As a technology business, Spotify is doing a lot of things right. It is building scale, new business models based in data analytics, and a valuable brand.
Yet, the Swedish media streamer is more often noted for its shortcomings. Although it was founded in 2006, the business is still unprofitable. And larger tech companies are entering its marketplace.
These factors have kept me from recommending shares, until now.
The music business is changing rapidly. Spotify played a big part in this transformation. Artists can't make what they used to selling their 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.
And 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 Oct. 6.
The changing business of music makes legacy catalogs less valuable.
This is a really big deal, because those pricey catalogues have been an Achilles' heel for Spotify.
The Spotify music streaming platform officially launched in October 2007, with 40 million tracks available to stream. Unlike iTunes, Apple's popular digital music store, 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, to 100 million in 2016.
But it came at huge cost. The record labels demanded 70% of all revenues.
In late 2016 and 2017, Spotify negotiated new label agreements with its four largest music partners. These new rates improved gross margins by seven percentage points, according to a research note from D.A. Davidson.
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.
Mathew Griffith, an analyst at Davidson, argues that record labels are becoming disintermediated. Their competitive position in the industry value chain is shrinking. He suspects Spotify will move aggressively to vertically integrate into concerts and merchandise, promotion and data analytics.
For example, 30% of music streamed on Spotify is curated by its editorial team or algorithms. RapCaviar, its urban music playlist, has 11 million followers. Landing on this playlist can launch an artist's career.
Spotify does have competitors with deep pockets. Amazon.com, Google and Apple 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.
Meanwhile, 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 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 36% in 2019, and trade at 4,4x sales for a market capitalization of $27.5 billion. By comparison, Netflix, the leading video streamer, trades at 8x sales for a market cap of $142 billion.
Shares recently traded at $145 following financial results July 31.
This stock could trade to $265 in two years, a gain of about 82% from current levels.
