Chit Chat Stocks - Why We Own Spotify (Ticker: SPOT)

Episode Date: August 10, 2022

This is our inaugural Arch Capital Update episode, a monthly recurring series where we explore holdings and decisions made for our investment partnership. Spotify provides audio streaming services worldwide. The company operates through two segments: ad-supported and premium. Brett and Ryan dive through Spotify and outline the investment thesis for why we own the company in our Arch Capital limited partnership. ------------------------------------------------------------------------------------------------------------------------------------ What is Arch Capital? Arch Capital is a concentrated, long-only equity fund aiming to compound capital at an above-market rate. Arch managers are perpetual learners with a long-term focus that strive to build wealth with our partners through intelligent capital allocation. Learn more here: https://www.archcapitalfund.com/ ------------------------------------------------------------------------------------------------------------------------------------ If you can't access this episode, you may want to subscribe to CCM+. Sign-up directly through Spotify or Apple Podcasts for $5 a month. If you listen on another podcast player, use this link and create a private RSS feed: https://anchor.fm/chitchatmoney/subscribe Need more information? Check out our launch newsletter: Here ------------------------------------------------------------------------------------------------------------------------------------ Timestamps Why we own Spotify (2:20) Spotify's Moat (39:12) Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now, please enjoy this episode. Welcome to Chit Chat Money. This is our inaugural Arch Capital Update episode. On these episodes, we're going to try to illustrate or give context around how Brett

and I think about a specific holding, why we bought or sold something in our separate investment fund. This has been something that a lot of listeners have asked for. us talking about holdings that we actually have and we've kind of been reluctant to do that in the past but we're going to start to be a little more open with that and so we're going to try to have one of these at the start of each month and today we're talking about why we own spotify we're still working out the structure working out the kinks let me give three maybe a couple other notes here one if you're interested in any more information about the fund we'll have a link in in the show notes. Two, there'll be written stuff along with this, just like we're doing with other

CCM Plus episodes. So look for that in your inbox or on the Google Drive, however you'd like to access that stuff. Let's see one more thing. These are only for CCM Plus subscribers. So we want to make it within this format. And I guess lastly, these aren't stock recommendation episodes whatsoever. We actually plan to do a lot of postmortems on the stakes and postmortems on why we sold something as well. So it's not going to just be bullish recommendations. Don't be looking for that. If you're looking for this to be a reason why to buy something, it should be a part of your research process, not necessarily buying because we own it as well. Yeah. And for those of you that are subscribers that have accessed the Google Drive already, there will

be a folder in there. It should already be in there that talks about that has tangential files associated with this posting so with that let's get into why we own spotify we've kind of just segmented the questions where uh i'll take one you take one we pose these to ourselves let me yeah so you have the first one should i ask you what does spotify do sure uh it's and and this is kind of a a first attempt to this so if you think there's any way we can try to fix or improve these episodes feel free to reach out to us you guys know where to do that chitchat money podcast at gmail.com but what does spotify do spotify is the largest audio platform globally it operates a freemium model so that allows virtually anyone in the world i think they're in 183 markets today

to access the most extensive catalog of music and podcasts and they can do so at different pricing tiers so and that depends on your geography and the plan type so there's like duo family plan individual plan and then the price is going to be different for an emerging market like nigeria than it will for a mature market like the u.s but you can either listen to it free with advertisements in between your music or in between your songs or you can pay that monthly price and get it ad free in terms of other parts of the business that are relevant part of the attraction for a lot of customers is that you get or users is you get curated playlists and Spotify really gets to know you and they have a really good recommendation algorithm. So

you're getting new songs that you otherwise might not have heard. You're getting to discover a lot of new music, new artists, not only on the music side, but also the podcasting side as well. And that helps drive retention. So customers want to stay because Spotify already knows them so well. But it also helps drive higher engagement among their users. There's a quote from Daniel Eck. I think this was on the second quarter of 2021 conference call where he says, Spotify has more than two or even three times the amount of engagement per user than some of our competitors do. And later on in the episode, I'm going to talk about some of the different stats relative to competitors, but it really is the go-to audio platform, the largest one globally and kind of

synonymous with music streaming really the pioneer of the space yep and it's a simple model at its face they just offer a lot of audio content specifically right now music and podcasts but as we'll get into it the business is a lot more complicated than well it's a complicated business i guess i don't need to compare it to anyone but there's a lot of uh just nooks and crannies i guess to get around to see what their margins are see who they have to pay all that good stuff Do you want to talk about the unit economics? This is one of the big, I guess, bearish point of views is that they have really low margins. So do you want to talk about just go through the unit economics and how you think that could change?

Yeah. So Spotify brings out its business into two separate segments. As Ryan mentioned, there's the advertising and basically that's the free users. although as we'll get into podcasts are for all users really and they're all right now basically supported by advertising but i like to think about it as two different categories there are premium music subscriptions and that's one separate category for the business and the second one is advertising which includes both music and podcasts and other audio content in this episode we're going to look at both and kind of why the gross margins are where they're at today

and maybe where they can go into the future. So first up, we have premium music. This is Spotify subscription revenue. We want to reference at the end of Q2 2022, it had run rate revenues of $10.25 billion and run rate is just taking the last quarter of subscription revenue and annualizing it. And then their gross margin was 28.8%.

And that is adjusted for accrual benefits and then a one-time charge for closing their car thing production. So actual gross margin was slightly lower, but I want to reference that 28.8% because sometimes the accrual benefits can make their gross margins look a little more choppy than they actually are. Now, the majority of their cost of revenue, which is making their gross margins so low, comes from royalty payments to both labels, artists, and publishing rights holders. Now, we could do an entire episode on how all this stuff works but generally royalty payments are calculated monthly and are based on a combination of a percentage of revenue and a per user amount uh royalty payments are lower for

their duo family and student plans which makes sense because those costs lower on a per user basis and they change depending on the country so whatever region you're in um how each month if you're an artist or actually most of the time is if you're a label you have a pool of dollars based and all the listens that your group of artists gets, you get your paid amount, and then you do that region by region by region. And most likely, if you want to go lower, by different plans.

