In this YouTube presentation, the speaker—representing New Constructs—offers a deep‑dive critique of Spotify’s current market valuation. He argues that the company’s recent surge to a 344% return on invested capital (ROIC) is unsustainable because Spotify has virtually no balance sheet assets, leaving it vulnerable to demands from music rights owners who will capture more profit as margins rise. Using a reverse discounted cash flow (DCF) model, he demonstrates that even highly optimistic growth assumptions (up to 30% annual revenue growth for 15 years) fail to justify the stock’s price, which implies a future revenue of about $560 billion and free cash flow of $30 billion—levels comparable to the world’s largest retailers. The speaker highlights that original content deals (e.g., podcasts, exclusive shows) further strain margins and will likely depress ROIC. He concludes that the market’s bullish narrative is already fully priced in, and when investors shift focus back to fundamentals, Spotify’s stock is poised for a significant decline, making it a prime short candidate.
Chapters
Welcome everybody, let's get going. As you guys know, New Constructs thinks about earnings reactions a little bit differently than other folks. My experience on Wall Street has led me to believe that, look, these quarterly meetings and reports, these are commercials to sell stock, and they're not really even allowed to give out any good information. So spot, good company, bad stock, really high expectations here. Look, it's a really profitable business. I had to do a double take when I first saw this 344% return on capital. Why? They got no balance sheet, right? That's also their biggest risk. No balance sheet is one of their biggest financial benefits, but it's also one of their biggest strategic risks. They don't own anything. So When margins get this good, what do you think the owners of this music are going to want to do? They're going to get paid more money. And so these guys are perpetually squeezed. This has been our thesis for Spotify ever since the beginning. We don't think profits this high are sustainable. We don't think profits this high are sustainable. Return on capital, look, it used to be terrible and it's really just skyrocketed here recently. We'll see here when we break down returns on capital into the 2 key drivers, you can see margins were really kind of hovering around zero. Skyrocketed here recently. Capital turns doing extremely well also. So the question is, are these margins sustainable? I would say no, they're not sustainable because the owners of the music are going to say, why is this person who's renting my music making more money than me? I need some of that back. So I think Spotify's margins are really boxed in. There, there's a cap, I think, on how much of a margin they can charge. Fun to do a reverse DCF here real fast. You can see we've got some jacked up numbers in here, you know, super steep on my neutral, and it still can't get to more than $300. Let's see what, let's see what we got for optimistic. Okay, so optimistic scenario. Oh my gosh, we can't even get there with the optimistic scenario. All right, let's play the game here. Let's go in and see how optimistic we need to be. So the optimistic scenario's got 25% growth in revenue going out for 20 years, and that's still not getting us to where we need to be. The last fiscal year margin is negative. Let's take a look here what the margin is at the TTM. TTM margin is 5.5%. We'll leave the cash tax rate at zero. Assume they maintain this really high margin, 5.5%. And then let's, let's go see what kind of revenue growth. So 25% didn't do it. Let's try 15% in the first year, 30%, 30%, 30%. Save that off. So this is a great way to use this model. If I'm bullish on Spotify, what do I need to believe? What's going to happen? What does optimistic look like? 15 years. So they've got to grow revenue at close to 30% or 27.5% compounded annually for 15 years while seeing the return on capital improve from -23% to positive 1,500%. We want to look at how high is that. We rank the S&P by return on capital here in this dataset I pulled together from our system. The highest company's at 415. I can tell you that no company in the last 5 years has been over 600%. Fortinet made it over 500, but it only lasted for a little while. So I think it's pretty fair to say that Spotify is pretty expensive here. If we want to look at implied revenue, we're getting up to $560 billion. Let's see, where would that rank in the S&P 500 in terms of revenue? Total revenue, largest to smallest. So they'd be up there. They'd be better, bigger than Apple, and just behind the biggest retail businesses in the world, Walmart and Amazon. That's what that's what the stock prices imply they're going to get to, while also seeing return on invested capital skyrocket. There you go, around zero all the way up to the average over the time frame is 1580, but the total that it gets to is 24. So I'd, again, I'd say that's pretty expensive. If we want to look at the free cash flow for Spotify, again, skyrocket, $30 billion. You know, that's on the level of these big companies we talked about. So I think this is a really tough business to want to buy at this stage. I think it's fair to say all the good news here is priced into Spotify. What about original content? I said, well, that'll be expensive. I think it'd be really expensive. And that means returns on capital are going to suffer. If you're going to have that kind of market share and that kind of growth, you're going to have to come up with a lot of great new content. You're going to have to do it at an extremely profitable level. It's kind of hard to believe that the labels and the owners of the music are going to let you do that. You want to create original content, that's expensive. They paid Joe Rogan a lot of money. He did them a lot of good, but that's expensive. And that's going to go on the balance sheet. That's going to hurt your return on capital. So what they're saying in the earnings Good news, rah rah rah, stock goes up. Nothing about the long-term implications that we show you here, which is, oh my gosh, a super profitable future is priced in here. Amazing growth, amazing profitability, as if they have no competition and new content is going to just grow on trees for free. That's why, you know, this is a stock that we have warned people about for a long time and is on our focus list short. We think when, when the narrative unravels, when people start caring more about allocating capital intelligently and not just chasing stocks, when people feel the risk of chasing stocks has just gotten to be too much and they care about fundamentals, this is one of those big ones that's going to fall and it's going to fall big.
