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We think it is time to give Spotify a new long write up here on VIC. The timing might not be perfect, but given the undemanding valuation of only 2x EV/revenue atm, we think the current entry is more than good enough to earn great returns from here over the next several years and beyond.

We find it hard to believe that Spotify won’t be able to get at least 10% net margins over time, which implies a 20x earnings multiple on this year's revenue - enabling returns that will at least match their future revenue CAGR from here, which we find hard to pencil out at a lot less than 15% over the next 5 to 10 years. We also think that the company will start to produce material amounts of FCF well before the end of this decade, which could go towards shrinking the share count.

I assume Spotify is no stranger to people here unless, of course, you have a lot of grey hair already and/or Smartphones aren’t really your thing. After all, it is one of the most popular apps in the world - ending up at #10 globally in terms of downloads in 2021 and at #9 in terms of downloads and active users so far in Q1 2022. Spotify ended the year with over 400m monthly active users that already use the service for almost an hour(!) every day. However, even though it is well known, I think it is not well understood and most investors underestimate the company’s true ambitions and its long-term earnings potential. So I will focus my energy mostly on potentially changing that for some members here, rather than explaining the basics. 

Spotify’s true ambitions

The company wants to fulfil and dominate all possible audio needs well beyond its core music streaming service and it appears perfectly positioned to do just that. If Spotify continues to play to its strength, the company goal of 1b active users (vs. ~410 currently) will probably turn out to be a conservative goal. Two things seem very obvious to us, in that regard. First, eventually almost every smartphone user in the world will have an audio-focused service on their phone. Second, Spotify seems destined to become the preferred choice for most of those people outside of China. 

Spotify is absolutely unique in its approach and seriousness about the audio opportunity. It plans to bundle all possible audio content in one place, with live content soon joining (link) the on-demand music and shorter-form news and story content (podcasts). They also plan to make all that audio content (including some video) a lot more engaging, discoverable and useful. There is a tremendous amount of experimentation going on and we think SPOT will eventually unlock their opportunity to not only penetrate the global smartphone user base a lot further but to also increase user engagement materially. In addition to live content joining the app, we think we will soon get TikTok style discovery and engagement features in the main app for both, on-demand and live content (link). The podcast version already looks pretty neat and the idea will also be applied to live and music content (here is a link to a first interaction of the music version). 

In our minds, this development has serious potential and could give many users new addictive reasons to regularly open and browse Spotify’s content feed on top of their current user behaviours. When it comes to reach and cultural impact, Musicians are the most powerful group of creators in any industry.  Three of the top four most-followed Twitter accounts and 23 of the top 50 Instagram accounts are musicians. When followings are added up across all major platforms, the trend remains the same: a disproportionate number of the most followed individuals across the world are musicians. (Borrowed from a decent article and visual capitalist (link)

Success in this area would also open up completely new in-feed-advertising opportunities and it would change the perception of Spotify in users and investors minds. To round out the audio content offering fully and to cement their cognitive referent status in that regard, it is also likely only a matter of time before long-form audio joins their service in a more serious fashion. 

Focus beyond its own DTC business 

In addition to aggregating and curating all the audio supply for consumers in one place, Spotify is also building a lot of services for audio content creators to improve their businesses everywhere, not just on Spotify, essentially playing the role of an open infrastructure provider in production, distribution and monetisation of all audio content other than recorded music which is part of the labels business, where supply is so concentrated that it is neither very viable nor smart to do so at the moment. However, there might be ways to eventually do more in that area as well.  

Content differentiation eventually on every front

So far we have seen their successful entry into original and exclusive content on the podcast side, which includes acquisitions and exclusive deals with some of the largest and most successful podcast shows in the world. We think that is only the beginning of their strategy. We believe we will soon start to see exclusive live music and music-related/specific content show up more meaningfully moving beyond tests and over time also some exclusive long-form audio content. The addition of live content, which by its nature is generally more exclusive, especially the long tail, also has the potential to materially increase Spotify's O&E content. However, Spotify will also pursue exclusive deals for some high in demand live audio content that otherwise wouldn’t be exclusive to Spotify. Stuff like the recently announced FC Barcelona's partnership (link) that very likely includes being their exclusive partner on the audio streaming front from now on. All of what we have seen and heard so far leads us to believe that Spotify will continue to move away from an initially completely undifferentiated content platform, that had to solely compete on functionality, curation, convenience and price to a position where they can increasingly and successfully compete on content differentiation as well.  

All forms of monetization in the future

Spotify is open to various ways of monetisation, which we think is the best and necessary approach for a company pursuing the whole audio opportunity. While it is true that their primary means of monetisation today are subscriptions, its advertising business is starting to become more meaningful (~15% of revenue in Q4). With management recently becoming a lot more bullish on it, which makes a lot of sense to us. Importantly, the company is also planning to introduce a la carte/direct payments where it makes sense in the future. 

Subscription dollars will remain the dominant revenue stream for Spot, but the other monetisation layers will likely become a lot more material than most people imagine and not just outside of music. Historically music always monetized the hardcore fans at much higher rates than the casual fans. While the first and current version of streaming changed that, we find it hard to believe that we won't reach that historic and very natural situation again. The easiest way to get there is probably that the main subscription stays as the base for the majority of people for the great majority of music content, but there are additional layers of content on top only available for more serious fans that are willing to pay up. 

