Introduction
This report will conduct the evaluation of Spotify’s shares in order to sell the rest of Warner Music group’s holding in Spotify and raise public funds. This estimation is performed with the help of Comparable Companies Analysis (CCA). The report will briefly discuss about the identification and selection of competitors and peers, analysis of data, making the necessary adjustments in order to eliminate bias, and the benchmarking as well as determining the value of the deal. It will also discuss whether CCA is the ideal valuation method and briefly mention the other analysis’ that are alternatives.
The Target
The selection is made after a thorough research of Spotify’s key features and characteristics. Spotify Technology is a company based in Luxembourg, which renders music-streaming services. The company allows its users to explore and discover new music, which includes the latest playlists as well as singles. This enables the customer to build his/her own personalized collection of music. Spotify free offers a multitude of advantages such as uninterrupted music, free of advertisements, allowing the user to listen to music offline, and enabling any track to be played with very high-quality audio.
Spotify has never reported a profit, but as the company is in the technology sector, they are bound to very high growth rates. They have experienced sustained losses, albeit they have managed to thrive in the market due to its backing from the users and investors. Their costs associated with the core activity is significantly high, and these costs come in the form of royalty expenses as well as licensing content.
Peers
The first step of CCA involves selecting the universe of comparable companies. This step is critical as it paves the path for the valuation of Spotify. Companies with similar trading and risk characteristics can be useful for the acquirer to evaluate Spotify.
The comparable companies in this analysis includes:
– Snap Inc. (Ticker: SNAP)
-Pandora Media (Ticker: P.N)
-Ansys Inc. (Ticker: ANSS)
-Netflix (Ticker: NFLX.O)
The reason these companies were chosen is that firms with similar characteristics serve as a relevant reference point for estimating the value of the target.
-The first company that is compared to Spotify is Snap Inc., and this selection is based on the similarity in the credit profiles of the two companies. Snap Inc. has no virtual debt. It is a camera company that owns the flagship product, ‘Snapchat’ which is a camera application that allows people to communicate through shorts videos and images called as ‘snaps’. Snap Inc. went public last year, and the value of the company is similar to Spotify.
– The second company is Ansys Inc. and they are the largest engineering simulation company in the world. They are a firm that is committed to innovation and R&D. They are renowned for their practice of extensively reinvesting their revenues each year. They are a public limited company that has no debt and an identical credit profile as Spotify. ANSS is also in the technology industry, which justifies the comparison.
-Netflix is the leading internet entertainment service provider in the world. They render streaming services to customers on a global platform. They are redefining the culture of the movie industry as the company allows you to watch as much as you want, free of advertisements. Netflix was chosen, as it is a sector competitor that falls under the same category of online streaming.
-The reason why Pandora Media was chosen was that it is a publicly listed company that is a direct competitor to Spotify that provides music streaming service.
All the chosen companies are public listed companies.
Data Sources
The financial information that was required to conduct the CCA has been procured from sources such as Thomson Reuters Eikon, the Securities and Exchange Commission filing, Yahoo finance, Google finance, and WRDS.
Analysis
After conducting the CCA analysis, the results show that Spotify has a significant equity value of approximately 24 billion dollars. This can be compared to the equity value of Pandora Media, which roughly around 2.3 Billion dollars, which helps us comprehend the size of Spotify, with respect to the competition within the same category. This depicts the difference in the market presence of two companies that competes in the same market rendering the same service. The equity value of Netflix is close to 125 Billion dollars, which is very high for an online streaming company. ANSS has an equity value of nearly 14 Billion dollars and is a large cap firm. Snap Inc. was valued much higher prior to its IPO but since then the company share price has gradually reduced. Snap Inc. has an equity value of close to 9 Billion dollars. (ROSENBAUM & PEARL, 2013)
The enterprise value of Spotify is close to 23.3 billion dollars, while the enterprise value of SNAP is close to 7 billion dollars. EV calculates the value of a company inclusive of the debt and cash. Pandora media has a value of almost 1.6 dollars and the value of Ansys Inc. is close to 13 billion dollars. These four companies have an enterprise value lower than its equity value. On the other hand, Netflix is valued at 129 billion dollars, which is higher than its equity value due to the amount of debt that the company possesses.
– P. N, SNAP and ANSS had revenues over a billion dollars. NFLX.O had revenues of close to 15 billion out of which nearly 6 billion dollars was gross profit. While the target company had sales that amounted up to 6 billion dollars and turned a gross profit of nearly 1.5 billion dollars.
-Only two companies reported a positive EBIT, and they are Netflix with 1.6 billion and ANSS with around 9 billion dollars. ANSS had a non-recurring adjustment this year, which justifies the abnormally high EBIT. On the other hand, SPOT.K, P.N and SNAP, had a negative EBIT. SPOT.K had a loss before interest and taxes of approximately 271 million, while P.N had a loss of 321 million, and SNAP had a loss of 1.8 billion dollars.
-All five companies have a positive growth rate with respect to sales and shows potential. There is an inconsistency with regard to the growth rate of EBITDA. All the companies but Ansys Inc is estimated to have a negative EBITDA in the next year.
