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Spotify Plays the Right Tune in a Changing Music Industry

07/03/2019 5:00 am EST

Focus: TECHNOLOGY

Jon Markman

Editor, Tech Trend Trader, The Power Elite, and Strategic Advantage

As a technology business, Spotify (SPOT) is doing a lot of things right. It’s building scale, new business models based in data analytics and a valuable brand, observes Jon Markman, growth stock expert and Strategic Advantage.

Yet the Swedish media streamer is more often noted for its shortcomings. Although it founded in 2006, the business is still unprofitable. And larger technology companies are entering the marketplace. These factors have kept me on the sideline until now.

The music business is changing rapidly. Spotify played a big part in the transformation. Artists can’t make what they used to selling recordings so most have jumped to a live performance model.

They go on the road, selling concert tickets and merchandise. They license their music to brands, advertisers and digital marketers. Top acts are making more than ever.

Taylor Swift, the country crossover sensation, earned $266 million domestically in 2018, playing gigs and hawking t-shirts, according to a recent story in Billboard. And that was from tour dates that ran from May 8 through October 6.

The changing business of music makes legacy catalogs less valuable. It’s a really big deal, because those pricey catalogs have been an Achilles heel for Spotify.

The Spotify music streaming platform officially launched October 2007 with 40 million tracks available to stream. Unlike iTunes, Spotify users got unlimited access to every track.

The concept took the industry by storm. Subscriptions surged from 1 million in 2011, to 24 million in 2013, and 100 million in 2016. But it came at huge cost. The record labels demanded 70% of all revenues.

The company was able to generate gross profits of $1.6 billion in fiscal 2018, based on $6.2 billion in sales. Net operating cash flow grew 101%, to $405.8 million. At the end of 2018, Spotify had 242 million users. It has become the way people consume and share music. It’s the way musicians interact with their fans.

Spotify does have competitors with deep pockets. Amazon (AMZN), Google (GOOGL) and Apple (AAPL) all have music streaming platforms, however these are add-on services to larger businesses. And they are not focused primarily on curation, cultural relevance or artists and their fanbases.

Spotify is doing a spectacular job of integrating music with video, biography and the explanation of lyrics, an effort that feels genuine and valuable in a way its larger, less focused rivals can't match.

Almost all of the artists who left Spotify for exclusive deals with competitors have returned. From Neil Young to Taylor Swift, the benefits of being on the most popular platform, with the most downloaded playlists, can’t be denied.

The Recording Industry Association of America reported in February that revenues in 2018 bounded 12% to $9.8 billion. Streaming now comprises 75% of that total.

Spotify shares have risen 25% in 2019, and trade at 4x sales for a market capitalization of $25.9 billion. By comparison, Netflix, the leading video streamer, trades at 9.4x sales for a market cap of $156 billion.

Spotify shares are trading around $145. If their plan for industry domination works out, shares should head toward the high $200s over the next few years.

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