Spotify: The Global Leader in Streaming Music
December 11, 2017

Spotify: The Global Leader in Streaming Music

Executive Summary

Spotify was founded in 2006 by Daniel Ek and Martin Lorentzon in Stockholm, Sweden. The Spotify brand revolves around the phrase “the right music for every moment,” and its service meant to be easy, personal, and fun. Through Spotify, listeners can discover new music, personalize playlists, connect with friends, follow favorite artists, and more. The company offers custom radio stations and on-demand tracks as well as ad-free and offline listening for premium subscribers. It also features original tracks, dance series, and radio shows. Spotify can be accessed on various devices through the Spotify Connect network.

In terms of numbers, Spotify”s leadership position in the music-streaming industry is noteworthy:

  • Estimated more than 150 million monthly active users (MAUs)
  • Estimated more than 60 million paid subscribers
  • More than 40 million tracks in its music library, with more than 20,000 tracks added daily
  • 2 billion playlists, with more than 4 million playlists created daily

Spotify has key licensing partnerships with each of the “Big Three” record labels: Sony, Universal, and Warner Music. In 2015, Spotify branched out into video content, adding clips, news, and full episodes from partners like ESPN, MTV, Comedy Central, Adult Swim, VICE Media, the BBC, and Condé Nast.

Consumers can either opt for a $9.99 subscription service (available after a three-month $0.99 trial) or use the ad-supported free version. The free tier features both a mobile and a desktop version. On the desktop version, users can play any song from Spotify’s catalog but must view and listen to advertisements. On the mobile app, users can only play music in shuffle mode. The company uses the free, ad-supported service as a way to onboard paid subscribers.

Spotify faces a growing market opportunity and is arguably the single biggest driver of the recent growth in global music sales. The key issue for investors to monitor over the next 12–18 months is the effect of relationships and direct deals with music labels on Spotify’s gross margins.

Highlights From Our Proprietary Mobile Music-Streaming Survey

In August 2017, we conducted an online survey of U.S.-based internet consumers that was designed to test unaided/aided awareness, usage frequency, and consumer likes/dislikes about mobile music streaming. Our survey included questions related to monthly subscriptions and opinions about royalty payments to music labels and artists. We received roughly 5,500 complete responses and have included more than 25 charts and graphs highlighting our survey takeaways in this report. Our top takeaways include:

  • Music-streaming apps account for the majority of music listener hours. Survey respondents selected YouTube, Spotify, and Pandora – rather than CDs or AM/FM radio – as their most common sources of music. Additionally, respondents indicated that they rely on streaming apps for more than 50 percent of their music listening needs.
  • About one in three music listeners are likely to purchase a monthly music-streaming subscription. About 24 percent of survey respondents indicated that they already maintain a paid subscription, and another 10 percent said they were very likely to purchase a subscription over the next 12 months.
  • The majority of music listeners are aware of the debate among artists and streaming services over royalties. About 26 percent of listeners believe that streaming services fairly pay artists, whereas another 33 percent believe that streaming services reduce the value of music.
  • Spotify users listen to about eight hours of music per week. About 40 percent of Spotify users currently pay a monthly subscription fee through a personal, school, or family membership. These paid subscribers pay, on average, about $7.80 per month.
  • Spotify users and subscribers have a high satisfaction rate and positive outlook. The overall satisfaction rates among Spotify users are comparable to or higher than that of consumer brands such as Uber, Pinterest, and Airbnb. Furthermore, 93 percent of Spotify users think that their usage will stay the same or increase over the next 12 months.