Just this week we saw Android announcing (link) that it is opening up its payment monopoly to Spotify - for the first time ever and for the only company so far - which will play an important step when it comes to new in-app monetization and in improving payment conversion. It is well documented that Spotify is also pushing hard for the same opportunity with Apple. This decision by Google has probably accelerated the inevitable fade for Apple to eventually follow suit. The company is under increasing regulatory pressure in that regard, especially in Europe (link) where it might be forced to open up maybe even sooner than later due to the implementation of the new Digital Act in Europe (link).   

Having their own payment system at reduced fees (hopefully much-reduced fees, that part was not communicated) can pave the way to a greater user conversion and experience in their subscription business on both the music and podcast side, plus it can provide a great profitability boost on future direct in app monetisation efforts. The Android move could be helpful to conversion in emerging markets, given their dominance there, but it might also not really have a big impact. It will also level the competitive playing field and enable Spotify to act more like a true platform, which the company clearly aspires to become. I think that Spotify got there as the first company speaks volumes about their management calibre.  

The only true software and hardware agnostic company 

Spotify is the only audio company that is truly global and software as well as hardware agnostic. Apple Music and Podcasts are basically non-existent on Android, which naturally constrains their reach, especially in emerging markets. The other way around, Google Music is not a natural pick for iPhone users and nobody will go and use Google's podcast app on iOs. Amazon Music is mostly bundled together with Prime and not available where its retail business is not operating, which makes it absent in many parts of the world with large populations. While the competitors all have a natural advantage on their home turf, we think their respective benefits are overall outweighed by their large disadvantages outside of their own spheres. They usually have limited ambitions beyond their own ecosystems, which we think is their largest drawback of all. On top of that, they face mindshare problems in the audio space and they usually lack some integrations. Spotify on the other hand is everywhere on neutral ground, everywhere equally ambitious, everywhere equally present in people's minds and it boasts by far the most hardware integrations with over 2000 different hardware devices across over 80 hardware brand partners. All of that can come in handy especially for families, duo plans (and password sharing groups) that are not exclusively married to one ecosystem. Even a single user can quickly face an issue considering that one might consume audio on smartphones, smart speakers, smart TVs, high definition sound systems, game consoles and in cars. 

Spotify's leading position provides unique advantages

Spotify's position as the largest audio player with a ~40% market share on a paid sub basis outside of China and even more so on an active user basis provides them with large benefits when it comes to their original and exclusive content strategy. There is simply no alternative if you want to maximise reach as an audio creator while reaping the monetary benefits of going exclusive - and while it might not win over everyone, especially if a competitor offers significantly more money, it is a powerful force on average to win over people. It also enables Spotify to have the lowest per-user acquisition cost, everything else equal. While it is still early days in their original content strategy, we think it will increasingly bear fruit, with the positive effects spilling over to the standard music streaming side of things as well, especially when they start to add some content beyond tests in that area. Given the fact that Spotify also has by far the most enthusiastic and engaged user base (2x more engaged than their nearest competitor), creators will be most likely engaging users on Spotify once more tools to do so become available. 

Spotify is developing its tech stack incredibly fast

Spotify has developed an amazing developer machine that gets a massive amount of stuff done in little time (basically the opposite of Twitter). For anyone doubting it, I recommend taking the time to go and scroll through this list (link) that covers parts of their developments and experiments of just the consumer-facing front over the last year alone. At the same time, they have launched in over 80 new markets and have built on a long list of new features for artists and creators, with important advancements, especially on the advertising technology front. On top of all that, they are constantly pushing and improving on their many software and hardware integrations. Heck, they even brought a self-developed niche hardware product to market, that might not matter overall and be unsuccessful but it is still impressive in the overall context. Here is an important excerpt from Daniel Ek on that topic on the Q3-21 CC: 

“So let's look at podcasting. We started our journey 3 years ago in podcasting with a catalogue of about 185,000 podcasts, and we were really nowhere compared to the largest players in the industry. Today, we have 3.2 million podcasts on the platform, a growth rate of over 1,500%. But despite the fact that we're still a relatively new entrant, previous data indicated we have become the top platform for podcast consumption in 60-plus countries. And now, according to Edison Research and our own internal sources, we recently became the #1 podcast platform U.S. listeners use the most. Given the U.S. represents the largest podcast market globally, I think this is quite significant.

I am confident to say that we're a leader not only in podcasting but in the burgeoning audio space on the Internet. So why did we succeed this fast? Well, obviously, our content investments have helped a great deal, but it's also another proof point of the impact our platform improvements and product innovations are having on our business overall. And the velocity of shipping matters.

From the recent launch of interactivity enhancements like polls and Q&A to the release of enhanced listening features and new original programming around the world, we fought hard to gain new listeners. And our success is not attributable to just one thing but literally hundreds, if not thousands, of improvements that we're working on in parallel for the benefit of creators, users and advertisers alike. And because it's a trend that is progressing so significantly, you should expect us to continue to invest to keep up with the demand.