So it's complicated, but from an investor perspective, I think there's two important things to truly know, and that royalty payments are approximately two-thirds of Spotify's revenue, and the company has favored nation clauses, which means it has to give similar, if not the exact same royalty deals to every label. so the labels um i don't know if you could describe them as a cartel that might be a bit

mean but they do collude on price uh which is you know definitely a negative for spotify they're not able to do specific agreements with specific labels cost of revenue also includes i think this is important to know when looking at the stock it includes payment processing fees customer support certain employee costs cloud computing and certain equipment costs so the only reason to include that because it's pretty standard is they are not um at least from our point of view putting a lot of variable cost within the operating expense line which you can see a lot of tech companies a lot of companies that maybe spotify could get grouped into from our you know when we're looking at you know the sec filings we're seeing them throw a lot of variable costs

sometimes people toss in those payment processing fees sometimes people toss in um i don't know customer support and operations within their operating expenses but spotify does not have that now if we're talking about what margins could expand to in the future and ryan's going to expand on this in the next section the main way spotify's premium gross margins can expand is through its two-sided marketplace um this is when a label an artist promotes their work on spotify and the royalty payments as a percentage of revenue are lowered which spotify accounts for as a contract expense and cost of revenue. Thank you to Sleepwell Capital for giving the explainer on the accounting behind that. Yeah. And if that's confusing, it's just raising the gross

margins on those plays for Spotify. Now, anything else to add there, Ryan, before we move to advertising? No, I'm going to talk about the two-sided marketplace, but you're basically paying Spotify for exposure because the platform is so large and it can provide you a bigger audience. Yes. All right. Yeah. I also just needed to break there from talking. So advertising is the second group, at least right now, when you're looking at their financial statements and advertising revenue includes both music listening and other audio content, which for now is mainly podcasts. I think a hundred percent podcasts for, for being honest, uh, for music, the ad quarter revenue has the same or very similar cost of revenue structure as the premium business,

but has historically had way worse gross margins that were generally in the teens before they started reinvesting into the segment. For podcasts, luckily, there are no royalty payments under the same agreements as music, but cost of revenue will include the amortization of Spotify's content assets, which are both owned and licensed stuff, and then also pay out to podcast publishers on its two distribution platforms, Anchor and Megaphone. For example, if we want to advertise through their network, which they don't offer on Anchor to us right now, so if you're listening, Spotify, please give us that.

Bit of a pain point for us, honestly. Yeah, we'll actually talk about that in the better case later. But in general, they'll pay out the ad-supported, excuse me, the revenue share, and that's included in their cost of revenue. Currently, Spotify's ad-supported gross margin as of the last quarter is only 1.1%. You heard that right. It is basically zero and has been depressed for the last two years as the company has ramped up its podcast spending. This includes stuff like buying studios like The Ringer and Gimlet, which now they're investing a lot into

the cost of producing those shows, which is included in cost of revenue. And then licensed shows like the Joe Rogan Experience and Armchair Expert. Again, that's included in cost of revenue as well right um now to expand gross margins if it the advertising statement is going to do that um there's going to be need to be strong growth in usage and both revenue from the spotify audience network which will probably refer to as span which will explain in detail in another section this is the main way they plan to monetize its ad supported content so if it scales up gross margins are expanded as well because a lot of their costs within podcasts uh well not like a no cost you know it's not uh i guess well they're not including capital expenditures but it has you

know there's some costs there but a lot of it should be fairly fixed um except for the payouts to those third-party publishers yeah i'm going to talk about span here in a second why don't we just During that period, we can give our experience as podcasters with that platform. Sure, a little addition there. All right, let me ask you the next questions here for the next section. Yeah. One, why do we think Spotify has operating leverage? So this might get into our thesis a bit.

And two, what are the levers it can pull to expand margins? Ryan, why don't you go through some explainers here? the why pretty much boils down to scale and benefits of being as large of a platform as they are the specific levers there's i think there's essentially three ways that they can expand their margins from here and so the first one is that two-sided marketplace which you mentioned which is using spotify's scale to grow your audience if you're an artist and so there's kind of three ways you can do this. It isn't super clear, but one of them is marquee. So if you're a Spotify user and you've ever gotten... Now, not all of these are promoted

by artists, but if you've ever gotten a pop-up, as soon as you logged into the app that says, check out Post Malone's new album, and you can click into it. A lot of that is artists paying for that exposure. They're paying to target certain customers or certain people that listen to or might want to listen to uh their music and so they're um that's basically pure margin when you think about it i mean there's no incremental cost for spotify to do that they have tons of users 433 million to be exact that it can just easily pop up to um the second one and this is primarily um or it's in beta right now is playlist inclusion so there's a lot of different playlists that spotify has there's editorial um i'm blanking on exactly what the three groupings are but some

of them are spotify's owned playlists so they it's not curated specifically for the user those are different ones but it's rap caviar think of that one or um i think rock this is a big one and they have millions of users and so if you're an artist and you're able to get into those playlists it's a huge value add because you get exposure to a massive audience um and so and i believe they kind of keep this under wraps but i believe the way that you're able to boost your chances of getting in is if you reduce the royalty payout that you would get if your song got included so yeah and moving into the edit the non-editorial ones as well we have the reduced royalty payment if you can put it in say a made for you or a discover weekly maybe although again

we don't have the details of what they're including uh or sorry what type of or what songs are including what type of playlist right now it's all a bit of a black box right so just as an example if let's say you would typically get 60 cents on i'm making up numbers here but let's say you got 60 cents on every dollar for every uh for your plays you could say i'll take 40 cents on every dollar for every play where i'm in this playlist um or every play from from a user that clicks on my song in this playlist um that way you're getting you well first of all you're probably nominally getting more dollars but then you're also just getting more exposure because if you're an artist you make money outside of streaming that's really your primary income

comes from outside of streaming concerts events stuff like that um and then the last one i'll say is spanned. So we talked about this Spotify audience network. If you're an artist, you're a singer, you can advertise using Spotify, um, in between other songs. So if you've ever used Spotify ad supported, you've probably heard, uh, let's use Ariana Grande as example. Um, maybe, uh, check out my new song kind of thing. Uh, they do these kinds of things on the radio as well, but Spotify is just a perfect place to do it because, uh, everyone's there looking for something new to listen to uh those are kind of the three levers uh within the music yeah and the easy thing is is the more two-sided marketplace gets used among or say as a

percentage of listens or i don't know the exact way basically the more the two-sided marketplace gets used the more people are paying for marquee and discovery the higher spotify's premium gross margins are going to be because it's that contra expense it's just uh they just need to get that oh they're just growing a little bit faster and again we do not i don't think unless you have the exact numbers on the pace of the two-sided marketplace but it's absolutely the usage of it is absolutely exploded over the last few years they referenced that in the investor day so that was a great sign when we saw those numbers um as an indicator to us that the strategy is working yeah i remember at least on the revenue growth rate last quarter they mentioned that the two-sided

