May 31, 2018 - 5:08pm EST by
2018 2019
Price: 158.42 EPS 0 0
Shares Out. (in M): 178 P/E 0 0
Market Cap (in $M): 24,182 P/FCF 0 0
Net Debt (in $M): -554 EBIT 0 0
TEV ($): 23,601 TEV/EBIT 0 0

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There is another good primer on SPOT written already posted on VIC.  Please refer to the prior VIC writeup for the general background and also on a bear's POV.  Multiple other bear POVs out there: Columbia's Value Investing newsletter has a short thesis on SPOT as well.  TWTR, as noisy as it is, is full of them.  You all know how to search TWTR for that.

I really have 2 questions I want to try to answer as best I can: 1) how is SPOT differentiated from the competitors and what is its barriers to entry? 2) Does SPOT have power over the record labels / publishers, which are basically its supplier in this relationship?  I throw in a minor point 3 for those interested.

Point 1

A clear bear case that every bear of all stripes bring up is...drum roll...competition.  This is not unknown, amIright?  Just about everyone (maybe except our grandparents) knows that Apple, Amazon, Youtube/Google, etc (list goes on) are getting into streaming music with similar price points.  Those who know the story better know that there are multiple others in the space outside of these tech giants.  So what makes 1 streaming company stand out from another?

1 differentiation and barrier to entry is the customer's personal investment in the service (users will inherently spend 100s of cumulative hours creating the perfect playlists for when the customer goes for a run in Central Park: you add a track here from Drake, add another track from Cardi B, add another track from Kings of Leon, you get my drift: the time spent building and adding your playlist quickly adds up and you can't port that easily).  Another differentiation or barrier to entry is the user's comfort / familiarity with the UI.  While incredibly subjective as to which platform has a more user friend interface, SPOT typically gets high marks even from competitors.

So the next question is what does SPOT do to acquire the customer to get them to a) spent time using and thus investing in SPOT's service/product b) become familiar with SPOT's UI and then it becomes habit-forming?  Brand recognition helps with customer acquisition.  SPOT has that and that definitely helps (see Investor Day for the biggest streaming brands in the various countries and SPOT is almost always #1).  But that alone is not enough.  There needs to be continued S&M spend to continue to keep that brand visible and recognizable and SPOT appears to be pretty darn good marketers.  Again, their Investor Day webcast for specific examples of the high ROI marketing things they cooked up with subsequent metrics showing you engagement and reach:

No doubt: AAPL's iPhone, with their streaming product preloaded, helps acquire customers.  However, we're talking about a global TAM and Android (i.e. non-Iphones) is still the majority of the payment-enabled phones (i.e. phones that have the capability to run a streaming music app) out there globally.  I, too, am be a bit too US-centric and iPhone-centric but when I take a step back, I realize that the idea of AAPL being able to on-board and acquire customers, while helped with the fact many customers own an AAPL hardware / iPhone, does not break and kill SPOT as an undervalued, leading business in a secularly growing industry.  On the latter point, the industry is still in its infancy: only 50% of Europe is streaming music and in Japan, it's < 30%.  These are developed countries where they have the phones and infrastructure to stream music.  Low hanging fruit may be an apt description.

Point 2

Shorts will say that record labels + publishers have all the power and SPOT (and all streaming platforms) are at their mercy.  Please note that this dynamic is not fully correct.  Record labels + publishers NEED SPOT as much as SPOT needs record labels.  Why?  Because streaming platforms keep record labels + publishers afloat financially: ~50% of the music industry's business comes from money from the streaming guys.  And SPOT is ~60% of that, which means that SPOT alone pays for ~30% of the entire music industry's revenues.  If SPOT goes away or gets beaten up by record labels + publishers, record labels + publishers get hurt immediately.  This sounds like a symbiotic relationship (maybe I'm using the wrong word here but you get my point: it's not antagonistic).

Further, my work suggests that in the near term, there won’t be a headline change to the 70% take-rate given to the record labels + publishers (and if in 2019, SPOT is able to move up its keep of the revenue, stock will pop; as is, no one expects the revenue split to record labels + publishers to change).   

BUT, I think there are a few ways to “effectively” increase margins:

1.     Mission-critical free stuff record labels + publishers get will no longer be free

a.      SPOT will charge for the data analytics (where song is being played, how often, how often skipped, etc) as a way to pay a lower effective rate to the record labels + publishers

b.      SPOT will charge for driving traffic

                                                    i.     From general consumers to specific content for specific record labels (30% of streams are driven by SPOT because after your initial searched-for song is played, SPOT decides what that next track is; also SPOT has their playlists which is pretty powerful as a way to discover new artists/tracks)

                                                   ii.     From specific consumers to specific tracks (e.g. The Weeknd drops a new single and no one has heard it yet and fans will get a push notification to hear it on their SPOT app; record labels don’t have access to the consumers and SPOT owns its users)


2.     Move streams away from the Big 3 by diversifying and driving listening to other music (indy labels not affiliated with Big 3, direct from Artists (e.g. Chance the Rapper, who made it big directly himself), white label music (e.g. piano music)) and non-music audio (podcasts, SPOT did a podcast with Amy Schumer that is exclusive to SPOT)

a.      Record labels get 70% take rate only when their content is used; right now, 87% of streams comes from the Big 3

b.      For $100 in revenue SPOT gets from subscription or ads, the Big 3 gets 70% of $87

c.      Once that 87% of the Big 3 streams decline, SPOT effectively increases its margins even though headline 70/30 split remains

Point 3

SPOT gets acquired.  If someone wants to use music as a way to acquire more users into their ecosystem, buying SPOT makes sense.  Very conceivable: SPOT is not that big (see EV above) and SPOT has the pole position right now.  Anecdotally, I spoke with an individual in AMZN’s Digital Music group in BD.  This individual stated that AMZN cares about video >>>> music and if AMZN can’t see traction relatively quickly in music, they’ll shut it down (or perhaps buy something).  Video is a more effective way to acquire customers into the Prime ecosystem vs music, because AMZN's streaming music service is not providing a customer proposition that is very differentiated in music.


So what's the value of SPOT?  I get to a number close-ish to this guy:

But instead of boring you with details and charts of what I do, I think this TWTR account lays it out somewhat well in a intuitive manner.  

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


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