I. Executive Summary
Our $1.0B valuation of SoundCloud reflects a per share price of $0.16 based on 683 million shares outstanding on a fully diluted basis. The valuation methodology was based on a comparable company analysis and a discounted cash flow model. We believe that upon maturation, SoundCloud will transform into a largely creator-focused business and become ubiquitous with music creation– the Youtube of audio content.
Revenue Model/Market Sizing: We expect SoundCloud’s revenue to grow to $636M by 2025, with revenue growth plateauing at 22%, on par with comparables. Soundclouds revenue comes from two main markets, creators and listeners. We project that the creator total addressable market (TAM) will reach 458.1 million music creators worldwide by 2025 and that SoundCloud will occupy 8.3% of this market with over 37.8 million creators on their platform. The listener TAM is expected to grow to 807.3 million listeners globally according to industry reports, and we project SoundCloud capturing over 176 million individuals on their platform.
Cost/Margin Analysis & Evolution: We project the company will become profitable in 2020, experiencing a positive gross margin of 47.4% by 2025. Revenues will increase due to their investment in their creator business, in which they have a unique product offering and have continued to invest to maintain market leadership. We projected cost structure based upon that of comparable company analysis, with Cost of Sales representing 53% of sales and SG&A representing 18% of sales.
Multiples/Comparables Assessment: SoundCloud’s comparables are Tencent Music, Liberated Syndication, and Spotify. We chose these comparables based upon their similar cost structures, product offerings, and revenue growth rates. We utilized comparables for revenue multiples and cost of capital in our discounted cash flow analysis.
Capital Requirements & ROIC: We believe the company will need to continue to need to invest in their business at a similar pace to achieve growth. ROIC is flawed because investment capital is negative, and will likely remain negative due to the nature of subscription-based businesses. This will be discussed further later.
Cost of Capital: We estimate the cost of capital at 7.21%. We used the average of the unlevered asset betas of Spotify, Liberated Syndication, and Tencent Music for SoundCloud’s unlevered asset beta and then used the Capital Asset Pricing Model with the risk free rate of 2.50% and market risk premium of 5.50%.
II. Market Sizing and Revenue Build
Market Size: SoundCloud’s business model addresses two main customer segments: creators and listeners. The company caters to creators by allowing them to have a platform where they can construct, record, and publish their sounds. Listeners have the ability to access these sounds and enjoy a personalized listening experience based on curated playlists assembled for their tastes. Due to this caveat, we needed to size two different markets.
Ideally, we would have had statistics for the amount of music creators or people with a music interest worldwide in order to determine our creator total addressable market (TAM). Unfortunately, there was no such data available, as it is very difficult to accurately measure exactly how many people there are worldwide with a music hobby/career. However, we were able to find the total number of documented musicians, which is most recently estimated to be 27.98 million. We also found that 91% of all music artists/talent is completely undiscovered based on social media research, which means that only about 9% of music enthusiasts are documented. So, we estimated the TAM by taking the 27.98 million discovered musician figure and divide it by 9% to get 310.9 million, which provides a fuller picture of how many people there are worldwide who would be able to benefit from SoundCloud’s creator service in 2015. Because there is a great deal of uncertainty surrounding the TAM figure, the best proxy for its growth rate would be the rate at which the digital music industry is growing, which was 6% in 2019 (Exhibit 5).
For sizing the listener market, we were able to increase our accuracy due to the greater data availability. We figured that the total listener TAM for SoundCloud would correspond directly to the total number of music streaming users worldwide. An industry report provided us with this information and also projected streaming user numbers for the future as well, which was a great way for us to see the current TAM and its growth rate. The most recent total of streaming users is 561.74 million with a 15% growth rate this year based on estimated increases in penetration.
Market Share: SoundCloud currently occupies 6.5% of the creator market based on the fact that there are 25 million creators using the platform right now with an approximate market size of 310.9 million creators. We estimate that the company’s market share in the music creator space will continue to increase at about 4% on the basis that they have added new marketing tools, distribution services, education tutorials, and free creator forums to their creator segment this year and will continue to improve the creator experience in the future. Additionally, the immense brand recognition that SoundCloud possesses in the music artist community will also continue to contribute to the growth of their market share.