marketplace is still growing triple digits uh percentage wise so uh more than 100 they are a bit coy on some of this stuff yeah it was in the investor day but god that was a long pdf so i i don't remember that exact slide but uh they do mention the size of it in there the second way they can kind of grow is just by the growth of podcasts overall so until until podcasts uh become a subscription like i know if you're listening to this you use subscription but subscriptions are not popular right now um and i think to really have a subscription you have to try to offer stuff um that's a other it has to be obviously be exclusive but um you probably have to offer stuff outside of the podcast experience but until those are popularized

the bulk of podcasting revenue is going to come in the form of advertising dollars and there's two ways that spotify generates those ad dollars spotify audience network and then the wholly owned and exclusive shows advertisements on those shows yeah and sometimes it's confusing because sometimes span is on the wholly owned and exclusive shows sometimes it's not but generally there's those two different categories right and so let's let's talk about spotify audience network i'll give sort of the boilerplate one-liner on what it is and then i'll talk about our experience uh or we can talk about our experience as podcasters so span or the spotify audience network is an automated advertising marketplace that leverages spotify streaming ad insertion technology i know that's

a lot of buzzwords but basically let's give an example if i'm an advertiser and we have been an advertiser before on span uh we tested it out yeah it might not have been our target uh made out of our best form but we did it on ad supported music bad move for from a podcast but uh that i I guess that was our mistake or they hadn't rolled it out from podcast to podcast yet. But anyways, if I'm an advertiser, I can sign up, I can pick a budget for my ad campaign. I can upload what my advertisement will be, the audio for that, or you can give them a script and they'll do it for you. It kind of varies.

They've changed frequently on that. And then you select the target audience that you want. So for us, it was 20 to 30 year old males who I think it was who are in their cars because They can, uh, they have sort of your geo, uh, typically a lot of the Spotify users will share their, uh, locations and so, or share their tracking. So you can target them if they're in their cars. Um, and I think we did who are interested in business. Uh, and so you can target like that specific cohort and then select the ad inventory.

So for, in this case, we should have clicked podcast ads, but we didn't have the capability. So you can either choose advertisements for podcasts or advertisements on the ad-supported music side, so in-between songs, that kind of thing. And then that ad will run automatically in any available ad slots where it comes in. You can give sort of a duration for how long you want it to run. But this is pretty much, we think at scale, going to be high 30% to low 40% gross margin, which is above their current aggregate gross margin. So it should be a margin lever for them. No, you say 30 to 40%. I think I'm a little bit more optimistic given the revenue share agreements on a lot of the

SPAN stuff, plus a lot of SPAN advertisements will hopefully be transitioned over to the owning exclusives, which will have a lot higher gross margins, hopefully, than the owning agreement. Because if they're sharing, say, a 50-50 on the SPAN stuff, I think the gross margin will be closer to 50% on the SPAN. There's other costs to run these businesses. I would figure it's just like any sort of digital business. You've got the same sort of costs, the cloud hosting fees, payments, providers, if that's included in there.

Your typical cost of goods sold, and then the 50% gets knocked right off the top. Yeah, and it depends what they're doing for the revenue share. It could be higher, it could be lower. We're doing 50% megaphone, but they could change that over time. Yeah. So it's a little unpredictable, but so for example, our, our podcast, we basically, we were, when we were using megaphone, we would go in, we would upload our audio. We would click, I think it was two or three places where we wanted to include an ad inventory and ad slot. those would automatically be bid on by all of megaphones various advertisers or spotify audience networks advertisers um and let's say our revenue was five thousand dollars we would get 2500 from that uh because the other 2500 would go to megaphone it which is owned by

spotify yes which yeah it and i know that sounds like a huge take rate and it is especially for for the time being but it really offloads a lot of the costs it makes it very youtube like or not costs a lot of the efforts we don't have to go out we don't have to find advertisers we get those which for a lot of small shows is very difficult to do um and so it really kind of helps scale podcasts yeah should we talk about the positives and negatives of span right now yeah why not um what did you like about it well i mean the clear thing is that it's just so much little so much less work on our end and and more certainty that you're going to get well let's say you're a small show and you've got two advertisers if those advertisers leave you have no revenue exactly

you will get some revenue with with span yeah that is that is for certain um yeah what i did like about it is basically and maybe it takes less than five minutes of work per episode to get the ads where you want it so the the incremental work you have to do is minimal and that's it you don't have to record any ads um which takes a lot of work you don't have to find the advertisers you don't have to sign a deal with them there's a lot of you know how talking with someone on the contract goes and you know you might have them only for a few months so you're doing all this work for just a few months of time and there's all the tracking all the billing yeah and we do that yeah and it's you know we we try to do that but it is a lot of work and to be frank when we've

been looking for new advertisers um as we went to anchor we do have as people who listen to the other the ad supported format have noticed i guess or have heard we do have uh host read ads from ourselves when reaching out to people if we don't really have a prior relationship with them it's extremely difficult to find someone to advertise on a smaller show which leads me to the positive of span is that they can go for the full plethora of podcasts that maybe have just a few listens up to whatever a million or 10 million like the joe rogan experience or something like that and you'll be able to monetize that long tail uh sorry go ahead you talk about the positive then we'll go to the negatives which is really execution if you're an advertiser and i think

strategy articulates this really well but you used to only target the big shows because they were worth the effort um you didn't want to do someone who got 10 listens because it just what it simply wasn't worth the effort um now each invent you are looking at it not on a per podcast basis but a per user basis you're getting you're targeting specific inventory as as opposed to a particular podcast, which really helps the little guy and should increase overall ad dollars in aggregate. Yeah. And if you're an advertiser, it's a lot simpler because instead of working with say dozens and dozens of shows, I'm going to use an example here of someone who's not our advertiser in the finance world that people might understand. So you've heard probably

tons of advertisements from Tegas. Which if you want to advertise with us, go ahead. you do when you're listening yes but they have to reach out to all these different shows um and i'm sure they're getting a good return on ad spend or else they wouldn't be doing this but you have to go out to all those you have to get you know the approval and maybe all the reads and it's a bill from each specific one if you're a tgs and you work directly with span and say instead of having a ten thousand dollar budget with 10 shows you have a hundred thousand dollar budget a year or maybe a month, however big they are with Spotify and you record one ad or maybe you have one ad recording and it changes maybe every two weeks or something

like that and it goes to Spotify, they can target the users more specifically to who you're looking for and it's a lot more of less work on their end. So from our point of view, as people who host a podcast and will listen to them as well and our investors in Spotify, the theoretical potential of SPAN is extremely high. But let's talk about the downsides. Cost. Well, Ryan, maybe you go through some of that on your mind

