Spotify has won the audio business and is now a money making machine

$Spotify Technology S.A.(SPOT)$ shares have been up 368.5% since the first Asymmetric Investing Spotlight was published on March 31, 2023. It’s the best-performing stock in the portfolio and a shocking performer to most investors. But go back to that article and you can see the path from there to here was clear.

Spotify was the first stock I covered here because the company fit some clear profiles that have led to long-term asymmetric returns.

1. #1 position in a large, growing audio market.

2. Ability to increase revenue per user to levels higher than the competition.

   1. I thought this would be through advertising monetizing free users, but the reality has been price increases on premium users.

3. Increased operating leverage by lowering operating costs.

   1. Multiple layoffs had already been announced by March 2023.

4. Aggregator — people choose Spotify first for music and podcasts.

   1. As a result, creators choose Spotify first because it monetizes better and provides more opportunities for growth (discovery, content creation tools, and targetted ticket/merch sales).

In 2023, Spotify had a good strategic position, but it hadn’t turned that strategic position into a good business. CEO Daniel Ek is now fond of saying he thought “We had a great product, but not necessarily a great business.“

In the nearly two years since, Spotify has indeed become a great business and there may be even more growth ahead.

The Margin Explosion No One Saw Coming

The biggest improvement in Spotify’s margins hasn’t come from advertising, where I thought there was high potential, but rather premium. The company has continued to grow its user base, but it has also raised prices and pushed margins higher, hitting 34.7% in Q4 2024 (not yet on this chart).

Since Spotify has to license music content from labels, it was always thought margins were limited to around 30%. But maybe the limit is higher for a few reasons.

1. Audiobooks are now being bundled into streaming and Spotify benefits from the bundle economics.

2. The “marketplace” where artists and labels can pay for promotion in playlists may be increasing the margin potential, similar to what we see with Amazon increasing their take rate through ads.

If premium margins remain near 35%, the profit outlook for Spotify is higher than I expected.

Where I thought there would be even more improvement is in advertising. In Q4 2024, the advertising gross margin was 15.1%, which is heading in the right direction, but ad growth is slow and this isn’t a business with real traction…yet.

Management has announced more programmatic ads and a deal with The Trade Desk for video ads, but this is still a point of potential and not great execution. To take another big leg higher, I think it’s ads that need to improve.

Operating Leverage Kicks Into High Gear

Going back to 2023, we knew operating leverage would kick up, but the pace and scale of the improvements are impressive. Free cash flow for the Q4 2024 quarter was 877 million Euros and still rising.

If we see ad revenue growth and margins kick higher, there’s still room for Spotify’s business to improve.

And the big takeaway is this: The battle for audio supremacy is over and Spotify owns your ears.

What’s Next?

I think Spotify has won in music and podcasts (audiobooks too, but that may be a tiny business).

Next up is video.

Management has been rolling out more video podcast tools and advertising will be rolling out through programmatic ads on video. Can Spotify become a video company too?

I’ve found myself watching more videos on Spotify because it’s so simple to put on a podcast and find out its video too. Maybe something like that will be compelling for the future.

At worst, video is optionality, and with a booming core, I still love where Spotify is positioned today.