In the listener market, SoundCloud currently has 175 million listeners, which means it occupies 31.15% of the market. We expect SoundCloud’s market share of the listener market to grow at a rate of 0.3% on the basis that it is enhancing the listening experience by enabling greater music discovery through its new playlists feature. This growth rate in market share is relatively conservative because SoundCloud faces very stiff competition from Spotify and Apple Music, and it is unlikely that they would be able to take a significant amount of share from these listener market leaders. Essentially, SoundCloud was a first mover in the music creation space, not the streaming space, and their competitive advantage is within the creator market, so it is plausible that their listener business will not expand as rapidly. For our revenue build, we utilized the paid listener segment of the market because only this market segment contributes to listener revenue. Through another industry report, we determined that the company had 15.31 million monthly average users (MAU) in 2019. We figured that the company’s MAU growth rate would be 0.5% on the basis that SoundCloud is enhancing its listener experience by boosting the quality of its inventory and curating playlists.
III. Revenue Model
SoundCloud’s revenue consists of subscription revenue and advertising revenue. We utilized historical split of revenue by nature to estimate 2019 revenue split between subscriptions and advertising (Exhibit 1). The subscription revenue can be further broken down into creator and listener revenue. We calculated creator revenue using the formula SRPC * # paying creators * 12, which translates to subscription revenue per creator times the number of paying creators times the 12 months that these inflows occur. The listener revenue was calculated as SRPL * # paying listeners * 12, which translates to subscription revenue per listener times the number of paying listeners times the 12 months that these inflows occur. In order to find the advertising revenue we did ARPU * (20% * Free Infrequent Users + Free Frequent Users), which translates to advertising revenue per user times the total number of ad revenue contributing users where infrequent users are weighted at 20% because they are thought to contribute 20% of the level of ad revenue as frequent users on average.
Subscription Revenue:
A) Creator Revenue: To determine SoundCloud’s creator conversion rate, we decided to take into account the company’s main value proposition, which is the service that it provides to creators. Currently, we estimate that SoundCloud has a 4% conversion rate based on using the software industry as a comparable and taking into account SoundCloud’s age. We project that the conversion rate will reach about 12% upon maturity due to SoundCloud continually strengthening its suite of tools and services for creators (like it already has with the introduction of marketing management, distribution services, creator forums, etc. this year). In order to get the subscription revenue per creator (SRPC) value of $13 we took the weighted average of the two seperate pricing options for the creator subscription (Exhibit 2): SoundCloud Pro Unlimited billed monthly ($16) and SoundCloud Pro Unlimited billed yearly ($12). Finally, the number of creators that were paying subscriptions was determined by taking the conversion rate and multiplying it by the number of creators that SoundCloud currently has (25 million).
B) Listener Revenue: First, we arrived at the subscription revenue per listener (SRPL) value of $5.99 by taking the weighted average of the two different subscription options (Exhibit 3): SoundCloud Go+ Premium ($9.99) and SoundCloud Go+ Regular($4.99). To determine SoundCloud’s total paying listener count, we took the listener revenue and divided it by the SRPL (calculated annually) to get 273,000 individuals. We arrived at the conversion rate by dividing the total paying listener count by SoundCloud’s MAU (monthly average user) count on the assumption that the subscription buying individuals would come from the frequent streamers on the platform. We grew the conversion rate by 0.1% because SoundCloud offering new tiered subscription options has made it cheaper to use the company’s subscription service over that of its competitors. This is a very conservative growth rate because SoundCloud has tight competition as mentioned earlier.
Advertising Revenue: We determined the advertising revenue per user (ARPU) by taking the advertising revenue number and dividing it by the weighted average of frequent and infrequent free users (Exhibit 4). There are no ads for users that pay subscription fees, so our calculations focus on the free users. The ARPU value grows until it converges at $1.03, which is the industry average we derived from comps. To determine the frequent free user count, we subtracted the paying listener number from SoundCloud’s MAU value. We calculated the infrequent free user count by subtracting the free frequent user count from the SoundCloud’s total listener value. Finally we weighed the infrequent free user count at 20% because we assumed that these users were on the platform for only a fraction of time when compared to frequent free users and only contributed 20% as much advertising revenue to the company.
IV. Cost/Margin Analysis and Evolution
Our discounted cash flow (DCF) model features five years of explicit unlevered free cash flow (UFCF) projections. We calculated SoundCloud’s UFCF as the difference between net operating profit less adjusted taxes (NOPAT) and incremental investment. Note that when we were transferring values from the Income Statement to the DCF, we needed to convert the euro amounts to dollars, which is why everything was multiplied by 1.1177 (the 2019 exchange rate before the recent economic crisis). Also, we used a corporate tax rate of 30% in order to go from earnings before interest and taxes (EBIT) to NOPAT in order to reflect SoundCloud’s location of incorporation, Germany.