and I'll talk about maybe some on mine. I mean, I think the biggest low light was really cost. And then you kind of- You mean by cost, just, yeah. Well, for one, until right now, they're still in the process of rolling it out to podcasts on anchor it is available to podcasts on megaphone but megaphone does cost money to host on and they take a big clip off your revenue um spotify or in this case

megaphone does so your cpm let's say you would get cpm is the cost per thousand listens um so let's say you are getting what in a manual agreement with an advertiser i can get let's say $30 per thousand listens with span. Let's say you're getting that $30. You're really only taking home 15. Yeah. So you either have to double the advertising on the show to make up for it, or the CPMs have to go up and theoretically they should,

but you have to get the adoption from the advertisers. Yeah. And the other downside is that span is not yet rolled out internationally. So we're missing a lot on that front. It doesn't get the plays that maybe you would get on a YouTube video where basically there's 99% execution rate on getting an ad filled where it's supposed to be. So the actual CPM that we were getting was much, much lower than even the, say, $15 that we supposedly had. Now, there's some, I say, positives, which from Spotify, they say their CPMs continue to go up on span and it's marching higher. But from our point of view, I think, and this is our point of view as investors, the two things we're looking for for continued execution on Span, because it's going to really help the creator community for podcasts, which will help Spotify make more money, is rolling out to Anchor, which powers, I believe, and the number, the exact number isn't really important, about 70 to 80% of new shows on Spotify or just new podcasts in general.

So that's just a huge amount of catalog content that people can use to make even a tiny bit of money or a lot of money. And second, rolling out to more international areas because podcasts are global. We're not even, I mean, we're just from the United States. We have barely any global reach. We're a small to niche show.

We still have tons of listeners internationally that when you're on spin cannot monetize at all, at least right now. And that's just a huge downside for someone who's trying to make money through advertisements. Right. And the other element of podcast is just the wholly owned and exclusive shows that Spotify has. And so these are, this is really a much more basic way of getting revenue. Those shows have advertisements. They collect revenue. That revenue goes to Spotify. Yeah. It's like the Joe Rogan experience or Bill Simmons show.

Very simple. Now, the actual gross margin of what podcasts will be in the future, it's kind of a wild guess. Spotify thinks long-term it can be 40% to 50%. I think they're probably right, assuming that podcasts get large enough and they get enough listeners and they get enough advertisers, or else it obviously won't hit that metric or won't hit that level of margin. And it also depends on the mix because the wholly owned and exclusive have much higher gross margin, but there's a lot of fixed costs. So, you know, you had to pay for Joe Rogan to come over. That's kind of upfront or you have, you know, you got to pay your studios, you got to pay salaries to the host, that kind of thing. So it's a higher margin than Span, but Span theoretically could be much larger business. The last thing I'll say for potential margin expansion or potential operating leverage is audiobooks. This is kind of speculative. We're going to talk about this a little more, but they recently closed on their acquisition of Findaway, which is, I believe, the largest audiobook

distribution platform globally. And so it basically, if you read your audiobook, or you might be able to get connected with readers, I can't remember specifically, and it gets spit out to all the audio book listening destinations, it's uncertain how this is going to be used or how this is going to be monetized. But in their investor day, they mentioned that this could be, I think it was either 40 to 50% or 50% plus gross margin.

It's going, even if it's a small business, if those gross margin, if that gross margin figure is correct, it's going to be a margin enhancer for Spotify and aggregate. Um, so that's just kind of the last potential lever, but it's still speculative. We don't know what that the audio book business is going to look like since it hasn't been rolled out.

Uh, I think that pretty much covers it for operating leverage. Do you want to talk about, I mean, we kind of already talked about the podcast initiatives, um, but there are some others that everyone keeps. I always hear people say Spotify is pushing into podcasts without a clear definition of what that is, what that push entails. Do you want to talk about the different parts of that podcast initiative and then how it can impact the business? Yeah, we did cover it a bit, but I think this comes from our experience. A lot of people misunderstanding what they're doing here, which I guess is great for us as investors, but just misunderstanding kind of their moves and what they've actually done.

So, yeah, this might take a little bit of time, but I'll try to speed through it fairly quickly and hopefully people can understand. So starting about three to four years ago, to give some context, Spotify heavily invested into the podcast market. At the start, they only had a few hundred thousand podcasts available on the service. But at the end of Q2 2022, so about four years later, there were 4.4 million podcasts available on Spotify. And it's estimated that the platform is now number one in market share across many different regions, slightly beating competitors like Apple Podcasts and YouTube in many markets around the globe. So how did this happen? They went from basically nowhere to winning the podcast market from a usage perspective. And we've already talked about

how advertising will hopefully come on top of that. But really, they had a three-pronged strategy for both user acquisition and growing podcast hours played. The first strategy, which they started out, I think the earliest, was buying studios. So over the past three years, Spotify has purchased the ringer for 200 million dollars gimlet for 230 million dollars and podcast for 50 million dollars these are three popular podcast studios that really help bolster the amount of content that spotify has full control over they also have their own studio which has been a bit of flux i think it's getting absorbed and across these other ones and spotify has invested heavily within their own studios uh ringer gimlet and podcast as well so to beef them up and invest

even more post-acquisition. Now, the majority of the shows across these studios are available across all podcast players for now, with Spotify mainly monetizing them through advertisements, like we mentioned above. Now, the second strategy is licensing top shows. Spotify's probably most well-known strategy has been to license these popular podcasts to go exclusive on Spotify, so available nowhere else. You have to download Spotify to listen to these shows, most notably the joe rogan experience call her daddy an armchair expert the company is spending hundreds of millions on these deals with some investors um which if you're just kind of looking at them uh just reading maybe headlines and some articles you may scoff at this because the roi or

return on investment looks unpromising when you just consider the advertisements that can be run on an episode of say the joe rogan experience when they're paying him 100 to 200 million dollars for two years of shows. However, we like to look at these deals holistically because they can be great acquisition tools for customers to say, I mean, maybe not one show, but in aggregate, tens of millions of listeners around the world to choose Spotify for their audio needs. Say switching for Apple Podcasts, switching from YouTube, switching from wherever. Spotify can then make money by upselling them to premium subscriptions for music or convincing them to listen to all their podcasts on Spotify and monetize that through Span, which hopefully

