Spotify Or Netflix: Which Is The Better Bet For Investors?

by Trefis Team
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Trefis concludes from its detailed interactive dashboard Netflix Vs. Spotify: Who Is Better Off? that Netflix might offer more upside, but it is the riskier bet from a financial perspective.

Netflix (NASDAQ:NFLX) has a higher P/S multiple compared to Spotify (NYSE:SPOT) on account of its stronger revenue growth, higher margins and its growing library of self-produced content which is a valuable differentiator compared to Spotify, which licenses relatively widely available content from music labels. Netflix also has more upside from international expansion, as it derived less than 50% of its revenues from markets outside the U.S. compared to Spotify, which derived over 62% of its revenues from outside the U.S. However, Netflix’s high cash burn rate remains a concern – especially since Spotify has turned cash flow positive over the last three years. Unlike Spotify, which has a net cash holding of over $2 billion, Netflix has been taking on debt to finance its content spending.

OVERVIEW

Spotify and Netflix are the two biggest names in music streaming and video streaming businesses, respectively. While both companies have seen robust growth over the last few years, there are some key differences in their operating and financial performance, partly due to Spotify’s focus on licensing content versus Netflix’s increasing pivot toward creating its own content. Below, we take a look at how the two companies compare in terms of key financial and operating metrics and take a look at which company could be the better bet for investors.

 

Spotify’s valuation in terms of P/S (based on projected 2020 revenues) is lower than Netflix, given its lower margins and its less differentiated content.

  • However, Netflix could see its P/S ratio contract in 2020, if its U.S. subscriber growth slows meaningfully with the launch/ramp of rival streaming services such as Disney+ and HBO Max.
  • Spotify, on the other hand, has an opportunity to improve its P/S multiple as it could possibly post a net profit next year.

A comparison of the P/S ratio for Spotify and Netflix with tech giants Apple and Alphabet is available in our interactive dashboard.

 

The Difference In P/S Ratio for Spotify vs. Netflix Can Be Explained By:The Difference In P/S Ratio for Spotify vs. Netflix Can Be Explained By:

A. Difference in Revenue Growth Rate
B. Difference in ability to generate Positive Cash Flows

 

A. Difference in Revenue Growth Rate

  • Spotify’s Revenue Growth rate has decelerated from 49% in 2015 to about 34% in 2018, and we expect growth to come in at about 23% in 2020.
  • On the other hand, Netflix Revenue growth has accelerated from 23% in 2015 to about 35% in 2018. We expect growth to slow to about 23% by 2020.

A (i) – Changes In User Base: While Spotify’s user base is growing faster than Netflix, driven by premium offering, its growth has decelerated more sharply. Netflix growth is being driven by its international expansion

  • Spotify’s user base grew from 91 million in 2015 to 212 million in 2019 and we expect it to grow to 330 million by 2020.
  • Netflix subscriber base grew from 75 million in 2015 to 148.5 million in 2018. We expect it to grow to about 186 million by 2020.

A (ii) – Changes in ARPUs: We expect Netflix to post stronger ARPU growth compared to Spotify

Data around trends in User Base and ARPU for Netflix vs. Spotify over recent years can be found in our interactive dashboard along with our forecast for 2020.

B. Difference in ability to generate Positive Cash Flows in the long run

The following factors highlight how well revenue growth for Spotify and Netflix translate into cash flows for each company:

B (i) – Gross Margins: Both companies are seeing Gross Margins (margins after accounting for content costs) trend higher. While Spotify’s growing subscriber base gives it better leverage in negotiating royalties with labels, Netflix is seeing better cost absorption on content amortization expenses.

B (ii) – Operating Margins: Both companies are seeing Operating Margins (margins the company earns after accounting for all Operating Expenses) trend higher driven by economies of scale, although Spotify’s margins still remain negative.

B (iii) – Cash in hand: While Spotify had a net cash holding of about $2 billion, Netflix’ Net Debt stands at over $6.5 billion

B (iv) – Free Cash Flows: Spotify is posting improving Free Cash Flows driven by improving cost management (both content and operating costs), while Netflix is seeing its cash burn accelerate on soaring content investments.

Details about the trends in Netflix’s Free Cash Flow and Spotify’s Free Cash Flow over the years are available in separate interactive dashboards.

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