If you have been watching Spotify (NYSE:SPOT) shares double over the last four months and have been kicking yourself for having "missed" buying it, there's good news for you: You haven't missed it. In fact, the stock's long multi-decade run is just getting started. Here's why.
Early innings of global opportunity
Spotify has exploded over the last several years into the largest subscription audio streaming business in the world with over 130 million Premium subscribers. Total monthly active users ("MAUs"), which includes those on the company's free ad-supported service, reached 299 million as of the end of June. Both metrics have showed no signs of slowing down -- and grew 27% and 29%, respectively, year-over-year last quarter -- despite the global COVID-19 pandemic.
That is huge-scale already, and reveals a product that is distancing itself from its competitors. And the company has a huge amount of room to run ahead of it in the coming years and decades. There are over three billion payment-enabled smartphones in markets Spotify operates in or plans to. That addressable market is 10 times Spotify's current number of MAUs, and more than 23 times its number of Premium subscribers, indicating plenty of opportunity ahead.
In addition, there's precedent for the leading global technology platforms to reach billions of users. Facebook now has 2.7 billion MAUs around the world, a figure that just grew 12% year-over-year. YouTube, owned by Alphabet, has over 2.0 billion users. In fact, Alphabet has nine products, including YouTube, that each have over one billion users.
As Spotify continues to reinvest in product innovation and research and development, it is likely to widen its already massive lead over its competition and become another billion-plus-user global platform.
Multiple levers to raise margins over time
Spotify gets a lot of heat in the investment community for its relatively low profit margins, which are due to the large royalty payments the company is required to pay to the music rights holders. Those high royalties may not be changing any time soon, but the company has several compelling levers it can pull to raise its margins over time.
The one that's gotten attention lately is the company's podcasting initiative. Spotify began this push by spending 357 million euros (equivalent to about $422 million at current exchange rates) to purchase podcasting businesses Gimlet, Anchor, and Parcast last year.
Earlier this year, Spotify acquired Bill Simmon's The Ringer, a podcast and media business, for up to 180 million euros (equivalent to $212 million at current exchange rates). That was followed up by an exclusive podcast deal, reportedly worth over $100 million, with Joe Rogan's massively popular Joe Rogan Experience podcast, which joins the platform next week and becomes exclusive in December.
The company also signed Kim Kardashian West, the DC Comics universe, and Michelle Obama to exclusive podcasts, and just days ago announced a multiyear partnership with Riot Games that will bring all League of Legends e-sports audio content exclusively to the platform. What's more, founder and CEO Daniel Ek suggested there could be many more announcements coming when he said, "this quarter, you started seeing some of those announcements come in a big way" (emphasis added).
This effort should enable Spotify to sell high-margin advertising spots during these podcasts. Importantly, as the company continues to grow its audience, it should sell more advertising impressions per podcasting unit. That is a huge opportunity for unconstrained revenue growth on fixed-cost content. Couple that with Spotify's Streaming Ad Insertion ("SAI") tool, which is bringing dynamic targeted advertising to podcasts for the first time, and this business should be a meaningful profit driver over time.
Another opportunity to expand margins is the company's "two-sided marketplace" initiative, whereby it allows music labels and artists to promote music on its platform. Ek has said these revenue streams have "software-type margins," which are very high. And Spotify is gaining meaningful traction with labels, having recently come to an agreement with Universal Music Group, the largest label, that includes greater collaboration on two-sided marketplace tools. Further, the number of artists and their teams using Spotify for Artists tools at least monthly grew 68% year-over-year to more than 690,000.
Finally, it is easy to imagine Spotify having greater negotiating leverage with the labels when it has 200 million, 300 million, or 400 million Premium subscribers in the future. Being that big and even more important to the labels would put Spotify in a better position to win better terms that would likely help margins further.
Opening the door on pricing power
Finally, Spotify has an underappreciated opportunity to raise its prices over time. The company's Premium subscription plan in the U.S. still costs $9.99 -- the same price it launched with in the U.S. in 2011. As the company continues to gain market share and entrenches itself further as the streaming audio leader, it is likely to eventually raise prices.
Interestingly, since the company's initial public offering, management has consistently thrown cold water on the possibility of near-term pricing power due to its effort to maximize subscriber growth at all costs. But this year, that may have changed.
On the second-quarter conference call, Ek explicitly referenced the "pricing power" the company should have due to exclusive content and as the economy improves. This would be a meaningful positive surprise to the market, since we have seen nothing but declining average revenue per user over the last several years as the cheaper per-user Family, Student, and Duo plans have grown.
For these reasons, investors who feel they "missed" buying Spotify should think again before the stock moves even higher.