So why does this velocity matter so much for Spotify? Well, I believe that we will ultimately determine - that will determine our long-term success. If you're slow, you better be right most of the time. But if you're fast, you can test and iterate more, which creates a culture of innovation. And at Spotify, we want to constantly iterate and improve. And there's no question that we will always have competitors. And some of them will be good, but I believe we will be better, because we're focused on our stakeholders, the creators and consumers and we prioritise speed and we adapt quickly. So by constantly improving our user experience, users will not only come to Spotify, but we will retain them. And if we retain our users, we will bring more creators to the platform to share their content. Better content means more advertisers. And all of these things coupled together, users, creators and advertisers, unlock the power of our flywheel.“

Spotify is executing its strategy near flawlessly

Daniel Ek’s comments are a perfect introduction to talk about their superior execution abilities. In our opinion, the company has executed its entry (via a buy and build strategy) into the broader audio world flawlessly so far. Since their entry into podcasts in 2018, they have recently become the #1 podcast platform in the US in basically no time and they are talking about ongoing meaningful share gains into 2022 cementing their position further. 

They have also done an outstanding job on the production and distribution front. Anchor, which they acquired about 3 years ago, has been a huge success so far. Apparently, over 80% of new podcasters on their platform are using Anchor and Spotify thinks that Anchor has about 50% market share across the entire podcast industry in terms of usage. 

With the acquisition of Findaway (link), they have recently entered the open infrastructure layer in the area of audiobooks. We wouldn’t be surprised if the next acquisition in that area would be fellow Swedish based and Stockholm listed audio company Storytel - the largest independent audiobook streaming company. Storytel offer over 700’000 audiobooks, with a successful 1P angle that posts 15% EBIT margins to over 1,8m subs (with 1h daily usage) coming from 28 markets, at a revenue of over 330m USD with blended gross margins of 25%, but 45% in their more mature Nordics regions. The company has an EV of $500m. So the acquisition would be quite bite-sized and the valuation doesn’t seem that demanding. However, Spotify might have a different angle in the audiobook area and might invest its resources elsewhere. Other European based targets could be Swedish based Acast and Uk based Audioboom, both of which are active in the podcasting space and where an acquisition would make sense to us to cement Spotify's pole position in the market even further.   

Coming back to Spotify’s own developments. The company has heavily invested in improving the ad monetisation of audio content, where they have quickly assembled a best in class monetisation tech stack that together with Anchor puts them into the pole position to materially improve the monetisation of audio content. That is especially true for their own platform where their ad targeting and insertion technology will produce the best results, but improvements go beyond their own platform and Spotify can access off-platform content via Megaphone. 

Spotify is not resting on its laurels in addition to internal improvements it has acquired another two companies in the space: Chartable and Podsights — two of the most prominent podcast marketing and ad attribution companies in the space. Borrowing from the Verge below, and a link to the story where one can also find a bit of additional info. 

Both Podsights and Chartable allow podcasters and networks to include tags in their shows that are used to track who listened, if they heard an ad, and whether they took action upon hearing it. Spotify also plans to use Podsights technology outside podcasting and will bring it to the “full scope of the Spotify platform, including audio ads within music, video ads, and display ads.” The Chartable acquisition appears to be more directed toward podcasters themselves rather than advertisers, particularly because of its technology like SmartLinks.

These tools add another important piece to their overall ad tech stack and perfectly fit into their business ambitions in that area.

Unlocking the targeted advertising in audio is a massive opportunity

While many people remain sceptical in this area, we think it won’t be long before the company will prove more clearly that its efforts are absolutely worth it. Their Q2 investor day will probably shed a lot more light on this area. We are certainly not among the pessimistic bunch, we think Spotify has really good chances of becoming the dominant player of advertising in the audio world, with a potential near-monopoly on the programmatic side. For this, to work you need great ad targeting and measurement technology, great automatic ad insertion tools, a large marketplace of content to advertise against and an equally large pool of brand advertisers willing to move into programmatic advertising. Spotify has assembled all the ingredients and they seem to have recently reached critical mass in that regard. So far we haven’t seen anyone else being able to follow Spotify into this position and since there are two-sided marketplace dynamics at work this won't become a crowded field. Here is a (link) to a great article listing Spotify's recent moves in this area, another one (link) where Anchor explains the ad opportunities to its hosts and here is Spotify talking about it (link, link and link) addressing both brands and creators. All are worth the read.  

While the programmatic opportunity might not lift the revenue potential of a top podcast that successfully uses good authentic host read ads, automated ads are of significant importance to the massive long tail of audio content that currently is either not monetised at all or montesited far below its potential. The great thing about a switch to programmatic is that the targeting goes down to a single individual so the size of an audience becomes irrelevant. However, there are also benefits for the advertisers. The self-serve nature of it opens the advertising opportunity up to all kinds of companies, not just the largest brands with significant budgets. The good thing for the company enabling all that is that it can take a far greater cut, than in the labour-intensive manual advertisement world. Spotify is currently offering a flat $13 CPM and will keep the upside to itself. Compared to the non-targeted radio world that apparently has a CPM anywhere between 4-8$, a audio CPM of $13 is already a fantastic uplift, but there might be a lot of additional upside that Spotify is keeping to itself. Below is an overview of CPM ranges across various media entertainment channels in the US from a recent PWC study.  

The opportunity extends beyond podcasts, Spotify can leverage its investment across music, against live content and on long-form offering a new form to monetize audiobooks (Only China has that option for audiobooks for now). So we think what they are currently building is really worth all the effort and they are potentially building a massive business down the road with benefits on all fronts. While in our opinion nothing of that sort is currently priced in, Spotify is already seeing famous flywheel effects with adoption increasing on and off-platform. Here is a recent Paul Vogel comment on it.  

