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How Long can Spotify Stay out in Front?

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First introduced in 2008, Spotify (SPOT - Free Report) has become the world’s largest streaming music service, boasting 140 Million users, 70 Million of which are paying subscribers.  Pioneers in the streaming music business, Spotify allows users to hear a vast catalog of music over the internet, either by listening to advertisements along with the music, or in a paid ad-free format that costs $9.99/month. A $14.99 “Family” version allows users to listen to music on more than 1 device at a time.


Spotify’s early advantage was the size of its catalog offerings, procured after negotiations with virtually all major record labels and that allowed Spotify to stream music directly to users and pay the labels a pro-rata share of all the revenue from music. Currently, Spotify pays out 70% of what it collects on subscription fees and ads.  
The arrangement is not without is detractors, with many artists feeling that they are no longer adequately compensated for their work as they receive a fraction of what they used to earn on the physical sale of records and CDs.  Recording labels, reluctant at first because of the reduction in revenue, have embraced the idea of late as more and more subscribers have begun to adopt streaming, resulting in significant payments to the owners of the content.

Newly Public


Sustained throughout its existence by private investors (with the most recent round valuing the company at approximately $23B), Spotify went public on the New York Stock Exchange earlier this month in a non-conventional “Direct Listing.” Done without the assistance of traditional underwriters, the company saved significantly on fees and allowed insiders and early investors to sell their own shares to the public immediately.


Spotify did not raise any funds from the listing, believing that they have enough cash to sustain operations for the foreseeable future. The stock has traded in a fairly tight range since the offering with the current market price essentially unchanged from the day trading began. Its market capitalization now stands at $25.7 billion. The S&P 500 is up 2.6% over the same period. 

Spotify carries a Zacks Rank of #3 (Hold), but the small number of estimates at this early stage makes those ratings subject to change quickly.


Due to sparse analyst coverage and a lack of even the first round of official financial results as a public company, it’s nearly impossible to do a detailed analysis on Spotify – as is normally our practice at Zacks.  The closest we can get is to examine the future of the industry and the major competition to try to get a sense of where Spotify might be headed.

Stiff Competition


Currently Apple Music (AAPL - Free Report) is Spotify’s closest competitor. Amazon (AMZN - Free Report) also offers streaming music through its Prime service and Pandora (P - Free Report) , which started as something closer to a radio station, now uses the Spotify streaming model.   Although it’s still the biggest player, Spotify has seen it’s rate of attracting new users level off, while Apple has experienced explosive growth, growing from 27 million to 40 million subscribers over the past year.

This has the potential to be a losing fight for Spotify.  Apple has a massive ecosystem of products and services that are designed to complement each other, encouraging users to purchase both hardware and content, diversifying revenue.  Apple is a behemoth with a market cap of almost $900B and $77 billion in cash on the balance sheet.  It’s easy to envision that they could run the subscription music services for a long time without making any money on it, crushing the margins at Spotify and other smaller competition. (Especially if Apple also sold you the iPhone, the iPad, the headphones, etc…) 

Apple stock is up 6% since the Spotify IPO.


Spotify is expected to announce changes to its interface on April 24th, and it’s advertising to hardware engineers, fueling speculation that they will be producing their own devices at some point in the future.  Considering the breath of Apple’s product offerings however, it may be too little, too late.


Spotify is a hugely innovative company that took a great idea and turned the entire music industry on its head.  It remains to be seen if the industry is already too competitive to support growth like we’ve already seen at Spotify.
At this point, it seems like the easy money in Spotify already got made by the early investors.
 




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