Spotify Deep Dive | Premium Report

Closingbell premium report covering Spotify, including downloadable valuation model

Introduction

Bob Marley once said “One good thing about music, when it hits you, you feel no pain” - and this has been true before he said, and will stay true well after he said it. All societies over time have developed their own form of music; whether it was the Geisenklösterle Flutes 43,000 years ago, the Ukrainian bullroarer - dating back to the Paleolithic period, or Tutankhamun’s Trumpets - which are believed to be the oldest playing trumpets found. The evolution of music in more recent years has shifted from vinyls in the late 1800s, to audio CDs and MP3 in the late 1900s, to the iPods and iPhones in the early 2000s. Warren Buffett’s famous comments about his investment in Gillette were “most men shave, and most men will continue to shave ‘til day dot”. Whilst not an apples to oranges comparison, we can safely state that most people listen to music, and most people will continue listening to music ‘til day dot. 

Despite its abundance and importance in people’s lives, the music industry experienced a period of value destruction. Between 1999 and 2015, the industry 54% of its value due a reduction in physical sales i.e. CD and vinyl, and the increased adoption of the internet providing an easy route to piracy.

Whilst the internet did contribute to its downfall, it has played a vital part in rejuvenating the industry. Since 2016, the global recorded music market has recovered tremendously, with the growth being largely attributable towards the rise of streaming platforms and smartphone penetration. Since this inflection point, streaming revenues have grown at a CAGR of 42%, compared to recording revenues growing at a 9% CAGR.

Apple was the first company to tackle piracy with the launch of iTunes. Whilst it did digitize music, provide consumers with flexibility, and access to songs at a relatively lower cost (compared to physical sales) - it was still unable to dethrone pirated music in the convenience rankings as piracy was still, while illegal, inherently free. This is where Spotify changed the game with its freemium business model, which allowed users to get access to an immense library of music for free with the downside of having to listen to short advertisements in between a few songs. With new entrants since like Pandora, Amazon, and SoundCloud - these tech-enabled operators have disentangled music from its delivery channels and changed the dynamic of the industry. Before we dive into Spotify’s business model - it’s beneficial to understand the music industry’s value chain.