Investment Positives and Upside Catalysts To Track

  • The global music industry is large and growing, largely due to digital music. According to the International Federation of the Phonographic Industry (IFPI), after a decade-long decline in global music sales, global music sales have increased on a year-on-year (YoY) basis in the past five years. In 2016, this growth accelerated to 6 percent, largely due to a tipping point in digital music sales, resulting in over $13 billion in annual sales. Revenue generated from digital music (including digital downloads, paid subscriptions, and ad-supported radio services) now exceeds physical music sales.
  • Paid music streaming is the fastest-growing segment in the global music landscape. Within digital music sales, there has been a clear shift towards paid subscriptions, which are growing at a rate of 45 percent YoY and now account for one-third of global digital music sales. Digital downloads have declined over the past several years, whereas ad-supported music streaming has increased at a CAGR of 25 percent since 2010. Our survey indicates that about 35 percent of music listeners are interested in paying for a monthly subscription, a trend that provides a sustainable growth runway for the Spotify business model.
  • Music aggregation and curation is arguably more valuable than video aggregation and curation. While Netflix and YouTube both create and produce content, Spotify does neither – and we don’t think Spotify needs to create content as long as it aggregates and curates content at scale. The role of a content aggregator is arguably more valuable in the music industry than it is in the TV or movie industry. Professional music tends to have a longer shelf life, whereas usergenerated music tends to have a lower value.
  • Spotify is a global leader in mobile music streaming. With an estimated 60 million global paid subscribers and more than 150 million MAUs, Spotify is a global market leader. In comparison, Apple has an estimated 30 million subscribers, and Pandora has only 5 million paying members and 74 million active users. Our survey indicates that Spotify’s brand awareness is comparable to that of leading consumer brands such as Uber and Pinterest and is clearly ahead that of Airbnb.
  • Spotify presents an attractive value proposition to consumers and music labels. Our survey of more than 2,500 Spotify users indicates that, on average, consumers listen to about eight hours of music per week and paid subscribers spend about $7.80 per month on Spotify. Our benchmark analysis of satisfaction rates shows that Spotify users are relatively more satisfied (and thus, less likely to churn) than users of other leading apps, including Uber, Pinterest, and Airbnb. Furthermore, Spotify pays out almost 70 percent of its total revenue to the holders of music rights and will likely pay out more than $3 billion in 2017.
  • Spotify has an impressive track record - An estimated 60 million paid subscribers & positive FCF. Ninety percent of Spotify’s revenues and 108 percent of its gross profit come from high-visibility subscriptions, which has led to positive cash flows despite negative operating margins. Although Spotify loses money on its ad-supported segment, this segment creates a powerful customer acquisition funnel. Spotify’s ratio of paid subscribers to free users has steadily risen from 2012 to 2016 – from 20 percent to 35 percent, respectively.
  • Spotify’s relationships with record labels and artists have gradually improved. We estimate that Spotify paid more than $2 billion to music labels and artists in 2016, and this amount could rise to 40 percent in 2017, a number that is in line with Spotify’s expected revenue growth. Along with this rise, Spotify’s gross margin has increased in 1H:17, largely due to direct deals with music labels, which suggests improved relations and greater negotiating leverage with its suppliers.
  • Spotify remains an attractive and potential acquisition target. Spotify’s success in building a global music distribution platform could make it an attractive acquisition candidate. Tech stalwarts including Apple, Amazon, and Google have aspirations in all forms of digital media. Given the acquisitive history of the digital media market and Spotify’s unique market positioning, we expect some investors to also bring up past acquisitions as a valuation proxy.

Investment Negatives and Downside Risks to Monitor

  • Spotify faces competition from mobile streaming apps and large tech platforms. Competition in digital music streaming is based on scale, pricing, content selection, content curation, and user engagement – and large tech companies such as Apple, Amazon, and Google have the aspirations and assets to fundamentally disrupt Spotify’s business model. We think Spotify’s global reach, brand awareness, and exclusive focus on digital music should mitigate competitive risks over the near term. However, we intend to closely monitor music subscription-related product announcements from mega-caps.
  • Spotify’s profitability potential remains unclear. Spotify has yet to prove the long-term viability of its cost structure and unit economics. While we have been encouraged by the company’s growing revenues and rising gross margins, the company’s operating losses have increased. The financial performance of both Spotify and Pandora reveal the challenges that hinder music-streaming companies from turning a profit, even at significant scale. Furthermore, Spotify’s planned geographic expansion, along with a ramp in usage and spend on Google Cloud, likely weighs on its near-term profitability. However, Spotify’s subscription-based business model will significantly help the company with cash flow management.
  • Spotify faces fixed and potentially rising content acquisition costs: With low gross margins, in the 18–22 percent range, Spotify pays about 70 cents of every dollar in revenues to music labels and artists. However, recent direct deals and partnerships, along with Spotify’s growing scale, may reduce its content costs over the near term. These low margins could have long-term implications for the company’s downstream cost structure, including Marketing and R&D.
  • The music ecosystem poses an economic risk to Spotify. Roughly 65–70 percent of global music is owned by the “Big Three’ record labels: Universal Music, Sony BMG, and Warner Music. The record labels’ consolidated negotiating leverage puts artists and original content creators at a disadvantage. While the record labels reap large profits, the creators often depend on the success of their music for their livelihoods. Streaming services haven’t been able to tilt the leverage balance away from the label owners yet and end up sharing the blame. Our survey shows that only one in four music listeners believes that music-streaming services fairly pay artists.
  • Spotify faces the challenges associated with a direct listing IPO. Media reports indicate that Spotify could go public using a direct listing approach. While this approach comes with a one-time saving in underwriter fees and avoids shareholder dilution, we believe it also risks near-term volatility and a potential investor discount on Spotify’s valuation.
  • Shareholders face incremental dilution from a 2016 convertible note. In April 2016, Spotify raised $1 billion via a convertible note that included specific terms around the timing of an IPO. For instance, if Spotify had gone public before April 2017, notes would have converted at a 20 percent discount. This level of discount (and thus, the extent of dilution) will step up by 250 basis points every six months.

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Recipients who are not market professionals or clients of SharesPost Financial Corporation should seek the advice of their own financial advisors before making any investment decisions. None of the information contained in this report represents an offer to buy or sell, or a solicitation of an offer to buy or sell, any security, and no buy or sell recommendation should be implied, nor shall there be any sale of these securities in any state or governmental jurisdiction in which said offer, solicitation, or sale would be unlawful under the securities laws of any such jurisdiction.