-A high ROIC portrays that the company uses the funds available to them in an optimal manner. Spotify has a significantly high positive ROIC above 50% which indicates that the company makes efficient use of the funds available to them. It also implies that the company is creating value. Snapchat has a negative ROIC above 100% that indicates the company is not creating value and is in fact destroying value. Ansys Inc. has a positive ROI as well which indicates that the company is creating value and is using the available capital well. Netflix has a positive ROI of nearly 20%, which essentially means that the company, irrespective of the size, is utilizing the funds very well. Pandora it will destroy value as the company grows. (ROSENBAUM & PEARL, 2013)
– ROE is more relevant when the companies are in the same sector. The ROE of Spotify was negative 93%, which is owing to the fact that the company has been facing persistent losses. In the case of Pandora, the negative ROE signifies the culmination of losses and debt that they possess. Ansys Inc. has a positive ROE of 13%, which means that the company is generating returns for its investors. Netflix is on the same page and has a positive ROE of 44%. Snapchat has a negative ROE, which portrays that the company has been reporting consistent losses throughout the last few periods. There can be an artificial increase in the ROE if the company buys back shares or due to write-downs.
-ROA varies from industry to industry, but the general belief indicates that higher the ROA, the better. The ROA of Spotify is negative 31%, while Netflix had a ROA of 9%. ROA is of significance when the companies are in the same industry. Some research suggests that ROA is not a valuable metric in numerous cases because it depends on an eclectic mix of factors. These factors include whether the company is capital extensive or not, also a higher ROA could be because the company is not investing enough in their assets, which might affect their growth opportunities. (ROSENBAUM & PEARL, 2013)
– Spotify, Ansys Inc. and Snap Inc., are free of debt. Netflix has a debt to total capital ratio of 62% and Pandora Media has a ratio of 83%.
-The last twelve months coverage ratio calculates the number of times EBITDA covers the interest obligations of a firm. Every company but Snapchat reports a negative value. Spotify and Pandora Media report a negative value because these companies are incurring losses. Netflix is reporting a negative value because of the company’s level of debt. Snapchat has a positive value, which indicates its ability to cover its interest obligations. Ansys Inc has a value of negative 1.3 times.
– Netflix and Pandora Media are the only two companies amongst the five that has a credit rating. Netflix has a credit rating of B+ and B1 as given by S&P and Moody’s, respectively. Spotify does not have any debt which the company is why does not have a credit rating and hence this metric does not help the evaluation.
-Ansys Inc had a non-recurring item in the form of cost incurred while restructuring the workforce to align it with the company’s future strategies. These items are added back as they are considered to be a one-time expense. This is a very important item to be included as it may skew the final results of the CCA if not done right. Written down expenses are also included in this column.
-The EV/EBITDA multiple is considered to be the standard for the valuation of companies across different sectors. This is because the multiple isn’t affected by the capital structure as well as the taxes. This multiple portrays that the enterprise value of Netflix is 65 times more than its EBITDA, and the EV of Ansys Inc. is roughly around 22 times more than its EBITDA. A very high EV/EBITDA ratio can be because the enterprise value is overvalued. In the case of Spotify, the company has an EV of negative 93.37 times the EBITDA. A negative value does not necessarily indicate that the company has an issue. Nevertheless, the valuation of Spotify isn’t possible using this ratio as a metric. The above analyzed metrics are considered to be core drivers and is preferred due to the ease of calculation and comparison. (PICARDO, 2018)
We can assume that the of usage of CCA is a suitable method as it facilitates ‘current’ valuation of the target company using the prevailing market information. As a result, this form of analysis is considered to be more relevant than other valuation methods such as discounted cash flow analysis, replacement cost approach and so on. Through the process of performing CCA, we can extrapolate information regarding the company that is useful in the process of valuation. Comparable companies are chosen based on profitability, growth and risk characteristics. This is because they are cross sectional drivers of a valuation multiple. It facilitates the comparison of companies with ease and it can also be calculated quickly.
Although, after thorough investigation of the key ratios, statistics and multiples, we can conclude that the results did not help us narrow down the benchmark companies. This was due to the gap in the range between the values of the key statistics, and ratios of the companies. The valuation was unsuccessful due to the drawbacks of CCA. In reality, trading levels may not depict the whole picture. This occurs when the market is irrational due to investor sentiment, which affects the valuation. Moreover, two companies cannot be the exact same. Hence, allocating a valuation estimate based on characteristics of similar companies may fail to enumerate a company’s true value. Another con is if the company is operating in a niche sector, it is very hard to identify comparable companies. In the case of Spotify, the identification and selection of the comparable companies were with regard to their credit profile and industry, but this effort proved to be futile as a range could not be ascertained.
The other valuation methods we can use includes free cash flow approach, the real options method, and replacement cost approach. The cash flow approach attempts to evaluate the company by using the future cash flows of the company after factoring in and adjusting for the time value of money. The cash flow approach is regarded to be a better estimator at explaining equity valuations than traded multiples. On the contrary, studies have shown that earnings multiples should be used instead of cash flow multiples because valuations based on earnings forecast are very accurate for a significant majority of the companies. Even when reported numbers to forecasts improve the operating cash flows, the study shows that the earnings improve better than the cash flows and justifies our assumption.
(Liu, Nissim & Thomas, 2018)
Real options method attempts to find out the value that the investors assign for different investments. The value of the company is derived by calculating the expected profits of different products and by considering, the potential for growth of the company. This is especially useful for biotech companies without current revenue. This enables the comparison of the value of different projects for capital budgeting reasons. (Kellogg & Charnes, 2000)