Saturday, May 5, 2018

For the First Time in Decades, Wall Street Is Betting on Music

Written by Amy X. Wang — UPDATE: Spotify has reported its first quarterly earnings as a public company, posting – as expected – revenue of €1.14 billion ($1.36 billion) and a monthly active user base of 170 million, 75 million of whom are premium subscribers. But Spotify also reported a loss of €1.01 ($1.21) a share, compared to Wall Street's expectation of a loss of €0.23 ($0.27) per share. In after-hours trading, shares in the company were down about 9%.

The music industry isn’t where investors typically go to get rich quick. The business, despite its sheen of lucrative glamour, took a painful nosedive two decades ago when cheap digital downloads and piracy edged out physical CD sales; its pitiful revenues and unpredictability have caused Wall Street to slap a semi-permanent caution sticker onto it.

The mood, though, is changing. Spotify is due to report its first-ever earnings after the market’s close on Wednesday – and banks are uncharacteristically optimistic. Morgan Stanley issued a research note this week that makes a bull case for both the newly public music-streaming company and the music industry at large. The firm estimates that Spotify’s number of paying subscribers (i.e. those on the $10-a-month premium tier) could grow from its current 70 million subscribers to around 200 million by the end of 2022. “We argue the strong value proposition of paid streaming services will drive penetration higher over time," analyst Benjamin Swinburne wrote. Translation: Music streaming is a desirable enough product that more and more people will sign up to pay for it.

J.P. Morgan sent a similar note of encouragement to clients, calling Spotify a force in an under-penetrated market. Analyst Doug Anmuth pointed out that the company has managed to boost its monthly active user base by 38% annually, and suggested that it could do for music what Netflix did for video content. “We believe Netflix is the closest operating comp to Spotify, as both benefit from the secular shift to streaming through subscription-based models,” he wrote.

Netflix and Spotify don’t make for an exact comparison. The latter, for one, has yet to turn a profit under its current business model, which offers users both a premium tier and an ad-supported free tier. (Guess which of those two is losing money?) As Spotify’s revenues swell, so do the losses it has to incur from licensing payouts made to record labels, songwriters and music publishing companies, and many in the industry fret that Spotify’s free tier will interfere with its path toward profitability.

The banks, though, seem less worried – or perhaps they’re just betting on Spotify’s ability to convert more free users into paying ones. Spotify opened on the New York Stock Exchange on April 3rd at $166 a share, taking on a valuation of around $29 billion. Its first earnings report is expected to yield promising numbers, and Swinburne wrote in his note that investors would do well to take advantage of this “music renaissance.”

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