Since 2019, the world's largest audio streaming company, Spotify (SPOT 0.20%), has been pouring money into the podcasting space with hopes of diversifying its business away from purely music streaming. These investments have included acquiring podcast studios, paying for exclusive shows, and even buying entire podcast distribution platforms like Megaphone and Anchor in an effort to bolster its advertising revenue.
However, Spotify's podcast initiatives have drawn plenty of criticism from investors because the company's strategy has continuously shifted and the gross margin has remained negative across its advertising division.
But despite these lackluster results, the company continues to believe there is a large opportunity in the podcasting industry. And last week, Spotify introduced a new program that could have big implications in the long run.
AI voice translation
In a press release from the company's blog, For the Record, Spotify announced that it is leveraging new artificial intelligence (AI) capabilities to test voice translations for some of the world's most popular podcasts. Thanks in part to OpenAI's new voice-generating technology, the company says it has developed a tool to convert a podcast into several different languages while "keeping the speaker's distinctive speech characteristics."
Though Spotify is testing this new technology by translating only three episodes from English to Spanish, the company says it is planning to roll out French and German versions in the coming weeks. It will gauge whether to keep investing in the project based on the feedback from this pilot program.
Image source: Getty Images.
The big picture
While a three-episode experiment might not feel like ground-breaking news, if the program is successful, it could certainly have a big impact on Spotify's overall business. According to its latest quarterly results, Spotify is home to 551 million total monthly active users. Just 20% of those users are located in North America, and that percentage has been shrinking.
Over the last four years, Spotify's fastest-growing markets have been Latin America and the rest of the world, which account for the majority of Spotify's non-English-speaking geographies. In contrast, it's estimated that roughly 60% of the world's podcasts are produced in English.
With more than 300 million users located in markets where English isn't the first language, eliminating or even reducing the language barrier could drastically open up the pool of potential podcast listeners. This would not only benefit Spotify's original and exclusive podcasts but could help its advertising network as well.
Through the Spotify Audience Network, advertisers of pretty much any size can run a campaign that targets specific audiences instead of specific podcasts. That means instead of signing deals with a couple of individual shows, a sponsor can tell Spotify that it wants to target certain listeners based on individual characteristics like age, gender, or location. If the pool of listeners gets bigger, that provides advertisers with more prospective customers.
Is it time to buy Spotify?
Although it feels as if this announcement could have big implications for Spotify's podcasting initiatives, investors should be cautious about buying on the news. The company has acquired and introduced lots of new products over the years, including live audio, audiobooks, and a self-serve advertising platform, and none have really moved the needle financially.
Despite strong growth in its advertising business and management estimating that podcasts will have higher margins than its music-streaming operation, Spotify's gross margins haven't budged. In fact, in the most recent quarter, Spotify reported a 24.1% gross margin compared to 25.8% in the same period five years ago.
SPOT Revenue (TTM) data by YCharts.
While the company has seen remarkable success over the last decade by becoming the largest audio streaming platform globally, Spotify still hasn't demonstrated that it can consistently generate strong cash flow for shareholders. Over the last 12 months, Spotify produced less than $30 million in free cash flow, which is far lower than previous years and is a long way from justifying the current market cap of $31 billion.
Until the company shows that its investments in podcasting can really improve its profitability, I think it's best for investors to wait on the sidelines.
