bundled average revenue per user (ARPU), generating about three times the gross profit of other revenue streams. They expect regular price hikes and growth in ancillary services to support this trajectory, projecting a ninefold expansion in gross profit total addressable market (TAM) by 2034.

Wolfe Research’s price target of $390 for SPOT is based on a discounted cash flow (DCF) and sum-of-the-parts (SOTP) valuation, reflecting steady user growth, low single-digit ARPU growth, and substantial free cash flow expansion.

They forecast €45 billion in revenue, €16 billion in gross profit, and €48 in free cash flow per share by 2034, reinforcing Spotify’s compelling long-term investment potential.