“…On the Megaphone side and the Spotify Audience Network, what we're seeing is we are now building on a tech advantage that's actually allowing publishers to monetize at better rates than they would in other places. And so if you look at our advertising over the last couple of quarters, you've seen it outperform and one of the reasons it's outperformed in the Megaphone side, in that third-party selling ads for publishers, we're actually monetizing, in lots of cases, better than they're able to on their own first-party direct sales teams. And so we've seen them add inventory into the ecosystem throughout the quarter, which has helped us outperform over the last 2 quarters.

Zooming out again to look at the larger audio picture

I am borrowing Matthew Ball’s great chart here to best illustrate the long term audio opportunity. The short version: It is still very early days for streaming/internet audio and growth seems assured for decades from here. 

As can be observed from the chart, prior to the internet piracy problem, the labels had proper control of the distribution of recorded music, so they could push monetization, leading to many decades of healthy industry growth. The loss of distribution control in the digital wild west broke that trend and shrank the recorded music market for at least 15 years. Per capita spending on recorded music was ~85$ (inflation-adjusted) in the US in 99/00 (the peak, but likely already impacted by piracy) before it declined for one and a half decades, finally bottoming in 2015 from where it started to recover. It now sits at ~45$, which is still far from its peak while consumption is materially up since then.

The huge under monetisation of music will be addressed

Now that the distribution and piracy problem that came along with the internet and led to a huge under monetization has largely been solved via broad adoption of streaming again, the industry's primary job over the next decade is to increase the monetization of music again. As a proof point that the problem is fixed - the viability of getting illegal access aside - it is simply no longer cool and desirable for a kid to illegally download music. Your classmates would view you as a complete weirdo these days, which is basically the exact opposite compared to the height of the piracy problem. While Spotify did the heavy lifting over the last decade to get the industry to today's situation. No other company is better positioned to drive up the monetisation of music over this decade and beyond.

While Spotify has started to increase prices here and there already, the real pricing opportunity for music in the streaming world remains basically untapped. We think there is tremendous room for price increases before the willingness to pay for the great majority of people were to be reached, in case all streaming players are increasing prices more or less in lockstep. This won't happen today or overnight of course, and it will be a slow process giving streaming time to reach its full penetration potential and the consumers the time to form even stronger streaming habits and of course, also time to adjust to price increases. This is the future we envision and we actually think that the labels will do their part and actually help Spotify and the industry to get there. The way to achieve that is to force the big tech players to follow Spotify along and the consolidated nature of the industry is a plus not a minus in that regard. Here are a few helpful excerpts from some of the recent public labels CCs. First from Eric Levi, the CEO of Warner Music. 

“…we all know that Spotify has started to integrate price increases as well. And all indications are that, that has been received well and hasn't had an impact on churn. And we suspect the other DSPs will take notice of that. And we would certainly encourage them to consider pricing as well. We've been very vocal about that for years that we think there's incredible value brought in the music subscription and there's significant pricing opportunities that we certainly encourage everyone to call the DSPs to consider to make sure they're not leaving value on the table.”

“…So yes, we expect to continue to be benefiting from strong continued paid subscription growth at Spotify, Apple Music, Amazon in 2022. Two, we expect to see price increases from these services in the very near future. And we do think that once some of these services start raising prices all of them we follow. So yes, we do expect that to play in 2022. And on ad supported monetization, we've seen a very strong increase of ad supported monetization in 2021 at YouTube, which we expect to continue to see in 2022,  at YouTube, but I would say we're not expecting acceleration there. And what we see from services as Spotify is there's a number of changes that they have done in the - with or organised to improve ad supported monetization. So these are like the 3 elements we see globally…”

“…With respect to the DSPs in particular, Spotify, Amazon, Apple, YouTube, Tencent, our relationships remain very healthy, very collaborative, and mutually beneficial. The streaming market, the traditional streaming market continues, as I said, to grow, and we believe that both the traditional market in these alternative use cases will be bolstered by price increases, which should become more regularized and should have potential meaningful upside. I think that these higher prices over time will arrest so to speak, and turn the ARPU curve back to positive territory year-over-year…“

“…While there may be in any given quarter what people interpret as slowing growth, a deceleration versus an acceleration and more growth, that's at some point just a lot of big numbers. But when we look at adoption levels, when we look at how much room there is to further adopt, when we look at Spotify has been experimenting with, Amazon has been experimenting with, I'm convinced the others will experiment with increasing prices. Spotify hasn't seen much churn. They've announced price increases on their family plans, some of their other plans. Others will follow when they see that because people build their own house with the new services by way of their library, the music they prefer, the alerts they get, that unless they feel really abused. It was this way with cable TV when they had monopolies even when somebody else came into the market, unless you felt incredibly abused, you would just stick with your regular carrier.

