Spotify for Windows

Spotify, the world’s most popular streaming music platform, is launching its DPO (Direct Public Offering) on April 3rd, 2018. The story that the financial press has focused on is Spotify being a music service, locked in a highly competitive market with similar services. However, the investor would be mistaken in assuming that this is the complete story. The market has fundamentally misunderstood Spotify’s business. There is a pivot on the horizon with Spotify, and it has already started to take place. Those familiar with the app have seen it. Music isn’t the only dimension to Spotify. When the shift from a music reseller and streamer to a true audio-first platform becomes recognized by the market, hidden value will be unlocked. This gives a unique opportunity to the shareholder.

Spotify was founded in Stockholm, Sweden, in 2006. It is now the global leader in music streaming. Market share is approximately 36% as of 2017. Other popular alternatives are Pandora, SoundCloud, Apple Music, and offerings by Amazon and Google. However, by being device agnostic and the largest service by users, Spotify is uniquely positioned to accelerate its business for years to come. Spotify is compatible with all major smartphone and computer operating systems, as well as major smart home speaker systems, and video game consoles. It’s now being installed on car stereo systems. Another company that Spotify inevitably gets compared to is Netflix. However, many Netflix users also subscribe to cable and other video streaming services. What makes Spotify different is that all anyone needs is one streaming music service. Having a large lead in the install base gives it a substantial competitive advantage. The market is highly contested, and margins will be thin for a long time to come, but first-mover advantages are particularly meaningful in this instance. In addition, Spotify does an excellent job integrating with social media. This feature isn’t a must, but is an additional narrow moat nonetheless. This leaves Spotify as the default option in this space.

Spotify offers two types of plans. An ad-supported (free) plan with less control over which songs are played, and a premium on-demand service. It currently has 159 million MAU’s, and of those 71 million are premium users. The portion of premium to total users is growing rapidly, from 30% to 44% over the last two years. Spotify currently gets 90% of its revenue from premium users, and only recently broke even with its ad-supported side. Spotify has to sign lucrative licensing agreements with major and independent labels. This is unlikely to change in the near future, given the way the contracts are structured (I won’t go into too much detail here, but it can be found on the F-1). his far from being a traditional value stock, but its platform offers promising opportunities in the future.

All figures are in millions Euros, unless otherwise stated. Financial data taken from the F-1.

While MAU’s have been growing, ARPU (Average Revenue per User) has been steadily shrinking. This is due to family and student discounts now being offered. It should be noted that churn has been steadily decreasing as well, confirming that this pricing plan is a sound strategy. With the global smartphone base of 2.3 billion and growing (statistica.com), there is still plenty of room for Spotify to grow. Worldwide expansion continues, currently present in 61 countries. In each instance, the service is tailored to the local music preferences of the population. Not simply a music provider, there is a strong emphasis on analytics in Spotify’s business model. A strong part of the user experience is music discovery. Using scale and analytics, users can listen to algorithm and custom created playlists, updated daily. Spotify’s lead in listeners among its competitors is being converted into a superior experience for the user. Spotify continues to invest in its platform. This growing expense certainly drives margin compression, but patient shareholders will be rewarded in the future. Its analytics also have applications beyond listening to music.

Spotify for Windows

Spotify undeniably had plenty of success in its first decade. It has a growing globally, the leader in its category, with growing user engagement. However, it has yet to escape the harsh competitive landscape that is the music streaming business. Besides smaller competitors such as SoundCloud and Pandora, it faces the prospect of facing not one, but three 800 pound gorillas named Apple, Google, and Amazon. Is Spotify’s destiny always to be fighting for narrow margins in a cutthroat business? Or, is there a shift already underway, one which will see much higher user engagement and profits in Spotify’s future.

It is often said that we’re currently living in the Golden Age of Television. Streaming television has revolutionized the economics and viewing habits in that market, and made shows like House of Cards and Game of Thrones possible. Less known, but just as applicable, is the world of podcasting. It has also been said that we’re currently experiencing a Golden Age of Podcasting. Interest in podcasts hit an inflection point a few years ago, and has been steadily increasing. This fact has become much more widely understood since the podcast Serial became a massive hit with mainstream audiences in 2014. Yet strangely, no publicly traded firms (and shareholders) have profited from this massive media shift. The podcast world still remains highly fragmented. There are dozens of popular apps available for both podcast creation and consumption. Some are proprietary, others are open source. The non-technical users do face moderate barriers to entry when being acclimated with podcast listing. Additionally, little or no data is known about viewing habits of podcast listeners, besides downloads. How often are podcasts listened to? How many times does the user pause the podcast? Which topics are most interesting and engaging? How many times is each episode shared? None of this is known, because there is no universal podcasting platform. Contrast this with Netflix, which has an entire department devoted to analytics, has offered prizes for users developing the best recommendation engine, and allocates capital based on the viewing habits of its users. In addition, most podcast ads are of exceedingly low quality, and uses televisions old “one size fits all” ad model. Ad agencies take a best guess at demographic data and everyone listens to the same ad. It should be noted that the podcasting world’s greatest hit to date came from public radio. It has never been easier to start a podcast, and never been harder to gain meaningful revenue from it. Spotify is the answer.

