Competition, Cost Structure Threaten Spotify's Lead

Ali Mogharabi: Swedish-based Spotify is the world's leading music streaming service provider, and we foresee the fast-growing digital streaming space as becoming the primary distribution platform of choice within the ever-changing music industry. We believe Spotify can benefit from various network effects that will help the firm increase its users and amass valuable user data and listening preferences. However, the firm faces intense competition and has a mostly variable cost structure that may limit Spotify's future operating leverage and profitability. Thus, we don't have sufficient confidence that it will generate excess returns on capital over the next 10 years.

Spotify is ahead of the pack in the growing music streaming market, but it faces stiff competition from behemoths such as Apple, Google, and Amazon. Unlike Spotify, these firms aren't solely reliant on streaming music to drive profitability and can actually potentially run at break-even, or even as a loss leader, while monetizing listeners via other products and services.

Competition aside, Spotify may be at the mercy of the record labels, as it'll need access to content to keep attracting more listeners. Over 80% of licensing is controlled by the big three major record labels. As these licensors gather royalties from Spotify and its peers, they maintain pricing leverage as content does remain king.

We value Spotify at $118 per share or $21 billion, and we assign the firm a no-moat rating with a stable trend.