will become adopted. So you can kind of see how all these pieces are. There's a lot of variables, but hopefully they will come together and, you know, we call it the audio Lollapalooza, but we'll see if it actually gets there. Now, the step one, the clear step one is getting podcast listeners more, as much podcast listeners as they can on the platform. And part of that is by cross-promoting to typical music listeners to get them to listen to podcasts, but also trying to get just new users by taking their favorite shows and making it available nowhere else. It's, I mean, unless you've seen data points, I haven't necessarily seen anything that gives a definitive. and there's no i don't even know if there's a way for spotify to know um how much of a benefit this has been on the user side these exclusive shows i think you just have to look at how many i think

they'd be able to do it because you just look at how many listeners of say the joe rogan experience you have and how many of them have come over since he yeah since he can't since he joined them exclusively but they haven't shared any with us so we don't know but we do think it's a key way they've been getting market share and kind of consistently growing their monthly active user numbers which if you're listening to this we're not just going to reiterate what their uh what their monthly active user numbers are and their q2 results or something like that you can read that yourself they have like a 20 page slideshow we kind of want to go into the deeper parts of the business and why we think they can be a compounder now let's get to the third part here

and maybe the most important but only important because it connects to the uh it connects to having all the users on the platform as well, or excuse me, on the service as well. And the third strategy they have is owning the distribution and technology. So Spotify has made multiple acquisitions and podcast distribution. We've mentioned Anchor, we mentioned Megaphone, and then there's Wooshka, which is a strange name, but it's basically just taking radio shows and turning them into podcasts automatically from what I'm aware of. So similar to Anchor, Megaphone, and hopefully we'll get tossed on to Span. And then there's podcast technology companies, which are charitable podcasts pods among some others they will serve uh theoretically as the

backbone for both third-party distribution and building the advertising business so for example the podcast you are listening to right now is distributed through a spotify owned entity anchor yeah well as we mentioned now megaphone and we're mentioning uh kind of more details here is one of the leaders for premium podcast publishers so say like the wall street journal while anchor covers the long tail as we've mentioned and i have the stat here exactly anchor powers roughly 70 of podcasts on spotify listenership is probably a lot lower but they've invested a ton into these companies anchor megaphone are both over 100 million dollar acquisitions so in whole if we go through their studio bios exclusive licenses and distribution buyouts spotify has invested

over 1 billion dollars building out a podcast content and distribution ecosystem how does it plan to monetize and get a very good return on all this invested capital by building a targeted advertising business as ryan was talking about above it's i mean to be frank it's a bit of a messy strategy and it isn't completely clear but if if we're if we could boil it down into one thing or like a few steps i would say it's get get listeners over first the advertisers will follow And in order to get the listeners over, it's not only original content, but also exclusive content. The original content, I guess, is more for the advertisers because it's also on other platforms. It makes it, you know, we've kind of dealt with this now.

It gives Spotify a lot more optionality in terms of monetizing if they're able to get listeners locked in on the platform. Yep. And let me close out this section by saying Span is only a year old, and a lot of the podcast investments are categorizing cost of revenue, which is why advertising gross margins have plummeted, as we mentioned above. Now, over the next three to five years, we're hoping to see, I mean, that's part of our thesis, to see the margins on gross margins expand. Where they're going to be, who knows? however with fewer variable costs than the music business if advertising revenue can continue growing at about 30 plus a year globally um as it's doing right now as we kind of project and obviously it's just you know assumptions are assumptions there should be gross margin expansion because there is that fixed cost element all right that concludes podcasting

initiatives why don't we go into maybe the most important question ryan does spotify have a moat does it have a competitive advantage and if so why so and you might disagree with me here but i'm not gonna i think it would be overly optimistic to say spotify has a clear moat and it depends how you define mode i guess but what is clear is that they have a superior user experience and that's demonstrated by the numbers and if a if a superior user experiences your definition of emote then maybe you can call it that and maybe that lends itself to different competitive advantages but i'm going to talk about why it why i think it has a superior uh user experience so over the last several years if uh if you've been paying attention to sort of

the music streaming landscape or you've been looking at different deals and maybe you've just been getting shoveled discounts um all of spotify's competitors have offered significant discounts on their products um and so these include let's let's go through them so youtube premium music you get for free with a youtube premium subscription uh apple music you can get six months of apple music free with the purchase of airpods beats or the homepod and then you can also get it's also pre-installed on apple devices it's it's very uh it takes a little more friction to go out and get spotify as opposed to apple if you're an ios user the third one out amazon music is free with a prime membership half of americans are prime

members so are you is that the that'd be their full tier i think i think amazon has different chairs but either way if it is a music service for free even if that's a light tier i went and looked At the Amazon Music, you get four months free. It said the deal ends tonight, but I'm calling BS on that. I guess they got to create a sense of urgency. They're giving these things away for free. And in that time, amidst all these, and there have been tons of different discounts over the years. But amidst all these offers, over the last six years, Spotify has increased its total MAU count from 104 million people to 433 million people.

and it's today it's far more than any competing service globally and it's even 1.6 times more users than apple music in the u.s where ios is the dominant operating system and it comes pre-installed and we should add uh ios is the dominant operating system in the u.s globally in most other markets android is the dominating operating system and android is owned by the same company that owns YouTube, which has YouTube Music, which is a clear competitor here. They're offering it as a bundle for YouTube Premium.

They have the platform advantage, and yet they're not getting the usage as Spotify is, or the user numbers as Spotify is for YouTube Music. Yeah, and they aren't getting the usage either. So Spotify generates more engagement than competing services. Their monthly active churn is significantly lower than all other peers.

It's clear. if the content library is largely the same across all of these services there's only one thing that could be driving spotify's relative success and that has to be a superior user experience so and we're speaking music there specifically right and a lot of the podcasts are aside from joe rogan and a few yeah only a few um color daddy i mean most of the podcasts are the same across platforms too so um seems to me pretty clear that they have a user experience and they've increased users i think every quarter in their existence uh don't quote yeah maybe of the of the public of the public system yes yes do you have the number there yeah you said that the user number