http://time.com/5136033/best-podcast-apps-android-ios/

https://www.podcastinsights.com/best-podcast-hosting/

While English-speaking countries have the greatest interest in podcasts, Sweden has the highest interest of any non-English speaking country. Spotify has a very large market share in its home country. This is a crucial insight that is almost entirely ignored by the financial press. If the trend continues for the rest of the world outside the Anglosphere, the opportunities for growth and monetization are massive. The challenges for setting up a podcast in Dutch, German, or Japanese are obvious, given the relatively limited size of your audience and the proportionally smaller ad market. Ads are already low quality in this space as it is, so podcasting in these markets remains a hobby, but not a business. A platform that offers new ways to monetize growth will reward both podcasters and audiences. The total global advertising market is currently $28 billion dollars, according to the F-1. Of that, podcast revenues consisted of $220 million. However, year-over-year growth was an astounding 85%.

https://archives.cjr.org/behind_the_news/is_this_the_golden_age_of_podc_1.php

https://www.thenational.ae/arts-culture/are-we-entering-the-golden-age-of-podcasts-1.59828

In the introductory portion of the F-1, it was noted that Spotify is and will remain an audio-first platform. Podcasts are already included with Spotify. Using a combination of its large user base, analytical expertise within the audio space, and freemium business model, Spotify has the ability to pivot from primarily a music listening service, to a fully integrated, end-to-end podcasting platform. This platform can give podcasters data on its users currently not possible with other platforms. Meaningful data can be used to drive growth and listener engagement. In addition, Spotify has the ability to serve ads targeted to each individual user. Something I envision is a “premium plus” model, where, for an extra $5 a month, premium users have the ability to listen to podcasts ad-free. If they choose not to, they will be served targeted ads within podcasts. What makes this different from its music service is that the supply is essentially free. Podcasts will not be subject to the same licensing restrictions as music. The end result will be greater profits for podcasters, higher margins for Spotify, a better listening experience for consumers, and most importantly, an excellent return for shareholders.

Spotify for iOS and Spotify for Artists preview in iOS App Store

In Ben Thompson’s excellent blog, Stratechery, he described something he called Aggregation Theory. In a nutshell, it describes a typical market with a small number of suppliers, a few distributors, and a large number of potential customers. Taking transaction costs into consideration, it makes much more sense to integrate backwards, linking suppliers and distributors. We see this in the newspaper industry (content and delivery), taxi companies (cars and dispatch), and book publishing (authors with publishers). However, the Internet changed all of this. Transaction and distribution costs are now zero, making forward integration the only option. Customers are now the target of integration, not suppliers. Facebook has a walled garden for social media content. Both individuals and news services upload content for free. Similarly, Uber and Lyft have done an excellent job getting users to use its platform, and demand from it mean that drivers will sign up on their own without any additional incentive.

Once this pivot takes place, a virtuous cycle will inevitable emerge. Podcasters will release exclusive or early content on the platform to bring in more users, with ad revenue trailing close behind. Greater analytics will increase the value of these ads. This will further encourage suppliers to join the platform, et cetera. The Flywheel Effect will be in full force.

As with any discounted cash flow model, a few assumptions are necessary to forecast the future. User growth rate continues at a rapid pace as Spotify pursues global expansion, but eventually slows down. Ad-supported ARPU remains small compared with its Premium counterpart, and Premium ARPU decreases as Spotify gains share in developing markets. As Spotify increases in popularity, it will obtain greater negotiating leverage when dealing with music license holders. In addition, artists (like podcasters) will be able to sign directly with Spotify as it becomes a global audio platform. This is reflected in the growing gross margins for the music business. The space will remain competitive, and Spotify will continue to spend a large sum on marketing and R&D. However, economies of scale should become a factor in later years, and this is reflected in the smaller proportion of revenue that will be spent on these expenses. Spotify competes in a highly contested space, but should reach an inflection point with its earnings sometime early in the next decade. Patience is required of the investor, as the stock will be volatile for some time, but the story is promising.

Spotify began as a music service, and still primarily exists at that function. But, as we have seen in the past, innovative, agile companies that have been able to shift business models have been very rewarding to its shareholders. Facebook’s transition from PC to mobile and Netflix’s transition from DVD-by-mail to streaming come to mind. In both instances, shareholder value exploded as each firm was able to tap into new markets and opportunities. The future remains bright for both music and podcasting. As we have seen time and time again, once you give the general public a platform to express themselves and monetize their talents, there is a burst in creativity. We have seen this with Twitter’s hashtags, YouTube and Instagram stars, Facebook’s viral videos, and we will see it again with Spotify.

It should be noted that Spotify’s offering is a DPO (Direct Public Offering) and not an IPO. Its price will not receive initial support from investment banks, and will likely be volatile for some time after it begins trading in the markets. The investor should have the appropriate appetite for risk, be patient, and buy the stock at a discount to its current intrinsic value ($22 billion, close to the initial price). There’s no need to chase a hot stock in a high-valuation environment, wait for the price to come to you. I know I will.

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