It's not hard to conclude that the stock of Spotify Technology (SPOT 1.24%) is absolutely a buy. The company has already established itself as the global paid music-streaming leader, which suggests there is a lot of growth ahead of it, given music streaming adoption is still in its infancy. But the company has even larger ambitions than just music alone.
A long runway
Spotify had 299 million total monthly active users (MAUs), including 138 million Premium subscribers, at the end of June. Those figures grew 29% and 27% year over year, respectively, during a period greatly impacted by the COVID-19 pandemic.
And the company's total addressable market is vast. There are over three billion payment-enabled smartphones in the territories Spotify operates in or plans to enter, and smartphone adoption increases over time. In addition, there is precedent for global digital platforms to eventually have user bases numbering in the billions. For example, Alphabet's YouTube has over two billion logged-in monthly users, and Facebook has over three billion monthly users across its platforms.
While Spotify does face competition, it has been distancing itself from its largest peer. Apple Music, the No. 2 competitor, used to update subscriber counts periodically but has been mum about it since June 2019 when the company said it had 60 million subscribers. According to MIDiA research, Spotify has widened its lead against the iPhone maker in 2020.
Spotify is dominating the paid music-streaming business for a very simple reason -- it has the best product -- though many investors wonder if that's a sustainable competitive advantage, because, in theory, technology can be replicated.
But what's not so easily replicated is focus: None of the big tech companies Spotify competes with rely on music streaming for their survival. Given its singular focus, Spotify continuously invests in improving the user experience. It was easy as the industry leader to justify spending 615 million euros ($722 million) on R&D last year. It knows the global audio streaming market is huge and is its to lose.
Spotify's industry lead is especially impressive, because it has an inherent disadvantage in not owning its distribution. It relies on platforms from some of its biggest competitors like Apple and Amazon to reach its user base. In contrast, Apple Music has a direct line to users of the company's 1.4 billion devices around the world. Similarily, Amazon, Alphabet, and even Facebook have smart speakers in millions of homes. The fact Spotify leads the market across these many ecosystems highlights how strong its product must be to overcome that inherent disadvantage.
Not just music
Spotify has a clear path to growth as it expands globally, but it's not just relying on music. Over the last few years, it has invested hundreds of millions in podcast platforms and exclusive podcast content. For example, Spotify spent 357 million euros ($419 million) to acquire podcasting businesses Gimlet, Anchor, and Parcast last year.
Later, Spotify acquired Bill Simmons' The Ringer, a podcast and media business, for up to 180 million euros ($211 million). And the company's deal-making grabbed headlines once again when Spotify signed the The Joe Rogan Experience to a multiyear deal reportedly worth over $100 million.
Spotify is likely to use its new exclusive podcast content to drive both Premium subscriber growth, at least in the short term, and high-margin podcast advertising revenue in the long term. That's especially true as Spotify improves its monetization efforts, including its Streaming Ad Insertion tool that should allow targeted and measurable podcast advertising. Advertisers can get more value out of targeted podcast ads, which should persuade them to pay more, padding Spotify's bottom line.
A couple of decades from now, we're likely to look back on today as a time when investors could have bought Spotify for a song, because the market didn't sufficiently appreciate its long-term revenue and profit growth potential. That's why Spotify stock is a buy.