This report does not constitute an offer to provide investment advice or service. Registered representatives of SharesPost Financial Corporation do not (1) advise any member on the merits or prudence of a particular investment or transaction, or (2) assist in the determination of fair value of any security or investment, or (3) provide legal, tax, or transactional advisory services.

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The analyst(s) certifies that the views expressed in this report accurately reflect the personal views of such analyst(s) about the subject matter therein, including all of the subject securities or issuers, and that no part of such analyst compensation was, is, or will be during their employ directly or indirectly related to their specific views contained in this report.

Analyst compensation is indirectly based upon the growth and success of SharesPost, Inc., including the overall performance of its subsidiaries, the individualized performance of any such analyst, and the development and progression of the overall research effort. SharesPost, Inc. earns revenue from, among other avenues, brokerage sales, and therefore the analyst may indirectly benefit from research reports that have the ultimate effect of increasing trading activity, either through SharesPost Financial Corporation and/or with SharesPost Investment Management, LLC.

DISCLAIMER

This report does not contain a complete analysis of every material fact regarding any issuer, industry, transaction, or security. The opinions expressed in this report reflect the judgment of the analyst at a specific point in time and are subject to change. The information contained in this report has been obtained from sources the analysts consider to be reliable; however, there is no guarantee the any of the information is accurate.

Securities referenced in this report may be offered by SharesPost Financial Corporation, member FINRA/SIPC. SharesPost Financial Corporation and SP Investments Management are wholly owned subsidiaries of SharesPost, Inc. Certain affiliates of these entities may act as principals in such transactions.

Investing in private company securities is not suitable for all investors. An investment in private company securities is highly speculative, involving a high degree of risk, and investors should be prepared to withstand a total loss of your investment. Private company securities are also highly illiquid and there is no guarantee that a market will develop for such securities. Each investment also carries its own specific risks and investors should conduct their own, independent due diligence regarding the investment, including obtaining additional information about the company, opinions, financial projections and legal or investment advice.

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Copyright SharesPost, Inc. 2019. All rights reserved.

PLEASE READ THESE IMPORTANT LEGAL NOTICES & DISCLOSURES

CONFLICTS

This report is distributed by SharesPost Financial Corporation, a member of FINRA/SIPC. SharesPost Research LLC, SharesPost Financial Corporation, and SP Investments Management, LLC, an investment adviser registered with the Securities and Exchange Commission, are wholly owned subsidiaries of SharesPost, Inc.

Recipients who are not market professionals or clients of SharesPost Financial Corporation should seek the advice of their own financial advisors before making any investment decisions. None of the information contained in this report represents an offer to buy or sell, or a solicitation of an offer to buy or sell, any security, and no buy or sell recommendation should be implied, nor shall there be any sale of these securities in any state or governmental jurisdiction in which said offer, solicitation, or sale would be unlawful under the securities laws of any such jurisdiction.

This report does not constitute an offer to provide investment advice or service. Registered representatives of SharesPost Financial Corporation do not (1) advise any member on the merits or prudence of a particular investment or transaction, or (2) assist in the determination of fair value of any security or investment, or (3) provide legal, tax, or transactional advisory services.

ANALYST CERTIFICATION

The analyst(s) certifies that the views expressed in this report accurately reflect the personal views of such analyst(s) about the subject matter therein, including all of the subject securities or issuers, and that no part of such analyst compensation was, is, or will be during their employ directly or indirectly related to their specific views contained in this report.

Analyst compensation is indirectly based upon the growth and success of SharesPost, Inc., including the overall performance of its subsidiaries, the individualized performance of any such analyst, and the development and progression of the overall research effort. SharesPost, Inc. earns revenue from, among other avenues, brokerage sales, and therefore the analyst may indirectly benefit from research reports that have the ultimate effect of increasing trading activity, either through SharesPost Financial Corporation and/or with SharesPost Investment Management, LLC.

DISCLAIMER

This report does not contain a complete analysis of every material fact regarding any issuer, industry, transaction, or security. The opinions expressed in this report reflect the judgment of the analyst at a specific point in time and are subject to change. The information contained in this report has been obtained from sources the analysts consider to be reliable; however, there is no guarantee the any of the information is accurate.

Securities referenced in this report may be offered by SharesPost Financial Corporation, member FINRA/SIPC. SharesPost Financial Corporation and SP Investments Management are wholly owned subsidiaries of SharesPost, Inc. Certain affiliates of these entities may act as principals in such transactions.

Investing in private company securities is not suitable for all investors. An investment in private company securities is highly speculative, involving a high degree of risk, and investors should be prepared to withstand a total loss of your investment. Private company securities are also highly illiquid and there is no guarantee that a market will develop for such securities. Each investment also carries its own specific risks and investors should conduct their own, independent due diligence regarding the investment, including obtaining additional information about the company, opinions, financial projections and legal or investment advice.

Accordingly, investing in private company securities is appropriate only for those investors who can tolerate a high degree of risk and do not require a liquid investment.

SharesPost, the SharesPost logo, My SharesPost, the SharesPost Index, and SharesPost Investment Management are all registered trademarks of SharesPost, Inc. All other trademarks are the property of their respective owners.

Copyright SharesPost, Inc. 2019. All rights reserved.