Spotify Technology S.A.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 3/5

Spotify is a publicly listed audio streaming and media services provider, offering a vast library of music, podcasts, and audiobooks to its users.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Spotify’s business model is built around a freemium model, where users can access the basic music catalog for free with ads, or they can subscribe for ad-free access with enhanced quality and offline downloads.

Business Overview

Spotify is a Swedish audio streaming and media services provider publicly traded on the NYSE. Its core offering is a digital platform that provides access to millions of songs, podcasts, and audiobooks, making it a dominant player in the digital audio space. It operates a freemium model. Revenue is generated via:

  1. Premium Subscriptions: This is the primary revenue stream, generated through monthly subscriptions to ad-free, high-quality audio content.
  2. Ad-Supported Revenue: Spotify generates advertising revenue from users who stream music for free on the ad-supported tier. These ads are inserted between songs or as part of podcasts.
  3. Marketplace: Spotify has a marketplace segment through which they earn additional revenue through sales of artist merchandise and promotion.
  4. Other Revenue: A small portion of their revenue is other, mostly coming from licensing revenue for their content.

Spotify is the world’s largest audio streaming service, with more than 600 million monthly active users and over 200 million paid subscribers.

Industry Analysis

The streaming market is competitive but growing, with strong projected growth for the foreseeable future. Several trends are shaping the industry:

  • Audio Content Diversification: Beyond music, there is a rising demand for podcasts, audiobooks, and other forms of audio content. This trend is shaping Spotify’s content offering.
  • International Expansion: Growth opportunities lie primarily in emerging markets. While North America and Europe are saturated, Asia, Africa and Latin America represent significant growth potential.
  • Personalization: Consumers are increasingly expecting personalized and high-quality content. Companies that can effectively serve these needs have a chance at capturing market share.
  • Technological Innovation: Technological advancements create constant change and competition, particularly from AI and new features.
  • Competition from Big Tech: Big tech companies are all trying to compete with their own music/podcast offering.
Competitive Landscape

Spotify faces intense competition from:

  • Big tech companies: Apple Music, Amazon Music, YouTube Music. Those have the advantage of existing infrastructure and often bundled offerings.
  • Regional competitors: Services like Deezer and Tencent Music, may dominate local markets.
  • Legacy media: Traditional radio and satellite radio, still attract audiences.

Financial Overview

Spotify’s financials are a mix of growth and challenges. On the growth side, it has shown an impressive expansion in its subscribers as well as revenues. However, profitability remains somewhat volatile, partially because its royalty payments are dependent on its growing subscribers and revenues, meaning that margins are relatively limited.

  • Revenue: Revenues have increased from $7.9 billion in 2020 to $11.7 billion in 2022, but growth is expected to continue.
  • Profitability: While revenues are increasing, profits have not been as consistent, largely due to high royalty payments to rights holders, with the result being that the gross margins are a big constraint for the company’s profitability.
  • Cash Flow: Free cash flow has also been erratic and tends to depend on the company’s investments, especially on marketing and advertising expenses.
  • Debt: While the long term debt of the company is only €1.5 billion, it has additional liability of convertible debt, along with other contractual liabilities, meaning that the company isn’t entirely free of long-term liabilities.
  • Share Repurchase: Spotify has done some share buybacks, most notably in Q1 of 2022 when it repurchased $357 million. In Q1 of 2023, there was another stock buyback plan that was announced, meaning that the company is starting to mature.
  • Q3 2024:
    • Total revenue of $3.5B, up 20% YoY
    • Gross profit margin of 27%
    • EBIT of $73m, and net loss of $142m.