Cost of Revenue: SoundCloud’s cost of revenue consists of paying artists and record labels royalty payments, developing creator tools and listening features, and distribution expenses. Under its direct monetization program, SoundCloud pays its artists 55% of the net revenue share for the songs they upload and own the rights to. It also distributes 100% of its publishing royalties to right holders and societies. Moving forward, as SoundCloud scales and finishes establishing the majority of its creator oriented products, we expect that the growth of the cost of revenue will experience modest decreases until it converges upon 53% of revenue, which is the average cost of revenue as a percent of sales measure derived from SoundCloud’s comparable companies, Spotify, Liberated Syndication, and Tencent. The reason behind using these companies as a comparable measure for SoundCloud upon maturity is because they all experience their cost of revenue coming from the same/similar activities.
Operating Expenses: SoundCloud’s operating/SG&A expenses mainly stem from marketing and advertising expenses, paying wages, and maintaining their extensive platform. We assume that as SoundCloud scales and increases in maturity, the growth rate of its SG&A as a % of revenue rate will converge to 14%, which is the average SG&A expense as a percent of revenue for SoundCloud’s comparable companies. We decided to use the same comparable companies as earlier for this estimate because Spotify, Liberated Syndication, and Tencent all function in the same industry and either have a similar composition of operating expenses as SoundCloud (historically) or were similar in size and/or growth to SoundCloud in the past. This allowed us to capture the effects of operating leverage in our projections.
V. Cost of Capital
To calculate SoundCloud’s cost of capital, we used financial information from Spotify, Liberated Syndication, and Tencent Music. Next, we used the formula, % Equity x Levered Equity Beta + % Debt x Debt Beta = Unlevered Asset Beta to the unlevered asset betas of Spotify, Liberated Syndication, and Tencent. We took an average of the three unlevered asset betas to get SoundCloud’s unlevered asset beta of 0.86. Using the Capital Asset Pricing Model with the risk free rate of 2.50% and market risk premium of 5.50%, we found the cost of capital to be 7.21%
VI. Capital Requirements and ROIC
We also observed Spotify, Tencent Music, and Liberated Syndication’s capital turnover ratios for industry comparison. They all had negative investment capital values, which resulted in negative capital ratio turnovers and negative ROICs. Currently, SoundCloud has a positive capital turnover, but this is expected to become a higher, negative number that is similar to comparables. This is due to a large Unearned Revenue account due to users paying up-front for services to be received in the future, which is the nature of an online, subscription-based business. Therefore, assuming capital turnover ratio will project to the comparable average, -5.95, is reasonable. We used simple assumptions with capital requirements, since this is a software-heavy company that requires little CapEx to operate, so these costs remain steady in our projections. Due to SoundCloud’s negative Investment Capital, our ROIC will remain flawed.
VII. Multiples/Comparables Assessment:
We analyzed Spotify, Tencent Music Entertainment, and Liberated Syndication, three public companies in the same podcasting and music streaming company as SoundCloud. To find sufficient comparable companies, we utilized Pitchbook similarity scores, and verified that their offerings and cost structures were similar. Spotify and Tencent are music streaming platforms, and Liberated Syndication is a platform for podcasts. Liberated Syndication is comparable in its similarity to SoundCloud’s creator business, providing professional tools for podcasters, while Tencent and Spotify lean more toward their streaming business. SoundCloud’s revenue growth rates were similar to those of these comparable companies during their earlier stages. Note that all of these businesses are also subscription based, which has resulted in a realistic negative ROIC value for SoundCloud as an indication of their operating liabilities only being able to be paid off once their subscription based revenue flows come in on a periodic basis. It was difficult to find true comparables because of SoundCloud’s unique offering as more of a creator platform than a streaming platform. We utilized the comparables for the revenue multiple, cost of capital, and in projecting the cost structure. We could not justify a stable positive EBITDA in the current period of high growth, so we forecasted SoundCloud’s terminal value using an EV/Revenue multiple. The EV/Revenue multiple we used was an average of our comparables, 2.7x.
APPENDIX
Sensitivity Analysis:
Multiples/Discount Rate: Assesses SoundCloud’s Enterprise Value and Price per Share in response to fluctuations in EV/Revenue Multiple and Discount Rate. Total Enterprise Value (TEV) is extremely sensitive to EV/Revenue Multiple.
