8 to 80 Spotlight: Spotify (2/18/21)

By Charlie Bilello

18 Feb 2021

A new series covering companies in the Compound 8 to 80 Portfolio

1) Why is Spotify an 8 to 80 Brand?

With 345 million monthly active users and 155 million subscribers, Spotify is available in 93 countries and used by people of all ages.

At 35% market share, Spotify is currently the world’s biggest music streaming platform.

Source: Counterpoint

2) What are its growth and financial trends?

Spotify last reported earnings on February 3, 2021.

Monthly active users (MAUs) grew 27% year-over-year to 345 million, exceeding expectations. In 2020, Spotify added a record 74 million users (vs. 64 million in 2019).

Here is the breakdown in MAUs by Region…

Source: Spotify

Premium subscribers increased 25% over the past year to 144 million, beating expectations. In 2020, Spotify had a record increase of 30 million subscribers (vs. 28 million in 2019).

Here is the breakdown in subscribers by region…

Revenues were up 25.8% over the prior year to $2.6 billion, a new high. Of this, a little over 87% came from subscriptions while the remainder came from ads. Ad revenue hit a new high in Q4, growing 29% over the prior year and quickly rebounding from the YoY decline in Q2.

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Spotify reported positive free cash flow of $79 million but a net loss of $149 million during the quarter.

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Spotify is forecasting continued growth in 2021…

In terms of content, Spotify continues to expand its non-music offering, with 2.2 million podcasts on the platform (up from 1.9 million in Q3). Notably, 25% of their MAUs engaged with podcast in Q4 with consumption hours nearly doubling over the prior year. In December, “The Joe Rogan Experience” podcast became exclusive to Spotify, driving a large increase in listeners.

Spotify made another acquisition in the podcast space in December, acquiring Megaphone for $235 million. The acquisition will allow Spotify to make dynamic streaming ad insertion available to third-party podcast publishers for the first time.

3) The Climb

Spotify has single handedly changed and perhaps even saved the music industry, but its success did not come overnight. There were many difficult years along the way.

Founded in 2006 by Daniel Ek and Martin Lorentzon, they set out to solve the growing piracy problem (interesting connection with Napster) by creating a better product.

From Ek in 2010:

“I realised that you can never legislate away from piracy … The only way to solve the problem was to create a service that was better than piracy and at the same time compensates the music industry.”

It took two and a half years for Ek to finally strike a deal with the record labels to begin operating in Europe, and then another two years after that to gain rights to stream in the US (good interview here).

These were not easy times, as Ek later revealed that he was “about to have a breakdown” before the streaming launch in 2008.

But Ek persevered, and Spotify went public in April 2018 via a direct listing.

The stock ($SPOT) initially traded higher, only to reverse course with a 45% drawdown. It came back, though, and broke above its 2018 highs in June of last year.

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4) What are major risks to future growth?

Spotify has a number of large competitors in the streaming space, including Apple, Amazon, and Google.

Spotify is no longer a small player (market cap of $50 billion), but its trillion-dollar competitors are in a different league with some enormous advantages, including massive platforms from which to promote from (phones, tablets, operating systems, Alexa/Google Home, etc.). They also have the luxury of subsidizing any losses from streaming with other highly profitable business lines.

To continue to grow, Spotify will have to continue to improve its offering with new technology features and exclusive content.

They will also need to continue to diversify beyond music (they are on that path with 25% of MAUs engaged with podcasts last quarter). An early mover in the podcast space (see purchases of Gimlet Media, Anchor, Parcast, and The Ringer), Spotify made headlines again last May with a $100 million licensing deal with Joe Rogan. More deals like this are likely to come as streaming services look to differentiate their offerings.

Spotify will also have to prove that they can turn consistent revenue growth into consistent profitability, though investors appear to be giving them a pass for the time being (similar to Amazon in its early years).

From a stock perspective, valuation is the primary concern, as is the case with many tech companies today. Trading at 7.4x sales, expectations are high, making Spotify vulnerable to multiple compression should it fail to meet or beat investor forecasts.

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5) Howard’s Take

“Spotify was a new addition in 2020 to my 8-80 portfolio. Spotify is a founder led company that has never had it easy. It has battled the music industry (a business with terrible margins) and internet juggernauts around the world to build a top global brand.

I believe the podcast and AirPods have helped make Spotify a buy the dip company for the very long term, but the risk of owning the stock has risen as the price has more than doubled over the past year.  They need to figure out how to get the Average Revenue Per User Up.  Unlike Netflix, they can’t keep raising prices as Apple Music is good enough.  I am keeping a close eye on this right now.” – Howard Lindzon

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About the author

Charlie Bilello

Charlie is the founder and CEO of Compound Capital Advisors.

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