104 million to 433 million long-term goals a billion and maybe we we probably have to discuss the well i think that's a pretty legitimate goal uh given our market share but basically if they hold their current market share of 30 and three to four billion people start streaming audio globally uh which makes sense given that most people 99 of people listen to music and almost everyone's going to have access to you know an internet connected smartphone at some point and i've mentioned i mentioned the 433 million total users globally not all those are premium users i believe it's at like 45 or 46 percent are subscribers the other 55 percent i think roughly are advertisers and that can kind of uh zigzag uh the those numbers tend to fluctuate but they

the we've we've laid out today why the advertising users are not just free users like the the those in the past are still going to be able to drive revenue yeah in the past they were kind of treated it as loss leaders but now um now there's they still need to execute but theoretically they should be a lot more valuable globally especially if span becomes a global advertising network um let's talk about valuation i think we want to talk a little bit more on the moat side now if you look at the general uh kind of definitions of a moat do they have a network effect no because everyone's just using it kind of similarly do they have economies of scale maybe it may be a workaround on the people like to talk about artificial intelligence and stuff like that

i'd say probably no well um do they have switching costs and i would say because of the discovery stuff because of the playlist stuff which sounds a bit like like you know like well whatever these playlists and stuff if you're entrenched with using spotify for multiple years and you can see that in the churn numbers being a lot lower than everyone i believe the switching costs are fairly high. And that could be maybe a light competitive advantage right now, but one that develops more and more over time. And then second, this might be not in the classical sense of a competitive advantage, but as they try to become the world's audio platform and get audio books, podcasts, whatever, even live audio as well onto the service, and they become the, as people like

to call the aggregator of audio, I think that can be a competitive advantage as well, similar to how youtube has been with video but that's more that last one is more speculative and could make them become a much larger business in the future but not um it'll take a lot of execution i guess all right let's talk about valuation how are we well maybe we can have our own opinions but uh how are you thinking about valuing spotify today yeah and this should we should talk here that before diving into the financials we should know that forward estimates and kind of complicated discounted cash flows are really not a huge part of our investing process as you maybe had picked up on and we'll probably discuss in this section we like disagree on what the exact

numbers might be and most likely we will both be wrong on some of this stuff we really care about identifying a competitive advantage or an emerging one um in a durable industry which for for this one we don't need to even talk about they're obviously in a durable industry um evaluating management basically asking whether we trust them and then seeing if the stock is at a reasonable price of course evaluating whether a stock is at a reasonable price requires making some sort of projections about future cash generation but we really find it foolish to put any precision on the numbers so we kind of just want to get a just a sense of whether we're not crazy yeah not crazy of what price we're paying.

So with that being said, here's some rough numbers we put together for our report on Spotify a year ago. Like I mentioned, we actually disagree with some of the numbers we put down there now,

which we can discuss for how we would update the model currently. First, let's look at the premium business. Our estimates are that premium subscribers will grow by about 10% a year through 2030,

which would be a big slowdown from today, which is kind of how we expect as they scale. Gross margins will steadily expand to 36%. uh due to the two-sided marketplace and average revenue per user will grow by three percent a year the arpu arpu number uh which is just average revenue per subscription across all

their premium subscribers that may shock some people because you think three percent a year that's a lot of pricing power but uh we can discuss or we have discussed really why spotify is a differentiated service they've raised prices before um last year actually and they've seen no material churn change. And basically, if that enables them to raise prices by 10% or so every three to four years, I don't think that's too much to ask for, at least in their core markets. Now, for the premium business, that would equate to about $6.2 billion in gross profit in 2026. Given their really propensity to reinvest for growth, it is unclear how much that growth, uh sorry gross profit a little spelling error there let me fix that will turn into say operating

income or cash flow but whatever the exact number is we believe tons of value is getting created for shareholders nonetheless so what will that segment do maybe a billion dollars in operating income but uh by 2026 i'd say it'd probably be closer to two to three billion but we never know that's kind of the thing with spotify a little bit of the uncertainty they love reinvesting for growth Now for advertising, our projections were in the report last year for 30% revenue growth through 2030. Remember, this is generally from a low base and we've already discussed whether it's this giant potential within the podcast advertising market and maybe add on audio books as well, maybe adding global music advertising, getting much, much bigger. And then we also model gross

margin expansion to 48% by 2026. This might be higher than what Spotify indicated on investor So we probably disagree and maybe put that a little lower now, but that equates to $2.3 billion in gross profit from advertising in 2030, which would balloon to $8 billion by 20, or excuse me, $2.3 billion in 2026, which would balloon to $8 billion in 2030. Yeah. And I know this, this is probably hard to digest in an audio format and talking evaluation can always be a pain. Yeah. We only have, that's basically all the numbers we have. So, let's do it this way. What do you think the premium gross margin will be in five years? Five years? I don't know.

30, 33, 34%, something like that. Okay. I mean, I could be completely wrong, though. Really, we think it's going to go higher because of the two-sided marketplace. I think that's the only question you'd ask. where do you think the gross margin can be on the ad supported side uh given what they've said we'd probably revise that down to about 40 percent um but that'll take a lot more execution there's more uncertainty with the advertising segment now if on a consolidated basis we bring

that back down to add up the two we think really again their estimates so let me just put some ranges here that they have a clear path spotify to generate about seven billion to nine billion in gross profit annually about five years from now, which will flow through to maybe $3 to $4 billion in operating income. And with free cash flow generally being slightly higher than operating income, free cash flow will be slightly higher than that $3 to $4 billion. And then at a market cap of about $22.7 billion today as of this recording, and even close to $40 to $50 billion, 40 to 45 billion dollars a year ago as we wrote that i mean we think you know spotify is training at a very reasonable price versus the cash they can generate five years from now now anything to

add anything to revise their um any key points no i mean the the premium gross margins are fairly are more predictable i will say this if they get to some blended gross margin of let's say 30, mid thirties, low to mid thirties, we think they can generate around 10% free cashflow margins. Which they've outlined. And that's kind of their long-term guidance. So we, yes, we, I know every investment is a good investment based on management's guidance, but on the investor. Yes. Yeah.

And we know this has probably been a pain to talk about or a pain to listen to. So if you want to check it out visually, it'll be in the drive. and I'm sure Brett will link to it in the write-up. Do we want to talk about anything else on valuation or should we talk management? I am good. Let me ask you this next question here. What do we think of management?

Who are the important, I don't know, executives here? I have three people, really two people that I think are important and you can feel free to add anyone. I guess there is another founder that I didn't include here who owns a big chunk of a stock. what's his name?

Why am I blanking? Martin Lorenzen. Um, and him, him and Daniel Eck both sort of were, uh, Martin was kind of the early capital and Daniel was really, I guess you could say the brains behind the operation.

