One of the most contentious stocks on the market is Spotify (SPOT -1.49%). The Swedish audio streamer has rabid fans who think it is the next tech giant, but also many skeptics who are rightfully concerned about the company's low gross margins and high payouts to the music labels.
It's hard to say who will ultimately be right on Spotify stock. But if things go well, here's what the business could look like five years from now.
A lot more users
The most important thing for Spotify's success is its ability to attract as many users to its platform as possible. It currently has 345 million total monthly active users (MAUs), and 155 million paying subscribers (known as premium users), up from 152 million MAUs and 52 million subscribers in Q1 of 2017.
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This past growth is impressive, and there are signs that it should continue over the next five years -- and beyond. This past winter Spotify announced it was opening its service to 80+ new markets throughout 2021, and adding 36 new languages. These new markets add over 1 billion potential new users for Spotify to go after, and bring the service to every meaningful market outside of China. With all these new users to go after, don't be surprised if Spotify hits its long-term goal of 1 billion users by 2026, with premium subscribers in the 300 million-400 million range.
Strong international growth will likely bring headwinds to Spotify's average revenue per user (ARPU). Users in countries with lower GDP per capita will likely not pay as much as users in Western nations, where the average premium subscriber shells out $10 a month to use Spotify (or $15 a month for a family plan). This, along with a higher percentage of MAUs vs. premium subscribers, could hurt Spotify's revenue growth in the short term. However, its investments into different audio formats (including podcasts) should make up for these losses.
Different audio formats
Spotify is most well known as a music streaming service. However, five years from now, management wants it to become a global audio platform, providing users with a vast library of different audio formats. Its biggest current investments are in podcasts. It wants to supercharge the industry that Apple has seemingly left dormant by investing in hundreds of original and exclusive shows, either through its internal studio or studios it has purchased like the Ringer and Gimlet. Only 25% of Spotify MAUs currently engage with podcasts, so it has a long way to go -- but the investments it is making should grow that number over the next few years. Podcasts open up additional revenue streams as the programming is more conducive to targeted advertising.
Outside of podcasts, Spotify is making some interesting investments in audio comic books. DC Comics is working on nine shows for Spotify to bring high-quality superhero stories to the platform. While technically labeled podcasts, these are really just audio versions of comic books, and they are an example of what Spotify means when it says it wants to become a global audio platform.
Higher profit margins
The big mark against Spotify is its low gross margins. These come from the high payouts it makes to music labels to license their catalogs on Spotify. While this dynamic will probably not change anytime soon, there are two projects Spotify is working on that could improve its gross margins over the long term.
One of these projects is Spotify's two-sided marketplace, which allows artists to pay to promote their work on users' homepages or within playlists. Artists either pay for the advertisements themselves or have the labels buy up discovery space in batches. Investors should think of the two-sided marketplace as a way for Spotify to get some of the gross profit dollars back that it lost from the labels.
Secondly, Spotify is working on an advertising network for podcasts. It is still in the early stages, but if successful the network should have Facebook-like margins at scale since it is essentially just a digital advertising platform in audio form. If this becomes a meaningful part of Spotify's business, it could drive its overall gross margins closer to 40%, which is what management has guided to over the long term.
Spotify has a lot working in its favor. The music industry is slowly migrating to streaming, and it is poised to grow for years because of it. It is also working on bringing all sorts of audio formats, including podcasts, to its platform, further increasing the value proposition for users. If Spotify can do all this plus increase profit margins with podcast advertising and artist promotions, the company should be a lot bigger five years from now.
