There are still a lot of reasons to be bearish toward Spotify (NYSE: SPOT). For one, it's a technology company that isn't really in control of its costs. Music royalties are a notoriously complex beast and -- more worryingly -- not fixed, which means that Spotify has to pay artists more money as more people listen, an obvious problem for a company in growth mode.
Its gross margins are also much tighter than those of other tech companies. In its most recent quarter, Spotify reported a gross margin of 26%. Though this was better than what the company had forecast for the quarter (23.5% to 25.5%), it still pales in comparison to the big tech companies like Facebook (NASDAQ: FB) and Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL).
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And speaking of big tech companies, let's not forget the ever-growing threat of Apple (NASDAQ: AAPL). Its music service might have arrived much later to the game, but Apple Music has already surpassed Spotify in terms of paid users in the U.S. -- 28 million paid subscribers versus Spotify's 26 million. Of course, Spotify is still ahead in terms of overall users in the U.S., not to mention its global paid subscriber base of over 100 million users.
But despite all of these concerns, Spotify has been making moves recently that suggests it is becoming a better investment opportunity. Here are three reasons why we're starting to become more interested in Spotify as a long-term investment:
1. Bringing new value to the music industry
Despite early concerns about the impact of streaming services like Spotify on the music industry, it's safe to say that this format of consumption is here to stay. Last year, global recorded music revenues jumped 9.7% to reach $19.1 billion, with 47% of that total coming from streaming sites.
Now, we can start to see how Spotify is actually bringing huge value in its own right to the industry.
As a service, Spotify is renowned for its curated playlists, which are hugely popular among listeners and frequently cited as one of the defining aspects of the service. Recent studies have indicated that a third of the total time users spend listening to music on the platform is in a Spotify-curated playlist. The service's most popular playlist, "Today's Top Hits," has close to 24 million followers and is reported to increase streams of included artists by close to 20 million.
Increased streams equals more money for the artists, and a study by the EU's Joint Research Centre last year estimated that a song's placement on Spotify's "New Music Friday" playlist could generate $117,000 in revenue for an artist. This is why some record labels now have people whose entire job is to pitching new bands and artists to Spotify's playlist editors, which highlights just how ingrained the company has become into the wider operations of the music industry.
When we start to see that the wider industry is changing and adapting to the features of one single company, it's almost an economic moat of sorts.
2. Leveraging its platform beyond streaming
Apart from simply streaming music, Spotify is leveraging its ever-growing platform in innovative ways to attract and engage customers.
For example, under its "Fans First" initiative, which launched last year, the company "collaborate(s) directly with artists to create unique opportunities for fans." This includes things like presale ticket codes for gigs of certain artists whom users follow on the platform, exclusive merchandise, or an invite-only event not open to the public. This drives users to the platform for reasons other than music and creates better engagement with customers.
In its most recent earnings report, Spotify management also alluded to new "marketplace services" that the company is currently building and testing with some label partners. Though details remain sketchy, the company says that it expects products to be launched next year.
For Spotify, expanding services like this means that both customers and collaborators will be drawn to the company's platform for reasons other than its basic utility (i.e., playing music). More importantly, if these new features are valuable, people will be more likely to stick around.
3. The big podcast bet
Though Spotify and Netflix (NASDAQ: NFLX) are often compared, one of the biggest differences between the two companies is that the latter creates and manages its own original content. This is something Spotify is never likely to be able to do with music, but there's a reason why CEO Daniel Ek said "audio -- not just music -- would be the future of Spotify."
Over the past few months, Spotify has been making a big push into the world of podcasts with a view of becoming the foremost publisher in the world. The company has bought big publishers like Gimlet Media in recent months, as well as announced a multiyear partnership with former U.S. President Barack Obama and Michelle Obama's production company, Higher Ground, to produce exclusive content for the Spotify platform. According to the company, the Obamas will "develop, produce, and lend their voices to select podcasts, connecting them to listeners around the world on wide-ranging topics."
This drive into the world of podcasting is even more interesting because there's no central authority controlling the value chain in podcasts, particularly in terms of podcast advertising. This could be a big opportunity for Spotify to become the "Google of podcast advertising," deriving subscription revenue from customers in search of exclusive podcasts, and advertising revenue from those on the free tier.
The growth is already clear to see, with Spotify reporting recently that podcast audiences grew more than 50% sequentially in the second quarter, nearly doubling since the start of the year.
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MyWallSt operates a full disclosure policy. MyWallSt staff currently hold long positions in Alphabet, Apple, Facebook, Netflix and Spotify. Read our full disclosure policy here.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Apple, Facebook, Netflix, and Spotify Technology. The Motley Fool has the following options: short January 2020 $155 calls on Apple, long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, and long January 2020 $150 calls on Apple. The Motley Fool has a disclosure policy.
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