So I think that the music services are beginning to realize they can uplift prices. That music represents an enormous value relative to services that provide long-term video. I mean the difference between the value they ask for bits and pieces of the long-form video universe versus what music asks for the whole universe is - it's like day and night. Spotify reported an uptick in ARPU. We've had a view that over the last couple of years, that's kind of bottomed out and it's going to begin to swing up. So when we look at that traditional bucket, again as I said, we think that both with mature and emerging markets or more mature markets, there's still a boatload of runway…” 

Here are two more excerpts from the CEO of Believe:

“…First, so yes, we expect to continue to be benefiting from strong continued paid subscription growth at Spotify, Apple Music, Amazon in 2022. Two, we expect to see price increases from these services in the very near future. And we do think that once some of these services start raising prices all of them we follow. So yes, we do expect that to play in 2022. And on ad supported monetization, we've seen a very strong increase of ad supported monetization in 2021 at YouTube, which we expect to continue to see in 2022,  at YouTube, but I would say we're not expecting acceleration there. And what we see from services as Spotify is there's a number of changes that they have done in the - with or organised to improve ad supported monetization. So these are like the 3 elements we see globally…”

“…I'm not going to comment on what Apple is going to do. But yes, I do personally think that given Apple's overall strategy around driving profitability for Apple Music in 2022, the likeliness of a price hike in the near future is very high…”

There is still material streaming penetration upside

The shift to focus on monetisation in this decade doesn’t mean that there isn’t a lot more room for streaming penetration to go up materially from here as well. 

Music streaming is around 30% penetrated across the developed world, with Sweden, where it all started, already closer to 50% and with the emerging markets on the other end with penetration levels still in the single digits. Lets borrow some insights from the labels again - here two excerpts from Eric Levi:  

“...I think part of what we're excited about, I think I mentioned earlier, is that the growth vectors we think are just increasing, not decreasing. In developed markets, which say, are about 30% penetrated on average of subscription streaming. We think that number could double or more potentially or I should say, we've seen research that indicates customer interest, so it could double or more, somewhere potentially to 70% over time. And that's exciting numbers to see. Emerging markets are mid-single-digit penetrated. We think it's just the very early days for emerging markets to come online…” 

“...I think emerging markets are a generation behind developed markets, if we can kind of think of it that way. Whereas if we were looking at this five, eight years ago, we were looking at developed markets in single digits and growing and growing quickly, we'd be talking about can they get to 30%. And now they're at 30%, we now look at research and say, does the research show it getting towards potentially 70%, we've seen research that indicates that's certainly possible. Emerging markets are now in the single digits. And so the ability and for those to grow in the next wave into double digits and then how far, how fast I wouldn't want to prognosticate upon. But I think there's an opportunity for emerging markets to really substantially deepen their penetration. What the ultimate penetration can be? I haven't seen research market-by-market from that in emerging markets. But obviously, we're excited about where it can go, and it's very, very early days, with Spotify just launching in 85 markets within the last year. So, really, a lot of this is just getting started in so many markets…”

Spotify labels' relationships aren't as bad as many think 

We think there is a much healthier symbiotic relationship between the labels and Spotify than most people appreciate. There are certainly tough negotiations all the time, but in the end, Spotify and the labels share the most important common goal of increasing the monetisation of music, while all other music streaming players that are under the umbrella of the big tech guys seemingly have completely different goals. They are in the market offering music to basically enrich their own ecosystems, increase overall engagement, bundle it with other services, and reduce core churn, while their focus is on monetising their core products, not music. Dealing solely with them would be much worse for labels and a world they certainly would not prefer to be in. 

Spotify is on a path of increasing its core music margins

Looking at Spotify's core music margins over the last couple of years, one can also come away with a favourable view, regarding its negotiation power. Margins have so far been on an upward trajectory, with the highest premium GM margin in Q4 2021. On the last earnings call, Spotify’s management has also mentioned that they are seeing favourable core margin trends continuing into 2022. 

We think as long as Spotify is the largest player with the most enthusiastic music fans and they continue to drive so much listening with their algos, the labels won't be in a position to play hardball. The threat of pulling everything off SPOT is also mostly a theoretical one, I believe. If a label did it, it would immediately have some extremely angry clients and I think more than one lawsuit on their table, simply because the great majority of their artists won't support it. There would also be a huge outcry from the fan bases around the world. Which is why we think everybody will focus their energy primarily on growing the pie and for the labels that might mean pushing the other streaming players to implement price increases. Long Term we could of course see something like in the TV world with Networks vs. the cable companies. However, if a label really pulls something in a negotiation round we think they would work it out in a few days due to the massive pushback. 

There is no real data, but we have seen at least one dispute in Korea last year that didn't go that well for the locally powerful label there. Apparently, Spotify didn't change its demands and they came back in a few days. Here is a link to the story that is worth a read and the most relevant piece directly here: 

“...A source tells Variety that the uproar on social media from fans of the label’s artists, which include IU and APink — as well as reactions from some artists themselves — led Kakao to return to the negotiating table, with terms not dramatically different from those originally offered…” 

Insights from the Joe Rogans cancel-campaign 

We have also recently seen the effects of individual artists pulling their music, which provided a view into the strength of Spotify’s position. The recent ones due to Joe Rogan were a complete shit show for the cancel group. These artists were holding out even shorter than the last time when advertisers wanted to make a stand against FB. They were quietly back in weeks and I mean Neil Young’s and Barbara Streisand's fan base is not even centred on Spotify and they still came back so quickly. No young artist whose fan base is centred on Spotify followed suit and a lot of young artists lean heavily left and could be really offended by Rogan. None of the labels used it as an opportunity to weaken Spot. There wasn’t even a public statement. They preferred to stay out of it and Spotify itself did in no way give in to pressure, even when it started to come from politics too. Spotify sided with Joe Rogan. We think the outcome of this situation tells you something about the strength of their current position. Spotify did the bare minimum that doesn't really affect Joe Rogan going forward and the labels' reactions were quite muted. Spotify will likely benefit from this whole saga. Firstly, we think Rogan really appreciated how Spotify handled the dilemma and secondly, other podcasters who are planning to go exclusive will take positive note as well. That story would have definitely played out differently if Joe Rogan had for example a deal with Apple. Smart podcasters will take that into account when going exclusive.  

