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Spotify Idea Proposal (SPOT)

Spotify Idea Proposal (SPOT)
 

Does Spotify have the leverage to get lower royalty rates or a bigger share of music label ad budgets?

Report Available: March 20, 2019

 

Blueshift’s initial research found SPOT turning its first profit in Q4 but with lingering concerns about its 2019 outlook and revenue-per-user trends. The streaming service continues to joust with record labels over royalty rates, its biggest operating expense. Ad revenue has been growing from a small base. The company is making a big push into podcasting to diversify its content and give it a leg up on competing services from AAPL and AMZN.

 

Observations

  1. SPOT reached a milestone in Q4 as its operating income, net income, and free cash flow all turned positive for the first time in the company’s history, while the streaming music service’s revenues climbed 30% year-over-year to $1.7 billion. The news was not all good, however, as Q4 revenue lagged analyst expectations and the company’s full-year guidance suggested it would swing back to an operating loss. Further, its average revenue per user continues to decline – falling 7% in Q4 – due to international expansion and discounts it offers for student and family plans.
  2. The company’s biggest expenses by far are the royalties it pays to music labels representing artists. The labels, particularly the Big Three – Sony (TYO:6758) Music Entertainment, Vivendi SA’s (EPA:VIV) Universal Music Group, and Warner Music Group – have typically had the upper hand in negotiations. The streaming services cannot exist without the content provided by the labels, who have successfully demanded 70% to 80% of revenues. However, the labels have incentive for a pure-play streaming service like Spotify to thrive and Spotify’s increasing gross margins suggest it has had some success negotiating better royalty rates. SPOT’s gross margin hit 26.7% in Q4, up from 24.5% a year ago.
  3. SPOT is the No. 1 paid music streaming service in the world, with 96 million subscribers at the end of Q4, up 10% from the previous quarter. SPOT also added seven million users to its free, ad-supported service, bringing that total to 116 million. Subscriptions account for almost 90% of the company’s revenue, but income from advertising has been growing, hitting $198 million in Q4, a 34% year-over-year gain. In a sign of the importance of the ad revenue stream, the company said it would be taking a tougher stance on people using ad blockers beginning March 1, suspending or terminating accounts.
  4. SPOT announced a pair of major acquisitions in February, spending a combined $340 million to buy Gimlet Media, a podcast network, and Anchor, which helps podcast creators record and publish their shows. The foray into podcasting is an effort by SPOT to diversify its content with audio that does not require royalties, possibly helping SPOT become less reliant on the music labels. The move may also give SPOT some exclusive content to differentiate its service from rivals like AAPL.
  5. Blueshift’s July 24, 2018, report concluded that SPOT will never become the runaway dominant force in music streaming that NFLX has become in video, but it has a much better opportunity to reach profitability than rival Pandora (P) ever had. SPOT already has trimmed some of its suffocating content costs in recent renegotiations with record labels. The popularity of SPOT’s curated playlists makes the platform hugely influential in user listening choices, giving it more leverage with labels. In addition, the major labels want an independent, pure-play streaming service to thrive. Sources said the company must significantly reduce overhead, diversify with less expensive content like podcasts, and further develop other revenue streams like ticket sales and merchandise, all while continuing to build subscriber numbers.

 

Does SPOT have enough leverage with music labels to negotiate lower royalty rates in the next round of negotiations? Or have the labels already budged as far as they are willing? Can SPOT grab a bigger share of the labels’ advertising budgets? Can SPOT continue to improve its gross margins? What impact will SPOT’s emphasis on podcasts have on subscriptions and margins? How is competition from AAPL and AMZN affecting SPOT? To answer these and other questions, Blueshift will gather data and issue a market research report from independent sources in the following areas: Record label executives, Brokers and rights management firms, Content creators, and Industry specialists.

 

Companies: Spotify Technology S.A. (SPOT), Amazon.com Inc. (AMZN), Apple Inc. (AAPL)

 

Research Begins: March 4, 2019

 

To see other ideas Blueshift Research is currently working on, please click here.

 

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