Um, and maybe that's not doing just justice to Martin, but he's still around, still a big shareholder. And he's a never sell guy, which congrats to him. Yeah. And I,

I think, uh, it sounds like he's sort of a, uh, an important part of the culture. um and then the the really the three important executives that i've outlined here are daniel at gustav soderstrom and paul vogel daniel's the founder he's the ceo people probably know who he is he's been steering the ship since they were founded in 2006 um only thing i'll say here is

that he's i think he's done a great job growing a business that no one that customers really wanted but stakeholders and competitors were fighting not to have i guess fighting huge incumbents in the labels basically until they can get mutually assured you know uh they had really bad agreements back in the day also fighting a giant company in apple by disrupting their itunes and then competing with them with apple music right there's an anecdote of steve jobs being really really like intent on killing spotify essentially and uh yeah the execution with that sort of competition bearing down your neck is just i think it's a pretty strong track record even though it hasn't been it's only been about 15 years extremely well uh extremely strong track

record yeah and there's there's a a good book written on spotify's history called the spotify play which i recommend reading if you're interested in and more of the founding story but But the second character here, and I should say that maybe Daniel's a bigger picture guy, kind of a longer-term thinker, just less involved in the day-to-day, it sounds like, from an outside perspective. The Cineco investors may laugh at that, but it's the situation here. Yeah. And then Gustav Soderstrom is the chief product officer. I think he's also chief R&D officer. Give him whatever title you want.

It sounds like he's managing the day-to-day operations and he's very hands-on as far as tech and actual and being involved with all things, the product. He seems to me like Daniel's most logical successor if Daniel ever left. I think he's just an important figure in terms of steering Spotify in the right direction product-wise. And then the third person is Paul Vogel. he's the cfo he was promoted in 2020 came on in 2016 i don't think he's the most important executive here and i wouldn't say like yes the cfo is not like a make or break spot for spotify it seems it's well cfo i think in general how we look at it is we want someone that's good but there's not like you just don't want someone that's bad because you can have like a bad cfo

that can ruin things but if your cfo is super good it doesn't matter the business comes first guess what i'm trying to say yeah it sounds yeah and it sounds paul vogel's been he said before he sort of outlined as a capital allocation principles and it seems to align with daniel and gustav's which is to invest first and foremost in the in the business before using that capital for other things um like like share repurchases or anything of the sort so um yeah not not too much to report on paul i guess um yeah and there's some good podcasts out there on sodastrom he actually hosts himself which is kind of talking their own book i think not talking their own book but basically you know doing and doing it in podcast format so there's from the some of the products

he's led um especially with those connect like the it's hard to describe because we're not software engineers but the way they engineered being being able to connect spotify seamlessly from device to device with through their accounts and then their transition from on-prem to cloud being one of google cloud's first giant partners the execution on there just seemed phenomenal right ship uh so sodastrom's i don't know execution as a chief product officer i think is quite strong and i hope he sticks around for many many years that someone will be tracking all right let's move on to the bear case now we outlined basically we think spotify can generate about let's say three to five billion dollars in free cash flow a year a few years from now

and trades, in our minds, at a discount to that at, say, $23 billion market cap. However, it trades at a $23 billion market cap for a reason, and that is because there are bear cases on the stock. First one, I guess, well, let me, you ask the question because this is my section. Yeah, this is probably the one that most, whenever we get into sort of disagreements with people around Spotify, this is the primary one we constantly hear, and it's kind of intertwined with the other ones, but Spotify is a commoditized service

providing content that they don't own. They'll never be able to expand margins because of that. How would you disagree? Yeah, and what is the saying? No wholesale transfer pricing. Yeah, we don't need to go through it all, but yeah. Well, that's the term here. All right.

And yeah, we don't want to, those people could be right. So yeah, we don't want to totally dismiss it. Yeah, I just love that. Everyone throws it out there. uh but again it is clearly true from at least a music perspective and like we mentioned before basically most of the podcasts and all the other stuff it is a commodity uh when taking the products at face value the music catalogs are 99.99 similar across apple amazon and youtube and others however

there are multiple indicators that we see are seeing that spotify service is not a commodity to users i'll speak on two but there are others first management has said that its users engage two to three times as much compared to competitors like Brian mentioned earlier. That was a huge indicator to us that they're actually getting the engagement that they were talking about. If the services were the exact same, why would that be? You just have to ask that question yourself. When we answer that question, we say it is because they actually have a differentiated offering. Second, and this kind of plays off of the higher engagement, is the focus on helping users discover new music to listen to. According to his last update for this stat, users discover

16 billion new artists each month on the service, which is just an example of how much value it provides to its hundreds of billions of users. That also goes into the total addressable market for the two-sided marketplace. That's a whole different discussion. Those two points, among other things, in our minds, is where the long-term competitive advantage or emerging competitive advantage can come from and why churn is so much lower than competitors because when i'm looking at something or looking at a business i don't think you can look at say okay churn is lower and maybe that's why they have a differentiated offering but we have to figure out why and the why is the discovery the switching costs the two to three times engagement they're getting over

everyone else yeah all right second bear case that we hear a lot heavy competition from apple youtube potentially tiktok uh there's been a lot floating around there with tiktok we mentioned this a bit about how even though i ios which apple owns and android which google owns have the platform advantage spotify has still been able to win but why don't you just address that bear case maybe where we disagree with it yeah i think the threats from apple and youtube have largely been overcome through execution and i think that's pretty visible in spotify winning in the u.s 1.6 times the the user base of apple in its home market on its literally on its devices um that that to me i think points to the fact that it's it's sort

of just yeah competition isn't that big of a deal here well while apple's literally being anti-competitive uh yeah and so i think those are kind of um not a huge concern i maybe would have been concerned about that at 100 million users but now that they're getting close to half a billion what are you going to be worried about it until they hit a billion it doesn't seem I think they've surpassed that by now. And then TikTok, I guess for context, TikTok's parent company, ByteDance, recently filed the trademark TikTok Music. And then there's rumors that basically they're going to launch their own music product. As anyone that knows TikTok's platform, it's this sort of seamless music, short form video.

um music's a big focus on there right yeah that's what i've read yeah but it's not like it's very video focused it's very video focused it feels very social media-esque that you don't necessarily have to have the i guess the the music component um on especially on some like some tiktoks are basically they're they're really music isn't that big of a deal on there um however they are really really good at discovery probably the best in the world at knowing their users and finding what they like so there's the i think a lot of people are worried about the threat of a product like that coming out and specifically because of the discovery could be better just go to spotify's yeah i guess i don't have a way to refute that

because it's always a possibility that a new product comes out that's way better. But first of all, I think music listening, music streaming is somewhat habitual. A lot of the time, like I'm not, I rarely relook at other services. I'm basically going in while I'm kind of on the move or getting in my car, that kind of thing. And I wouldn't really think to move it. I also personally, and I'm kind of trying to use this to extrapolate out to more users, I segment, and I think Western market generally segments a lot of their apps, a lot of their services to different apps. There isn't one huge super app here like you might have in, I think there's some in the Asian markets. And so, you know, I watch YouTube on one service and I listen to music on the other. i uh watch or i use social media i scroll instagram for whatever discovery i don't have