Other thoughts on label negotiations

Daniel Ek's calm persona, his incredible smarts and his patient long term orientation are perfect ingredients to negotiate a favourable long term outcome for Spotify. There are many ways to get there, for example, Spotify could handle the labels' price increases while for example getting more flexibility for direct monetization of unique music content possibilities in return. This provides an immediate win to the labels, but likely weakens their long term negotiation power against Spotify since it would most likely increase the chances of them gaining a larger market share over time, given they would likely end up getting the largest unique content advantage. 

In the negotiation game for new features, Spotify also doesn't need to convince all the labels at once. They only need to convince one of the big labels. If it is good for the artists, but strategically bad long-term the others can't hold out. 

Importantly in the long term game - while Daniel Ek will always focus on the long term, the management teams of the labels will change here and there, some will be just generally more short term oriented but also compensated in a way that will influence their short term decisions. So we think the labels won't always act in their best long-term interests. Spotify can also do a lot of the convincing directly with artists themselves and build some pressure from that side too. It's a big deal if they convince a few new rising stars of new monetisation possibilities and they buy in. 

Spotify also has a large opportunity to capture music ad dollars

Over time more of the labels' ad dollars will shift to Spotify. That trend has already started and since Spotify drives so much of the listening time via algos/playlists, I think it will only continue. The labels that want to see a return on their back catalogue will lean in, they will also lean in because new artists will want to lean in. The marketplace opportunity seems like a great one to us. It's a slow process at first and while it is already affecting Spots GMs favourably, we see it as a snowball that just started. 10 years ago nobody thought that Amazon could build a $40b ad business on top of its third party business that already had considerable fees, but they did. This is of course not apples to apples, but we think it will work because after a few years there is no turning back anymore. 

Management is increasingly calling out the marketplace as a reason for core margin outperformance and lift, which means labels and artists are leaving into the tools.  Some of the products get increasingly adopted, and they work for the artists. For example, the usage of Marquee (link) drove over 27m tracks saved or added to playlists in 2021. The Fans First product (link) drove over 60m USD in revenue to fans via merch and ticket sales in 2021, with merch sales more than tripling YoY. The recently announced partnership between Spotify and Shopify (link) will certainly improve that merch trend further. Spotify is also testing things like Discovery mode (link), where artists are accepting a lower royalty rate in return for preferential treatment on playlists. While the timing of the adoption and development is difficult to pinpoint, we believe this is a one-way street and we are only at the start of it. Here is a recent comment from Daniel Ek: 

“…Overall, I am very excited about the progress with Marketplace. We continue to see very strong engagement with artists, teams and labels across the board. I think a huge testament to that is just how performant these formats have been during this testing period. Many artists are seeing uplifts of 50% or even 100% on their campaigns. That is obviously driving even more demand from teams and more teams who want to try this product.

So I think the best way I would characterise it is much of last year was really around finding product-market fit. I think we have proven that product-market fit now and are scaling this nicely across the board and iterating the product for all the demand and feedback we're getting from across the creative community.

 And then as you think more broadly on Marketplace overall, I think you're totally right to point out that there's a lot more we can do to service our creators and musicians on the platform. And Live is obviously one of those opportunities that we think a lot about. We did experiment quite a bit with virtual sort of live shows during the pandemic. We saw really nice results from that. I do think long term, we can be a very important part of that ecosystem, too, in enabling more fans to discover more live shows and allow artists, of course, to interact with them in that way, too. So that's something that the team is working on and we're thinking about what the right experience is…”

The Live Concert and streaming opportunity 

The whole piracy dilemma also created a situation where live performances became the most important piece of musicians' incomes. A situation musicians likely do not prefer and therefore might be due for a reversal again over the next decades. For example, they might choose to perform fewer live concerts but monetize them better and more directly via a much larger audience that participates over live streams at lower ticket prices but high net take rates for them.  

Spotify will start to play a bigger role in this market. It is the perfect place to market concerts since nobody is in a better position to have better audience targeting tools than Spotify (or other streaming platforms) given the data advantage. Spotify is testing the water in that regard, primarily promoting it in the app here and there. However, they might just have decided to enter that concert world more directly with the recent deal that we have seen announced with FC Barcelona and the Camp Nou Stadium. That deal (link) likely marks the beginning of a concert venue partnership that has some exclusive elements to it with live streaming likely being a part of it.   

