On June 8, audio streaming platform Spotify (SPOT -7.28%) hosted a comprehensive investor day at which it went over its different business units and long-term goals. The event featured many Spotify executives, including founder and CEO Daniel Ek and CFO Paul Vogel, who provided plenty of insight into the company's music, advertising, and podcast segments. At close to four hours, the livestream was quite long, so it's likely many people were unable to watch the entire event.
Luckily, I was able to watch the entire investor day last week. Here are three big takeaways Spotify investors need to know.
Image source: Getty Images.
1. The music business is getting better
One big knock investors have againt Spotify is the low margins of its music business. Back in 2018, the company reported gross margins close to 25%. On a consolidated basis, this has remained relatively unchanged due to the amount of money being poured into podcasts, but Spotify revealed its more mature music segment is seeing nice margin expansion. From 2018 to 2021, music gross margins expanded around 0.75% per year, hitting 28.3% in 2021. Over time, management expects the segment to hit gross margins of 30% to 35%.
What's driving this expansion? The growth of Spotify's two-sided marketplace, a promotional tool that helps artists and labels get their work discovered on the platform. In 2018, the two-sided marketplace contributed only $21 million in gross profit dollars. By 2021, that grew to $167 million and should increase another 30% in 2022. That's still just a small part of the company's $11.8 billion of trailing-12-month revenue, but this promotional marketplace has very attractive gross margins and can be the key driver of Spotify's gross margin expansion over the next three to five years.
2. Podcasts are growing fast but remain unprofitable
Spotify's consolidated gross margins have remained stuck at around 25% to 26% since 2018 mainly due to the heavy investments it is making in podcasts. Management thinks the category will grow rapidly over the next decade, and it is trying to become the advertising engine that content creators use to monetize their work. At the investor day, the company provided some good data on how these investments are going and what its goals are for the next few years.
In 2021, the podcast segment generated around $210 million in revenue. While only a sliver of Spotify's consolidated business right now, it is currently growing rapidly, up 300% year over year. Management thinks it can become a $20 billion revenue opportunity over time. Right now, gross margins for this segment are at negative 57% as the company builds out its advertising business and scales its licensing deals. However, over the next five years, it expects podcast gross margins to surpass music gross margins and eventually reach the 40% to 50% range. This would have a material effect on Spotify's consolidated financials and likely enable it to reach 10%-plus operating margins even as it continues to reinvest into new audio verticals.
3. Large long-term ambitions
Perhaps the biggest takeaway from Spotify's investor day was its long-term financial ambitions. Daniel Ek said he has a goal of hitting $100 billion in annual revenue, 40% gross margins, and 20% operating margins by 2030. These are ambitious goals and will require many years of 20% or higher revenue growth along with sustained operating leverage.
How does he plan to achieve this? First is through the continued expansion of music and podcasts, which both have huge addressable markets around the world. Second is by expanding into new audio verticals. The first new vertical will be audiobooks. While minimal details about the consumer model were discussed, it will likely tie into the company's proposed acquisition of audiobook distribution service Findaway. After audiobooks, it is unclear exactly where Spotify will look to make waves in the audio market, but there could be huge opportunities in live audio, sports, and news. Investors should watch for announcements over the coming years.
Spotify has a lot to prove and a ton of moving parts to its business. But if you believe in the long-term vision Ek laid out, the stock's market cap will likely be much higher than its current $20 billion five to ten years from now, making it a compelling investment opportunity at current prices.
