One of the most underappreciated stocks on the market today is Spotify (SPOT -0.63%), the streaming audio company. Since its founding, Spotify has been known as a music company, but its real future may be in podcasts.
Not only are podcasts growing in popularity, they're only now starting to be monetized at a high level. The days of MeUndies and Casper Mattresses dominating podcast advertising are over. Big brands are finding ways to advertise on podcasts, and as the industry matures, there's a lot of growth potential in improving the advertising model. Here's why this is one of my top stocks today.
Spotify's podcast play
The business of music has always been tough for Spotify. It's negotiating with a handful of music labels that control most of the popular music libraries, which squeezes margins and financial upside from listener growth. But podcasts are different.
Podcasting is done by everyone from big companies to someone in a closet studio. And Spotify's main job is hosting that audio and connecting it with millions of listeners. But there's an important piece of the podcast ecosystem that Spotify can address better than any other -- and that's monetization.
That closet podcaster doesn't have the sales team to sell ad space in a podcast, and even if it has a sponsor, the ads won't be very well targeted. Spotify can use its place in the market to connect advertisers with listeners, giving podcasters a bigger income stream than they could get anywhere else. And the strategy to become a long-term growth stock is pretty simple:
Step 1: Grow the audience
To dominate podcasts, Spotify needs to be the go-to place for podcasts. According to The Infinite Dial 2020 report from Edison Research and Triton Digital, podcasts reach over 100 million Americans each year, and 75% of people are now familiar with podcasts, up from 70% a year ago. Half of Americans age 12-34, a key advertising demographic, listen to podcasts monthly, and those who listen to podcasts weekly spend an average of six hours and 39 minutes listening to podcasts. And all of these numbers are growing.
There are certainly tailwinds behind podcast listening, but Spotify is building a strategy to own podcasts as a business. And that starts with getting listeners to switch to the Spotify platform:
- Spotify started by acquiring leading podcast maker Bill Simmon's The Ringer, which creates over a dozen podcasts, some now exclusive to Spotify.
- Another big splash took place when The Joe Rogan Experience signed to be a Spotify exclusive in a $100 million deal.
- In 2020, Spotify signed podcast deals with Michelle Obama, Brene Brown, and Kim Kardashian West, along with other influencers.
Once Spotify has content that attracts users, it can begin to wall off some of that content to Spotify-only networks. And that can help build scale that competitors can't match, which matters a lot in advertising.
Step 2: Data, data, data
Once Spotify starts bringing people into the Spotify app for podcasts, it can start tracking who its listeners are. It knows your name, location, music and podcast preferences, what you have searched for, who you follow, and your email address, gender, phone number, birthday, and more.
Advertisers can use this data to target ads. The problem with podcasts has always been that live reads were embedded in the podcast itself and couldn't be changed dynamically. So, ad targeting was limited. But Spotify is changing that too.
Step 3: Print money
Once you have a big audience and the data to understand that audience, it's a matter of monetizing the audience with targeted ads. That's what Spotify is expanding today:
Podcast Streaming Ad Insertion -- Spotify can now insert ads into a podcast dynamically. This allows advertisers to target ads to specific people, which is much more effective for advertisers and is the kind of targeting that makes Alphabet and Facebook so profitable. Spotify is trying to copy their model in audio.
Ad Studio -- This is a self-serve advertising platform that levels the playing field between large advertisers and very small companies for streaming ad insertion. Again, this is copying what made Google and Facebook successful, where spending $10 or $100 on ads to a very targeted market eventually added up to huge tech businesses.
These products have only been available for a short time for podcasts and will likely grow on their own as advertisers large and small begin to see their value. But they may not be the end of advertising innovations.
Given the fact that Spotify is running on a web-connected device, it could incorporate interactive ads or even play video along with ads. There will be many ways it can monetize podcasts if it owns the audience and has the data advertisers want.
Audio is a big market
Podcasts have the potential to be a huge business for Spotify, and there are some proxies we can use for the market's size. In the U.S. alone, $12.8 billion was spent on advertising on radio stations in 2019, according to Statista. Spending was as high as $18.1 billion in 2006.
Radio might not be the best. Digital advertising spending was $325 billion in 2019 and could grow to $389 billion in 2021, according to Statista. Any way you look at it, Spotify may just be scratching the surface of its potential with just 772 million Euros in ad-supported revenue in 2020.
Spotify's best days are yet to come
Here's what I think investors are missing with Spotify. The company is very early in its podcast strategy, and it'll take years for the advertising market to catch up. The best comparison I can think of is Facebook.
Facebook had 1.1 billion users in 2012, but it had just $5.1 billion in revenue and $53 million in net income. In 2020, its user base had grown 155% to 2.8 billion users, but revenue was up 1,589% to $86.0 billion and net income exploded to $29.1 billion.
Over that time, Facebook improved its ad platform and how it targeted ads to users, but the real gains came from advertisers getting used to the platform and the effect it had on their businesses. As that happens, budgets increase and ad prices go up. Facebook is no longer a niche ad spend for major companies -- it's a huge line item.
The same could happen at Spotify as advertisers get used to building ads for the Ad Studio and learn how to target audiences they're trying to reach. Over time, I think it's reasonable to expect that podcast advertising revenue will rise even more quickly than the growth in hours listened for podcasts -- and that's very bullish for Spotify stock.