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Spotify (SPOT) Stock | NYSE:SPOT

Covered by Stratosphere

Putting Growth on Repeat

Spotify, headquartered in Stockholm, Sweden, is one of the world's largest music streaming service providers, with hundreds of millions of total listeners. The firm monetizes its users through both a paid subscription model, referred to as its premium service, and an ad-based model, referred to as its ad-supported service.

Spotify aims to unlock the potential of human creativity - by giving those the opportunity to make a living off their craft and for others to enjoy it. Providing access to over 75 million songs and over 2.6 million podcast titles, Spotify is the go-to for audio streaming services.

Stratosphere Score

9

Growth

10

Valuation

9

Quality

9

Margins

2

Dividend

0

Balance Sheet

8
Braden Dennis

Author

Braden Dennis

Founder

Investment Thesis

  1. Spotify owns the largest market share in the audio streaming business. Providing a product that people love, providing useful insights and listening recommendations, the founder-led business has market leading engagement rate and continues to post impressive growth of paid and ad-supported users.

  2. To create a paid user acquisition channel, Spotify can be used completely for free with advertisements. To go ad-free, or "Premium", users pay an ongoing subscription. This model creates a powerful user acquisition model and high conversion rates to users eventually becoming paid subscribers.

  3. Spotify is building a powerful network effect in audio streaming allowing for collaborative listening and live audio.

  4. The business is well positioned to capture the enormous and growing total addressable markets of music streaming, podcasting, live audio and concert distribution.

  5. Spotify as a platform is very sticky for users as their listening experience improves with listening data, recommendations and playlist creation. Eventually, a business like Spotify with low churn and high growth will produce exceptional operating leverage and profitability.

  6. Spotify is executing an exclusive content creation model with creators that will drive more users to the platform and widen the gap between them and competition.

Key Company Metrics

A set of metrics we constantly keep updated to monitor the investment thesis.

Competitive Advantages

Two-Sided Marketplace

Spotify's main competitive advantage over traditional audio platforms (i.e., radio, CDs, etc.) is the ability to connect millions of listeners with millions of creators and artists.

Listeners have easy, quick, and convenient access to all their favourite songs and podcasts without having to pay $1.29 / track or go through the bulky effort of finding a high-quality free version online.

That's the "buyer" side, but "sellers" also have many reasons to place their content onto Spotify for consumption by their fans. Artists and labels are enjoying a revival in recorded music revenues following a structural decline from the late '90s until 2014 / 2015. Without streaming services, particularly Spotify, we struggle to find a reason why recorded music revenues would not continue their decline over time. For this reason, we think labels and artists are optimistic overall on what Spotify has done and will do to the audio industry.

As Spotify grows in prominence and continues to take share away from traditional listening media, we think labels and artists will be more inclined to sign deals that increasingly favour Spotify. As it stands today, labels still have a fair bit of leverage over Spotify as the gatekeepers to recorded music.

Should Spotify's MAU base surpass 1 billion and beyond, we think there is a high chance the (negotiation) tables turn in favour of Spotify. If streaming services become the main medium for listeners to access music and podcasts, how much power would labels really have despite being the gatekeepers to recorded music? Quite little, in our humble opinion.

Millions of Songs, Tons of Data

A remarkable side effect any technology company with millions of users experiences is the amount of user data that can be tracked, fed into algorithms, and ultimately spewed back to the consumer as a higher value product.

For a two-sided marketplace like Spotify, trackable user data benefits both buyers (i.e., listeners) and sellers (i.e., labels and artists).

Spotify helps labels and artists reach their target audience more effectively than traditional media by identifying who listens to what music and when they tend to listen to it most.

Listeners also benefit immensely from Spotify's algorithms. Spotify literally listens to what users listen to through algorithms. These algorithms chew up the data and then spit out high-quality, personalized playlists for the user to enjoy.

Spotify is the dual-threat platform that listeners and labels both never had. Listeners hear more of what they like in a significantly more convenient and cheap platform. Labels and artists reach listeners from around the world in seconds. Even small independent artists making music in a niche subgenre can reach their specific audience in no time.

From the two-sided marketplace comes a wide variety of benefits for all parties involved. Spotify is winning and we expect it to continue to do so.

A Personalized Experience Creates High Switching Costs

Spotify is a sticky subscription. The data advantage that Spotify has is with their users listening habits and music recommendations makes switching platforms a poor proposition. These high switching costs should allow Spotify to flex pricing power over time.

Owning Multiple Sides of The Podcasting Ecosystem

Spotify is on a mission to own the podcasting ecosystem through acquisitions of podcasting publishing platforms, advertising technology and exclusive rights to the biggest names in the business.

By owning podcast publishing platforms they own distribution. By owning advertising technology they own monetization. By signing exclusive content deals, they own attention. It is a very smart playbook on what will continue to be an important audio medium.

Network Effects

Spotify has built a collaborative experience for users to be able to share and collaborate on their playlists with friends and even listen together simultaneously in groups.

Spotify from a data platform intelligence platform and from a social aspect is better as they scale the user base.

Opportunities Ahead

  • A long runway for growth in podcasting. Podcasts are exploding and yet still in nascent stages of adoption. There is big money to be made in podcast advertising and Spotify is gearing up to own all sides of the ecosystem with product development and acquisitions.

  • Continued growth in users. Spotify can continue to achieve respectable user growth globally in both free and paid users on the platform.

  • Distribution advantage gives them optionality in live events, live audio streaming, audiobooks and exclusive audio. There is quite a long roadmap of optionality for this business. They just have to prioritize and execute on the gigantic total addressable market ahead of them.

Risks

Fierce Competition

Spotify may be in first place, but many of its large competitors have one advantage that Spotify may struggle to compete with over time.

Apple Music or Amazon Music hold about 30% of the market and they have no intention of achieving a near-term profit target with the services. These music services are merely value-added services for other services they provide.

Spotify is adversely impacted by the existence of these services for two main reasons:

  1. These services provide a viable alternative to Spotify that caps Spotify's pricing power now and in the future.

  2. If audio platform providers like Apple and Amazon are not as concerned with obtaining music rights and the costs associated with them, labels can maintain their leverage at the negotiating table with Spotify.

Apple, Google, Tencent, and Amazon are all highly profitable companies with or without their streaming services. Their mere existence could severely limit Spotify's negotiating leverage, margins, and pricing power capabilities. Spotify's growth profile could also be severely impaired if any of these services decide to cut prices to drive adoption of these companies' platform ecosystems.

Suppressed Pricing Power

Spotify is a highly sticky service that customers undeniably love (ourselves included). However, the structure of Spotify's royalty-based deals with labels implies that price increases may not fall directly to the bottom line. In fact, price increases may see commensurate increases in music rights costs, eliminating any benefit from the top line.

Shareholders may feel uneasy with the nature of these unit economics. While Spotify likely has lots of room to expand its top line, it might take substantial price increases to show up meaningfully in the bottom line. If this is at the expense of what a listener believes is a reasonable price for the service, Spotify may be limited in its true pricing power.

A mitigating factor for this is Spotify pioneering the monetization of podcasting, which completely circumvents having to sit face-to-face with a label and negotiate contracts with them. If Spotify can pull this off well, it may set itself up for massive success.

Exclusive Content

We have seen how the public reacts to controversial exclusive content on the platform with Joe Rogan. There is a potential for large scale churn if there is more negative sentiment on the platform.

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