Radio is destined to slowly die to the benefit of streaming

Given the inherent disadvantages of terrestrial and satellite radio, the technology is destined to die over time. Not the style of it, there will always be people who enjoy certain hosts and the layback style of entertainment in a mixed format, but the broadcast radio delivery mechanism. Streaming the whole thing is superior for everyone involved. Consumers can get better ad targeting and can enjoy a lower ad load at equal monetisation for the station or the station could make a lot more money by keeping it at the same high ad rate. Consumers will also have the opportunity to occasionally switch out of a chosen song that they don’t like, rather than switching the station altogether like they have to with FM and Satellite radio. More interactive features, like polls, can be implemented, and hosts in general, will get not only immediate feedback but just much better feedback in general to target the preferences of their intended audience. The artists/labels will finally get a cut as well. Initially, that won't matter, of course, since we all know that the total streaming revenue just gets distributed differently between the artists depending on the mix. However, it will increase the value of the streaming service again and will enable higher prices over time, which everyone benefits from. We are talking about a massive shift that is yet to happen. The global radio industry is collecting around $40b in advertising revenue a year.  

Here is an excerpt from Daniel Ek (Q3 21 Call) on the opportunity ahead:  

A good reminder, linear radio still has a 46% share of audio listening in the U.S. alone, this despite consumption shifting steadily away from it. And this year, more than 60% of all audio ad spending will go to traditional radio. I think this clearly shows that we have plenty of room to grow, both in listening time and in our effective monetization. And the U.S. is one of the most advanced markets, so internationally, there's even more growth ahead of us.

The transition will take time of course, especially due to the fact that modern technology needs to work itself through the car park. However, it's almost impossible to imagine a radio being installed in a Tesla or other new electric or modern ICE cars that want to keep up with Tesla and their competitors down the road. It is also hard to imagine people buying radios for their homes in a couple of years - they will increasingly buy smart speakers, where radio stations can still be accessed but in terms of share of listing and relevance it is very likely all downhill from here. Spotify is best positioned to take advantage of that. They already enable mixing music with news, and playlists like the Daily Drive are becoming more popular. It also acquired a company (link) that already makes it easy for radio stations to bring their content to on-demand streaming. Once Spotify's live product becomes available it will enable them to stream into that channel as well. This provides the stations with a way (maybe not the optimal but an easy one) to transition to streaming and reach this audience. Importantly, it will allow them to benefit from ad targeting using Spotify's technology - which effort-wise doesn’t sound like a hard thing to do and will provide a strong monetisation uplift, especially longer term if this becomes the or one of the industry standards to use for audio advertising.  

Streaming opens up the whole world to monetize audio

Historically most of the money outside of radio went into distribution (special physical equipment to play music, CDs plus physical retail). This distribution cost dilemma limited the recorded music consumption to high-income countries, a barrier that no longer exists today with distribution costs approaching zero. The streaming companies together with the labels can now price their product to match income levels, opening up the whole world for them for the first time ever. There might be sceptics who don’t think that emerging markets are addressable via paid streaming, but we agree with Daniel, that the doubters will likely be proven wrong, just like the people who years ago thought advertising is not a viable business model in emerging markets have been proven wrong. 

New audio content opportunities due to tech advancements

Technological advancements like AirPods, other wireless headphones, smart speakers, voice control and other new developments lead to many more audio consumption opportunities. Additionally, new forms of audio formats start to proliferate. For example, audiobooks are a completely new market and the creator economy is blossoming in the audio format like never seen before. All that will lead to a significantly expanded market opportunity over time. 

The Industry will become a lot more inclusive 

The music industry will always be very top-heavy, but streaming in general and Spotify in particular, are increasingly levelling the playing field between big and small artists and the overall listening patterns of people are becoming a lot more diverse. This benefits Spotify and the long tail of artists. The recent loud and clear publication has great data on it (link) and here is Daniel Ek's perspective on it.

Over the past 15 years, what we've seen and helped drive is an audio renaissance. And I use that word intentionally. It really is a renaissance. It is not a restoration. We're moving forward, not turning the clock back. People love to look back fondly on the music industry of 2 decades ago, they are fond of the record store and FM radio, a time before piracy. And I understand the nostalgia, I get it. As a kid, I remember spending hours at my local record store, flipping through the bins and selecting what albums to buy. But looking back, what really strikes me is how limiting it was. 

The amount of music you could discover back then was limited by shelf space and floor space, by the physical distribution capabilities of music companies, by the personal preferences of our radio DJ, and of course, by where you lived and how much you could afford to spend. There were also fewer possibilities for creators. The shelves and the airwaves could only support so many artists, and industry gatekeepers could only invest in so many artists. A lot of great music was put out in the '70s and '80s and '90s, but unfortunately, many more never got a chance.

Over the past 2 decades, streaming has fundamentally changed the audio ecosystem. It's lowered barriers to entry and it democratised access to audio for listeners across the world. More creators are creating and succeeding than ever before.

20 years ago, the music industry was a pretty restrictive club. Unless you had the resources to produce a physical product and distribute it to record stores and get your song on the radio, it was difficult to breakthrough. Case in point, back in 2002, just over 30,000 albums were released in the U.S. and only 8,000 sold more than 1,000 copies, representing 98% of sales of new releases. By comparison, in 2020, 1.8 million albums were released on Spotify in the U.S. and 6x as many albums represented 98% of the streams for these releases. So it's not just the possibility that more artists can be heard by a global audience, it is that more artists are being heard. This means that meaningful income is flowing to more artists than ever before.

Today there are already 60’000 tracks added daily and this is before the live side of the business is getting traction on Spotify. To us it seems quite obvious that Spotify is increasingly becoming more important in the music and audio world of the future.    

