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Music-streaming platform Spotify takes the stage
June 18, 2019

From Stansberry Research

The music industry changed forever in June 1999...

That was the year file-sharing service Napster launched. The platform allowed users to create a free account for sharing digital music files in the MP3 format.

It didn't take long for Napster's popularity to explode.

At the same time, the platform facilitated widespread violations of copyright laws. Lawsuits from heavy-metal band Metallica and major record companies shut down Napster in July 2001... But regardless, the digital-music revolution had begun.

With Internet-based music downloads, you could purchase the usage rights to MP3 audio files... And you didn't have to buy the entire album. You could pick and choose the songs you liked.

The way people consume their audio entertainment continues to change... And it's threatening the business of some traditional content providers.

For investors, putting your money behind huge trends can be a great way to make money.

As companies "ride the wave" of a trend, they usually see their businesses succeed.

What's even better than investing in a company that's riding the wave is betting on the business that's leading the trend. We covered a similar theme in April with TV-streaming giant Roku (ROKU)...

Today, we're looking at another company that's transforming the way people listen to music. This business also focuses on digital music... But unlike Napster, it's doing it the right way.

In April 2006, Daniel Ek and fellow entrepreneur Martin Lorentzon co-founded Spotify Technology (NYSE: SPOT). The music-streaming platform rolled out in several European countries in late 2008. Now, Spotify has grown into the world's largest music-streaming service.

Today, streaming music – gaining access to content libraries and playing songs in "real-time" over the Internet – is just another part of our lives... But when Spotify was launched, it was a novel concept.

Spotify was able to make streaming nearly instantaneous by building an end-to-end delivery network – from server to client. Now you can stream your favorite songs in seconds through Spotify's app.

Since Spotify launched its U.S. operations in 2011, the music-streaming industry has taken off. Streaming accounted for 0.7% of total global music revenues that year. In 2014, that figure had reached 1.9%. In 2018, streaming accounted for nearly 50% of global music industry revenues.

Spotify and streaming have returned the music industry to growth.

Since bottoming in 2014, global music revenues have risen alongside streaming demand. Total sales were about $19 billion last year. That's still far shy of the record of about $24 billion. But streaming should lead the global music industry to record revenues once again...

Users have two options with Spotify – either a free ad-supported version or a paid, ad-free version. And you don't need hardware for either version. Just the app. Spotify doesn't want to restrict you to just using its hardware, it just wants to provide seamless integrations to as many platforms as possible.

For $10 per month, subscribers get access to Spotify's entire music library, as well as personalized playlists.

If you don't want to pay $10 per month for Spotify's premium subscription, you can still use the service free of charge. Spotify just limits some of the features and flexibility of its service. Free users don't get an unlimited number of song skips and can't listen to songs offline. Plus, they have to put up with commercials.

Spotify's free service doesn't just generate advertising revenue for the company. It's a key tool in driving premium subscriptions. Spotify has seen about 60% of its free-tier users eventually upgrade to its premium offering.

That's a huge conversion rate from free to paid customers. Spotify has around 117 million "free" or ad-supported customers today who it can target to convert into paid customers in the future.

And its paid service has more than 100 million subscribers. That's about double the paid subscribers for its top competitor, Apple Music.

Unlike Apple – a company that has established itself among the "Global Elite" – Spotify is still in its hypergrowth phase. Its revenues grew around 34% in 2018. And this growth should continue.

Spotify is still expanding its service to new countries. Right now, it's "only" available in 79 countries, compared to about 120 for Apple Music. Spotify is already the leader in music streaming, despite being in fewer countries than Apple Music. As it expands into new countries, it will continue to rapidly grow its subscriber base and sales.

Spotify's revenues are expected to grow to $9.4 billion by 2020, according to analysts tracked by Bloomberg. That's up from $6.5 billion today.

But Spotify isn't just about sales... It also has thick profit margins. Last year, Spotify reported gross margins (revenue minus cost of goods sold, divided by revenue) of 25%. That's more than double its 2015 gross margins. And it expects to keep widening these margins, which will help with profits. Spotify has a long-term gross margin target of 30% to 35%.

These trends in Spotify's margins and revenue should continue.

Spotify had its highly anticipated IPO in April of last year. After shares were issued at an offer price of $132, the stock shot up nearly 50% over the next three months... But as the broader markets declined in the last three months of 2018, so did Spotify's shares.

Spotify's shares have rebounded in 2019. Since bottoming around Christmas, the stock is up more than 35%.

Music streaming is the way people will listen to their favorite artists going forward.

And Spotify is the clear leader in this massive trend.

Sometimes investing is simple.

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