Moat Analysis: 3 / 5

Spotify has a narrow moat. Here’s why:

  • Switching Costs: Although switching costs might exist because of curated playlists, it is relatively easy to create a new profile and start from scratch on a competing app, or to use third party tools to import playlists. The switching costs are not high enough to completely protect Spotify’s market share.
  • Brand: The name Spotify certainly has name recognition, but is it truly enough to establish a moat? Probably not, and this is indicated by a decline in prices as soon as revenues start to dwindle, showing that prices are too tied to earnings rather than intrinsic value.
  • Network effects: Spotify also benefits from some network effects because friends will probably want to share music on the same platform. However, this effect is not strong enough to make Spotify a true winner in its space, as most people use multiple apps to listen to content.
  • Scale: Scale helps reduce costs. While a large catalog creates a benefit for users, it is relatively easy to obtain the same collection of music, or podcasts. As such, scale, while important, is not a big moat.
  • Proprietary technology: Proprietary technologies aren’t really a competitive advantage, because they are easily copied.
The overall moat score is 3 / 5 because it certainly has some network effects, and a decent enough brand, and a huge catalogue, meaning that the app is extremely valuable to users, and this value will likely allow the company to remain relevant and attract subscribers for a while longer. However, because of low switching costs and easy replicability by competitors, its moat is likely narrow and easily eroded. The company lacks a truly sustainable advantage.

Risks That Could Erode the Moat

  • Intensifying competition: As stated earlier, Apple, Amazon, and other tech giants are all trying to get a piece of the streaming market. Their strong position in tech coupled with their deep pockets and desire to bundle services may reduce Spotify’s moat.
  • Royalty/licensing changes: Increasing royalty payments to artists can squeeze margins. The reliance on third-party content makes the revenue flow depend on the power dynamics of record labels.
  • Technological Disruption: A better technology might make Spotify less attractive. For example, a newer technology that makes it easy to create a personalized playlist might make users less reliant on Spotify.
  • Shifting Consumer Preference: Changing taste in music and entertainment may shift consumer preference from existing offerings.

Business Resilience

  • Spotify has had good success in growing revenues over the past decade. - Its user base and international presence are expanding rapidly.
  • Although it is likely that the growth will plateau at some point in the future, Spotify is still growing at a reasonable pace.
  • The company is likely to withstand financial disruptions as long as its subscriber and revenue base remains strong and its operating losses remains relatively low.
  • Spotify has been improving its profitability, but might still see a lot more volatility going forward.

Understandability: 2 / 5

  • While the core business model of audio streaming is relatively simple, Spotify’s complicated contracts, international operations, and unique revenue streams make it harder to fully grasp the ins and outs of the company. The value added by the company to artists and creators and the complexity of that is difficult to comprehend.
  • The factors that affect the company’s performance such as user growth, royalty obligations, advertising, and subscription management, while not complex on their own, are very volatile, making the entire business a complex thing to analyze.

Balance Sheet Health: 3 / 5 

-   Spotify's balance sheet is reasonably okay, with cash and short-term investments outweighing total debt by around 3 billion.    -  Although its liabilities, especially regarding leases are quite high.    -  Moreover, intangible assets also play a significant role.    - The company has a sizable amount of short-term and long-term debt, and the profitability isn't as great as one would expect. The net cash flow is highly dependent on the company's revenue growth.

This indicates that Spotify has good enough short-term solvency, but may be prone to some financial vulnerability in the long term. It's also important to note that the company is also undergoing some transformations as it shifts into higher-margin services.

Recent Concerns/Controversies

  • Layoffs: In January 2023 and Dec 2023, Spotify announced layoffs in a bid to improve efficiency and reduce cost. While such restructuring can be beneficial in the long term, they will temporarily impact performance.
  • Content Moderation: There has been controversy about its podcast content, with some content creators being criticized for spreading misinformation. While Spotify is working hard to improve its content moderation capabilities, investors should keep in mind that a bad reputation could hurt the company in the long term.
  • High royalty payments: The company’s high royalty fees to rights holders are the biggest constraint on the company’s profitability. Those could increase, further squeezing the margins.
  • The Red Sea
    • Competitors in the market are extremely aggressive and are all trying to innovate, often with a lower cost base than Spotify. This makes competing even harder for the company.