Why Spotify is the Living Dead

Below I include a recent article from Barron’s Magazine, presenting the financial challenges to Spotify, the dominant music streaming service.  Here’s why I believe it’s dead:

Spotify [is] a “pure play on a loss-leader category.”

Streaming music has been priced as a loss leader, in other words the costs of streaming music exceed what platforms receive from subscribers in revenue. This is not atypical for networking platforms as the platforms hope to monetize the data these networks create through their users. Of course, a network does not really become valuable until it is of dominant size and able to maintain continued user engagement. Facebook is the one we are most familiar with. And Facebook did not become profitable until it had been in operation for 6 years and experienced phenomenal user growth. Also, FB has an ad revenue model (more on this later).

The problem with Spotify is that its major product line loses money, a lot of money. Streaming unlimited music costs a lot more than $10/month per subscriber. But raising the price merely loses subscribers, and customer acquisition costs (CAC) on the margin often increase over time. So, the desperate strategy is to find a way to generate revenue from the data sharing network.

But Spotify faces some serious competition: Apple, Amazon, and Google. All three of these tech titans can afford to lose money on streaming for a long time, much longer than Spotify can stay solvent or keep the support of its investors. Spotify is a dead man walking. Its subscriber base will be auctioned off before it depreciates to zero. Or not.

For example, how does Spotify compete with this?

Facebook may be next

I expect the revenue squeeze will also hit Facebook’s main advertising model. Digital advertising is dominated by Google and Facebook. Google monetizes search routines it gathers every time you invoke its search algorithms. Facebook monetizes social sharing and likes. Each then sell access to this data to third-party advertisers. Now, search is a more robust indicator of interest than likes, so Google’s ad reach and keyword auctions offer greater value than FB “likes.” FB tries to increase its value through social network dynamics, but there is so much noise there that there’s a real question how much that is really worth in terms of advertising conversions.

But both platforms need to look at the big shadow hovering just over their shoulders and bearing down on their ad models. Amazon knows what people buy on its platform, which reveals a far more robust indicator for what people will buy again. Access to Amazon’s data will be worth that much more than FB and even Google. I expect FB has the weakest attention model and thus Amazon and Google will continue to eat into its ad revenues. I’m sure FB is working overtime trying to figure out how to pivot and leverage its massive user base. Libra Coin is a clear indicator of that. FB is hoping to use crypto tokenization to monetize peer-to-peer finance and banking. Unfortunately it faces some serious regulatory opponents in the central banks and the commercial payments industry. But I suppose FB has much cash to burn trying to find its next lily pad.

The real problem with the scramble for data real estate is that there are only so many hours in a day. On top of that, users and consumers are becoming cognizant of the value of their personal data and will be less inclined to give it away for free. This blows up most of the “mobile app” bubbles vying for attention in the digital economy. The future, if one is to believe in technological progress, is a far more decentralized digital universe where users reap much more value from the data they create and share, and successful platforms will need to deliver much more value than a free app for their users.

The question for us all is who will eat whom on the way to this future? (If we believe Elizabeth Warren, she will be eating them all. Politics is always a wild card.)

Spotify Stock Has Had a Miserable 6 Months. Wall Street’s Optimists Are Wrong.

By Avi Salzman

Barron’s October 5, 2019

A miserable few months have made Spotify’s stock as dull as elevator music. Now, some analysts think the stock is beaten down enough that a rally is coming, and Wall Street is ready to groove on the remix.

Spotify Technology (SPOT) has fallen 17% since Barron’s wrote a skeptical cover article on the company (“Spotify Stock Is Risky Because the Music Industry Isn’t Changing Fast Enough,” April 19). Short interest on the stock, which was below 3% for much of the year, is now above 5%.

Yet two formerly bearish analysts have recently shifted to a more neutral stance, on the theory that the bad news is already in the stock’s price.

Spotify is the global leader in streaming music, and it passed 100 million paying users this year. Still, doubts have grown on Wall Street about the company’s ability to sustain subscriber growth.

In August, Spotify started giving new premium users three free months of service, up from one month, which “has supported fears of negative subscriber trends,” writes Credit Suisse analyst Brian Russo, one of the analysts who has become incrementally more positive about the shares. The company has launched other offers, too, including six free months of Spotify for people who buy an Xbox Game Pass.

Investors will have to wait until Oct. 28, when Spotify reports third-quarter earnings, to find out whether the generous offers are cutting into its margins. For now, the stock still seems stretched. Its market cap is $21 billion, more than the $19.1 billion that the music industry took in worldwide in 2018—and most of that money goes to labels and artists.

Spotify, meanwhile, is expected to lose $1.92 a share this year; in April, the loss had been projected to be $1.48. Kevin Rippey, an Evercore ISI analyst, calls Spotify a “pure play on a loss-leader category.”

Spotify is looking at new revenue opportunities. The company has branched out into podcasting, with plans to spend as much as $500 million this year on acquisitions in the space. But there is no obvious payoff from those purchases; the podcast ad market in the U.S. is still below $1 billion. Spotify didn’t respond to requests to hear the company’s case from top executives.

Spotify leads rivals like Amazon.com (AMZN) and Apple (AAPL) among young customers, but it will probably need to find older fans in developed markets to hit Wall Street targets, Russo argues. That could be tough. Amazon’s smart speakers have helped it sell music packages to older customers and will make it difficult for Spotify to expand in that market, Russo says.

And Spotify’s rivals are increasing their offerings. Google-owned YouTube Music is promoting personalized playlists to help users find new music, an area that has been one of Spotify’s biggest strengths. Amazon has released a high-quality music service that costs $12.99 for Prime users—a small premium to Spotify’s $9.99—offering listeners CD-quality sound, or better. Unlike Spotify, those companies don’t depend on music to make money.

Because of the competition, Russo expects Spotify to grow disproportionately in emerging markets, “where disposable income is lower and monetization, both in terms of subscription and advertising, is more challenging.”

Spotify stock may well rise when the company reports third-quarter numbers, given the bearish setup in the market. But for it to become an attractive longer-term investment, it needs a clearer path to profitability.

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