04 Nov 2021

Under the Spotlight Wall St: Spotify (SPOT)

The days of Limewire, YouTube converters and unintended viruses are over largely thanks to some Swedish innovation. Daniel Ek’s Spotify beat out Silicon Valley in the race to make music available to all for free…for better or worse. With 365 million users, we put Spotify under the spotlight.

Just a tap away

For decades the music industry has struggled against copyright infringement: first against fake CDs, then against music download sites and apps like Napster and other P2P transfer services, where file transfers are made directly between users. For artists and producers, the battle was considered lost, but leave it to the 21st century to disrupt and innovate. Within a few clicks, users have access to over 70 million songs for no cost in a freemium business model.

Spotify users can pay monthly subscriptions or choose to use a free plan which includes ads between songs. Today with more than 165 million subscribers and 365 million active users in 178 countries, something is working. With so many competitors in the space (Apple Music, Tidal, Youtube Premium), Spotify is offering more than just cheap access.

Pocket robot

One of Spotify’s greatest differentiators is its personalisation features. Spotify uses an algorithm to recommend new music to listeners based on most played artists and genres.

In-app music curation is not restricted to robots, though. Spotify also allows its users to create and share playlists made for different moods, which not only helps those who have no vocation for DJing, but also helps the app to go viral, as its users create and share playlists for friends and family members in the most diverse social networks.

In its marketing efforts, the company also closes partners with other large companies in the quest to further expand its user base. Only in 2021, Spotify closed deals with Samsung, Microsoft, PayPal, Epic Games (producer of the game Fortnite), TikTok and Vivo. The partnerships work in different countries, but in general, the model is very similar: offering a completely free premium account for three months, hoping that eventually users will retain their loyalty and continue subscribing to the service.

Shelling pods

If Spotify intends to continue growing in number of users, it is clear that it could not stay out of the fastest-growing content format on the internet: podcasts. There are already more than 2.9 million podcasts available in the app.

To kickstart their podcasting conquest, Spotify acquired the Joe Rogan Experience in a US$100m plus deal.

With over 1,700 episodes, each with millions of streams, it was the biggest podcast on the planet. The use of the adjective “biggest” refers not only to the podcast’s popularity, but also to the length of its episodes, which can reach more than five hours.

Hosted by UFC commentator Joe Rogan, the podcast breaks all tacitly established rules for content creation: episodes are long, without a set script, and in which there are no themes or guests too controversial. The show has been the most popular podcast on the platform since being acquired.

Since the 9-figure Rogan deal, Spotify has gone on to sign Kim Kardashian, Michelle Obama and Harry and Meghan to deals.

All that jazz

It’s no use making great partnerships and bringing in big names in show business if that doesn’t translate into profitability. Fortunately, Spotify has proven to be a strong cash generator: just in the second quarter of 2021 the company earned more than US$2.6b.

Revenue has been growing about 23.35% over the past three years, with a gross profit margin of 26.39%. Operational and R&D expenses have been falling, which shows that the application is already becoming consolidated in the market and needs less and less improvements. On the other hand, marketing expenses have been increasing (partnerships will not pay for themselves).

However, Spotify’s worst expense is intellectual property: currently, the company spends US$4.1 billion just to pay royalties from artists and content producers that are played on its platform. One wonders how much pop singer Olivia Rodrigo must have earned from the release of her album SOUR, which had more than 63 million listeners on her first day on the app alone.

Despite the freemium model, Spotify is still highly dependent on the subscription model. Of the US$2.6b in revenue for the second quarter of 2021, only 225 million came from ads played for those with a free account. The company is also struggling to gain traction in Asia and Oceania, which represent less than 20% of its market, which is still highly concentrated in Europe. The old continent accounts for 34% of sales, while North America accounts for 24% and Latin America accounts for 22%.

The Spotify share price is down 5% so far in 2021 while the S&P500 has gained 25% (as of early November 2021). Whether the company’s balance sheet will go out of tune or whether it will continue to sound like a symphony, only time will tell.

This does not constitute financial advice nor a recommendation to invest in the securities listed. The information presented is intended to be of a factual nature only. Past performance is not a reliable indicator of future performance. As always, do your own research and consider seeking financial, legal and taxation advice before investing.