The major record labels are losing share on Spotify

While many people dwell so much on the label point here are some more trends in this area. The major labels - the big 3 + Merlin are slowly losing share on Spotify while Spotify on the other hand is gaining a greater share of their revenue. Balancing the power to a degree. The percentage of the major labels share of all music streams on Spotify declined every single year over the last 5 years, going from 87% in 2017 to 77% in 2021. While the Chart below shows Spotify creeping up as a percentage of Revenue with Warner Music, where there is data available.    

This doesn’t strike as a situation where the labels are gaining leverage against Spotify. They certainly carry significant power, but the trend is the other way around. However, as already mentioned we think it is wrong to assume this is a zero-sum game with throat-cutting negotiations all the time. There is a common goal. Lastly, here is a recent CC conversation between analysts and the Warner Music management team. Spotify renegotiated a favourable outcome with them. Generally, there is a narrow band, supporting our view that the labels can push the big tech DSPs to follow Spotify's price increases. Here is the Q and A:

Analyst: I'm sure you know after the last earnings call, there's a little more concern about your relationship with the DSPs and where the leverage sits. I think the market had gotten comfortable that there was no real risk to your share of streaming revenues. Maybe you could just update us on your perspective and whether anything has in fact changed in terms of your ability to monetize traditional streaming.

Analyst: I want to ask you a couple of questions about your relationships with your largest streaming distribution partners. First, Lou, you referenced that $28 million headwind from the new deal with a streaming partner. Can you expand a bit on why this renewal had a negative impact? What it means for your growth for the balance of the year and beyond? And what it could mean for renewals with other partners?

Warner Management: So Michael, on the first question with regard to the DSP renewal. This is a short-term financial anomaly really understates the strength of streaming that we're seeing at Warner. All the deals we have with our global DSPs now fall within a very tight band and the oddity of the comparison that we're seeing, and that's created - won't exist beyond fiscal 2022. We're incredibly confident that traditional - both traditional and emerging streaming platforms will continue to experience strong growth. And as a result, our 2022 and beyond outlook remains unchanged.

Warner Management: Now as Lou mentioned, virtually all of our deals fall within a very tight band of economics. And when you look at Spotify, they are in the process of building, as Daniel Ek announced several years ago, a podcast business. The economics of that business are different than the economic relationship that we have with Spotify on the music side.

Pencilling down some possible future financials

Given that paid streaming has significant penetration upside and that there is also significant ARPU upside, it is not hard to see Spotify’s revenue CAGR staying at a very high rate for a long time. For example, moving from 410m MAUs to 1b MAUs while keeping their paid conversion of around 45% till the end of this decade would lead to 450m paid subs and would be a development that we don’t find unreasonable at all. ARPU just turned the corner and for the first time started to grow, but as described there are good reasons to believe this is just the beginning. An ARPU lift of about 50% over the same time frame would yield around 7,5$ from slightly below 5$ today, which also doesn't feel like a huge stretch over 8 years' time (For example half of it would be just keeping up with inflation if it were running at 3%). Putting those two things together would bring home $40b annually from the paid sub-business alone. 

On top of that, we know that the company thinks and currently does indeed grow the advertising side of the business even faster. While the advertising revenue for a long while hovered around 10% and was largely seen as a conversion tool to the paid side of the business, the recent tech stack built out and the broader audio focus have already moved it to 15% of revenue in Q4 21, growing 40% YoY. We hopefully made a case for why there is a tremendous opportunity and why Spotify is really well-positioned to go after it and can become a dominant leader in audio advertising without a lot of competition. The company recently moved up its longer term targets of where it thinks the ad contribution as a percentage of total revenues will pencil out. Daniel now thinks it could potentially end up being between 30% to 40%.

Daniel Ek on Q3 CC: So I'm really excited about ads. I think we have had a tremendous quarter with 75% growth year-over-year. But this is just the beginning, as I stated in my opening remarks. Long term, I believe at the very least, this should be 20% of our revenues, but it might possibly be a lot more than that, 30%, 40% even, over the next 5 to 10 years. 

Let's go with the lower end of it, that would add another $12b in Revenue and let's cut that again and say they will do $50b in revenues vs. ~$12,5b this year. We don’t think there are good reasons to believe they can’t get a blended gross margin in the mid 30% range and achieve their targeted level. The core premium margin is already creeping towards 30% with the marketplace just getting started. It is also not hard to believe that their advertising gross margins can eventually move a lot higher than the core music margins, once they reach a more sustainable level of growth investment into content and the broader audio opportunity. So overall let's give them a GM level of 35%, which would provide them with $17,5b in gross profits at which point it's hard to believe that they won’t be able to convert 30% of that or overall 10% of revenue into net profits, earning over $5b in profits. A multiple of at least 20x sounds like a reasonable one for the scaled leader of a whole medium with significant daily engagement and ongoing long term global growth opportunities, probably even too cheap. So a market value of over $100b and 4-5x depending on what they do with FCF and what the multiple eventually is at that time seem perfectly in the cards in our opinion. We find it hard to create reasonable scenarios where one doesn’t at least do ok from Spotify’s current EV    

Catalyst

Ongoing advertising outperformance

Q2 Investor Day shedding more light on the advertising/marketplace business

Introduction of new features with obvious revenue potential

Fading worries stemming from their new guidance methodology 

Nasdaq composite losers continuing to turn around ;-)