If you've been in the stock market for a while, you've likely heard that it is better to be a long-term investor. But what does it actually mean to invest for the long term?
Every person has a unique perspective, but for me, it means investing with the goal of holding a stock for at least five years. If you're buying something today, your time horizon for the investment should be until at least early 2027.
One stock with great potential is Spotify (SPOT -0.62%), the global music and audio streaming platform. Shares are down over 50% year to date (YTD), even though the business looks quite healthy, potentially providing a buying opportunity for investors. Taking the long view, let's see where Spotify's business could be in early 2027 and what it might mean for the stock.
Will Spotify get to 1 billion users?
Spotify runs an audio streaming service where users have access to the world's music and podcast catalog, mostly for free. On top of this, it offers an ad-free music listening experience for a monthly subscription, with prices that differ across the globe.
At the end of Q1 2022, the company had 422 million total monthly active users (MAUs), growing 19% year over year. Eventually, the company aims to have over 1 billion MAUs across the world. With Spotify being the leading audio service in the majority of markets except China, and music/audio having such ubiquitous popularity around the world, I think this is an attainable goal.
Could Spotify reach 1 billion MAUs by 2027? To do so, it would have to keep up its current annual growth rate of 19% for the next five years. This might be a bit of an aggressive projection, but even if Spotify "only" grows MAUs at 15% a year, it will have 850 million subscribers by Q1 2027.
Right now, 43% of Spotify's MAUs subscribe to its premium music service. If this ratio holds up, the company should have around 430 million premium subscribers once it hits 1 billion MAUs. At a current monthly average revenue per user (ARPU) of $4.72, that would equate to $24.3 billion in annual recurring revenue from the premium segment.
Over the past few years, Spotify has invested heavily in podcast content, distribution tools, and technology. Because of these investments, it is now the most popular podcast player in many markets, dethroning the long-term leader in Apple Podcasts. This will help Spotify get even more MAUs around the globe, some of which will translate into premium subscribers.
On top of the benefits for the premium business, Spotify is monetizing podcasts directly with its new dynamic advertising network called the Spotify Audience Network (SPAN). You should think of it like YouTube (part of Alphabet) advertising but with audio, allowing podcast hosts to easily earn money through advertising without having to reach out to advertisers directly. Of course, Spotify keeps a cut of all this spending as revenue.
In Q1 2022, Spotify's advertising revenue grew 31% year over year to $304 million. Over the past 12 months, it has generated $1.37 billion in advertising revenue, with a lot of the growth coming from the launch of SPAN a little over a year ago. With the podcast industry expected to grow at a 27.5% clip through 2027, Spotify should be able to ride this tailwind and drive sustainable growth for its advertising segment.
At a projected 30% annual revenue growth rate, Spotify could be doing $5 billion in advertising revenues if it can keep executing with its podcast ambitions.
New audio formats
Spotify has a lot on its plate right now. Not only is it trying to aggressively win in streaming music and podcasts, but it looks like it wants to grow in audiobooks and live audio as well.
In 2021, it bought the live audio chatting application Lockerroom, which is now rebranded as Spotify Live. Popular podcast hosts do live shows on the app, which can then be listened to on their podcast feeds. The app hasn't gotten a ton of traction yet but should be additive to Spotify's podcast ambitions.
With audiobooks, Spotify hasn't made any moves on the consumer front but recently acquired a popular distribution platform called Findaway. In a press release, Spotify management said it plans to "revolutionize the audiobook space as we did with music and podcasts" but didn't give out any details on its plan. Still, we know the medium is a part of its long-term strategy.
It is unclear how Spotify plans to monetize both audiobooks and live audio, but it provides some potential upside in the form of optionality for shareholders. By 2027, we should know more of the details of its long-term ambitions.
So what does this mean for shareholders?
Combining the projections for the premium and advertising segments, Spotify could be doing around $30 billion in annual revenue by 2027. Through leverage in the premium business and scaling of podcast advertising, management thinks it can eventually reach gross margins of 30% or higher. If it can reach 30% gross margins by 2027, the business could be doing $9 billion in annual gross profit. And this is without considering any incremental benefit from audiobooks or live audio.
Given how much Spotify likes to reinvest for growth, we don't know how much of this projected gross profit will fall down to the bottom line. But with a current market cap of only $22 billion, I believe the stock price would be much higher than it is today.