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Spotify Could Transform Its Business by Following TikTok's Lead

By Leo Sun - Sep 9, 2020 at 8:58AM

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The streaming music leader could jump on the short video bandwagon to keep pace with TikTok and other platforms.

Spotify (SPOT -3.00%) recently filed a patent that could allow its users to create short "video moments" synchronized with its music. The filing, which was first spotted by Digital Music News, also indicates a viewer can look up a song's name and artist on the video's overlay, then listen to the rest of the song on Spotify's main platform.

A patent doesn't guarantee Spotify will add the feature, but it seems like the streaming music giant is interested in gaining some users from ByteDance's TikTok, the popular Chinese app facing potential bans in the U.S. and other markets amid escalating tensions with China.

The filing also suggests Spotify could follow Tencent Music (TME 0.23%), the largest streaming music company in China, into the "social music" market. Tencent Music generates most of its profits from its WeSing karaoke platform instead of its streaming music platform, and TME and Spotify already own significant stakes in each other -- so it wouldn't be surprising to see the two companies drawing ideas from the same well. But would an expansion of Spotify's platform with short videos actually strengthen its business?

A young woman listens to music on her phone.

Image source: Getty Images.

Reviewing Spotify's main challenges

Last year, Spotify's monthly active users (MAUs) grew 31% to 271 million, its premium subscribers rose 29% to 124 million, and its ad-supported MAUs climbed 32% to 153 million. Its total revenue jumped 29%.

That user growth continued in the first half of 2020: Its MAUs rose another 29% year-over-year to 299 million, its premium subscribers grew 27% to 138 million, and its ad-supported MAUs rose 31% to 170 million. However, Spotify's total revenue increased just 18% during that period.

Spotify's revenue growth decelerated significantly in the second quarter, as the COVID-19 crisis throttled its ad revenue from free listeners. The loss of that ad revenue then reduced its gross margins and offset the higher margins from its subscription revenue.

Spotify expects its user growth to remain stable in the second half of the year, but it only expects its revenue to rise 7%-18% year-over-year in the third quarter due to the pressures on its ad business and currency headwinds, and 11%-21% in the fourth quarter. It also expects to remain unprofitable throughout the entire year.

In that context, it makes sense for Spotify to launch a third growth engine beyond subscriptions and ads to generate higher-margin revenue.

Can Spotify emulate TikTok and WeSing's success?

TikTok generates most of its revenue from ads and virtual gifts, which viewers can buy for their favorite content creators. ByteDance is privately held, but Bloomberg claims the company more than doubled its revenue to $17 billion last year, with a net profit of $3 billion. TikTok and its Chinese counterpart Douyin currently reach over 800 million MAUs worldwide.

A young woman listens to music in a library.

Image source: Getty Images.

Tencent Music's WeSing generates most of its revenue by letting viewers buy virtual gifts for their favorite karaoke performers. The app is the core of TME's "social entertainment and other" segment, which grew its revenue by 36% to 18.3 billion yuan ($2.67 billion) last year. However, that business lost significant momentum in the first half of 2020 as cash-strapped users bought fewer virtual gifts throughout the pandemic.

Based on those facts, Spotify might launch a short video platform with ads and virtual gift purchases, which could squeeze more revenue from its free users who won't commit to monthly subscription fees. If the feature takes off, Spotify could also conceivably bundle virtual tokens or gifts as perks for paid subscribers.

But it's all speculation for now

Spotify's patent filing suggests it's interested in expanding into the short video market, but investors shouldn't assume it will happen anytime soon. It's all speculation for now, but it highlights some interesting ways for Spotify to expand its ecosystem, keep pace with social media platforms, widen its moat against its streaming music rivals, and eventually generate stable profits from a new high-margin business.

Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Spotify Technology. The Motley Fool has a disclosure policy.

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Spotify Stock Quote
$118.73 (-3.00%) $-3.67
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Tencent Music Entertainment Group
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