Creator Revenue Assumptions: Assesses SoundCloud’s Enterprise Value in response to assumptions in creator revenue, market share growth rate and conversion rate. TEV is rather sensitive to the creator conversion rate, as this is a significant revenue driver.
Cost Structure Assumptions: Assesses SoundCloud’s Enterprise Value in response to assumptions in cost structure, for both COGS as a % of revenue and SG&A as a % of revenue. Relatively insensitive to these major assumptions in cost structure.
Model:
Revenue Build:
Income Statement and Forecast Drivers:
Balance Sheet:
Capital Turnover:
Discounted Cash Flow Model:
Comparable Companies Analysis and Comps based Forecast Drivers:
Exhibits:
Exhibit 1: Revenue by Nature
Figure A
Figure B
Exhibit 2: Creator Subscription Features (Source: SoundCloud Website)
Exhibit 3: Listener Subscription Features (Source: SoundCloud Website)
Exhibit 4: Advertising Revenue Per User
Exhibit 5: Global Digital Music Industry Revenue Projections (Source: Statista)
WORKS CITED
Cirisano, Tatiana. “SoundCloud to Help Artists Distribute Directly to Spotify, Apple Music & More.” Billboard, 19 Feb. 2019, www.billboard.com/articles/business/streaming/8498611/soundcloud-distribution-tool-spotify-apple-kerry-trainor.
Houghton, Bruce, et al. “Free SoundCloud Creator Forum Announces 5 Cities, More To Follow.” Hypebot, 19 Feb. 2020, http://www.hypebot.com/hypebot/2020/02/free-soundcloud-creator-forum-announces-5-cities-more-to-follow.html.
“IFPI Global Music Report 2019: Global Music Market Grows for Fourth Consecutive Year.” Music Business Association, musicbiz.org/news/ifpi-global-music-report-2019-global-music-market-grows-for-fourth-consecutive-year/.
Ingham, Tim. “SoundCloud, with More than 200m Tracks on Its Platform, Saw 12-Monthly Revenue Run-Rate Top $200m Last Year.” Music Business Worldwide, 20 Jan. 2020, http://www.musicbusinessworldwide.com/soundcloud-with-more-than-200m-tracks-on-its-platform-saw-annual-revenues-top-200m-last-year/.
“LSYN: Liberated Syndication Inc. Annual Income Statement.” MarketWatch, www.marketwatch.com/investing/stock/lsyn/financials.
“Music Streaming – Worldwide: Statista Market Forecast.” Statista, http://www.statista.com/outlook/209/100/music-streaming/worldwide#market-revenue.
Peoples, Glenn. “Tencent Music Shares Drop Despite Solid First Earnings Report.” Variety, Variety, 20 Mar. 2019, variety.com/2019/music/news/tencent-music-shares-drop-despite-solid-first-earnings-report-1203168403/.
Smith, Craig. “16 Amazing SoundCloud Statistics.” DMR, 12 Feb. 2020, expandedramblings.com/index.php/soundcloud-statistics/.
“SPOT: Spotify Technology S.A. Annual Income Statement.” MarketWatch, www.marketwatch.com/investing/stock/spot/financials.
Statista Research Department. “Number of Musicians in the U.S. 2011-2014.” Statista, 30 June 2016, www.statista.com/statistics/192834/people-playing-a-musical-instrument-in-the-us/.
Titlow, John Paul. “Why Spotify Should Totally Buy SoundCloud.” Fast Company, Fast Company, 14 Apr. 2017, http://www.fastcompany.com/3064202/why-spotify-should-totally-buy-soundcloud.
“TME: Tencent Music Entertainment Group ADR Annual Income Statement.” MarketWatch, www.marketwatch.com/investing/stock/tme/financials.
Ulloa, Nina. “91 Percent of All Artists Are Completely Undiscovered.” Digital Music News, 28 Oct. 2019, http://www.digitalmusicnews.com/2014/01/17/nbs/.
Watson, Amy. “Global Music Industry Revenue 2023.” Statista, 3 Dec. 2019, www.statista.com/statistics/259979/global-music-industry-revenue/.
“What’s a Good Conversion Rate? (It’s Higher Than You Think).” What Is a Good Conversion Rate? It’s Higher Than You Think!, http://www.wordstream.com/blog/ws/2014/03/17/what-is-a-good-conversion-rate.
Apple & Pear 