instagram anymore but theoretically and then i watch music on another i think that's a lot of the way western markets operate i wonder if tick tock would be able to i don't know if 400 million users are automatically going to just hop over to tick tock that seems very theoretical to me now new users they could steal some new users in emerging markets but we'll see i think another way that spotify can counter position themselves versus say a music streaming startup or say even a podcast only place or a audiobook only place is when they aggregate all these things into one service uh podcasts audiobooks music eventually others they want to get into live then it's even harder to compete with because you have to get all those things as someone to have that same

sort of offer now the last bear case we have and this is probably the one that we think about the most that maybe doesn't get that big of a hit and maybe it's because we're on the podcast creation side as well is that and this is what made me be the bear case the podcast market opportunity is not large enough or too fragmented or both i think this is a decent bear case because one apple podcast still has a lot of listeners and generally and youtube also has a lot of listeners for video focused stuff and you're really just podcasts as well and it creates a ton of friction for spotify to to build a seamless advertising offer now second there also are a lot of advertising marketplace as well. There's a cast, there's a gosh, what's it called Omni. There's

plenty and plenty of other smaller ones that are maybe taking a tiny bit of market share here and there. Now, I do think Spotify will win in the long run. But there are some hurdles here, there is some friction to get to getting all the users over to Spotify. And that's the key. They have to basically, I don't think they have to. But it'll make life so much easier if they can just crush apple podcasts yeah uh it would make it very easier make it very easy on all the other aspects of the podcast business like attracting the advertisers and um rolling out subscriptions because yeah so really talked about that from our point of view market share they're all estimates we you only see them from time to time those numbers are

very important for us to track all right do we want to talk speculative discussion about audiobooks live and other non-podcast categories or do you want to save that for the future because we are going a little bit long let me just pose one question how do you think audiobooks will be monetized yeah that's probably the only really question we had discussions here i i don't have a strong take on this but i've had the bets i would say a mix of both subscriptions and advertising they're gonna try to flood like not flood the market however okay maybe i don't make any sense here i i think they're gonna try to do subscription uh versus say the audible offering which is a bit worse i know it's subscription but they're gonna have to kind of have a different and

better offering than audible if you get what i mean i kind of feel like they're gonna if they can get it with the licensing and however that's gonna work i feel like they're gonna try to do ad support at some point because not i don't think many people have tried it yeah i think there's pretty much three ways you can go about monetizing it and the first is to have some sort of increased or enhanced subscription i don't think there would be any way to make it work cost-wise to have it integrate in their existing plan those margins would be low and then the second one is a la carte so basically you can browse a whole bunch of different audiobooks purchase them one One at a time, let's say $4.99 for an audio book, whatever, $9.99 for an audio book.

Or the third one, I don't know, ads between chapters, sort of an ad-supported book. I have no idea. I don't really have a preference, but it would fit in to Span well. I think so. It'd be very easy to integrate that inventory. Yeah. And we'll see. They said on last conference call, a new product announcement will be coming out in Q3.

So it is Q3. so i guess we'll watch out for the next couple months here all right but yeah last question what do we see we're going to both answer this i'll let you go first what do we see as the most realistic risk that spotify ends up being an underperforming investment uh i guess either from this price or basically when we bought which was brought you know uh to be frank when the the price was doubled from here yeah uh i've got two so first one podcasts don't work out it sort of is this constant spending trying to get users over and it basically perpetually loses money um and maybe the by not being able to attract all the

users over the value proposition for advertisers is not quite as clear cut so and the reason i say that is and this is really kind of a big part of it in my opinion ads are skippable and the tracking on that is not great you it's not clear what your roi is yet as an advertiser it's getting better but it's still bad right and so and a lot of it i mean this is kind of similar to radio too um and it's just audio advertisements generally they're not interactive um so it's not like it's not a performance ad it's more brand advertising um spotify's trying to change that they've got the call to action cards but you know most of the time you're listening to spotify you're probably not looking at your phone so um the no visual component might be

a detractor from advertisers advertisers might prefer prefer like a youtube or google or something like that second uh one for me and this is probably the the one that really frustrates me and maybe I'm just being impatient, but gross margins expand, but they never get anywhere near or to the 10% free cashflow margins that we hope for. In this scenario, I think it's likely that we're in this state where profitability constantly feels theoretical. We're like, oh, if they start to expand their cashflow margins, if they can get to 10%, that kind of thing. but instead management continues to choose to allocate capital to reinvest all the cash at their disposal into stuff that's maybe a little speculative where the payback isn't quite there

and so a few of the ones that i'm thinking of are acquisitions that i don't think have done that well um i don't think locker room was a good acquisition semantic i guess it remains to be seen it was recent but i don't see how that's a huge value add well here's the only thought is that they can make AI advertisements. Automatic ad voice. Yeah, which could be helpful from a cost perspective, but they spent $100 million on this thing, so

possibly. But there's always this theoretical, if they can add this in this way, and I think we're yet to see a whole bunch of good integrations. Wooshka, still, maybe that's just not my realm, but

I don't see how that's paid off. You think about all the podcast distribution platform acquisitions they've had anchor megaphone whooshka's kind of along there as well there's very little integration that's occurred between them yeah there's benefits of each but they're all separate and they haven't all gotten the product offerings that spotify promised for example i believe it was a year ago or farther than a year ago when they launched spam they said it would be coming to anchor and going international within a year that that didn't happen so three other ones pods we're yet to really see anything with that what was that that

was a small one that's like uh podcast discovery yeah there's like little clips of podcasts that play and then you can like browse them that way um we haven't really seen that the pod sites and charitable granted those were relatively recent those haven't been integrated into either the distribution platform so i'm still not seeing the benefit of having that under their umbrella No. Yeah. Those are reasons. So maybe that will be in the next few months, but that's what we always say. So that's my worry is they just keep throwing capital at acquisitions that never get integrated.

All right. I'll hit mine and then we'll wrap up. I have two risks that I'll be watching. I agree with yours as well. On premium and music side, I think the threat of the global streaming music app from TikTok could hurt MAU growth and churn a bit. Actually, I said churn here, but I really think it could hurt MAU growth, which is just user growth i think so because spotify's core differentiator on music is discovery which tiktok is extremely good at we talked about this before maybe tiktok's music app if they get you know some of that market share uh spotify will lose market share and maybe they can't get a billion users yeah there are a lot of users out there though even excluding china

where spotify does not operate so i don't know if it's a giant concern but it could be and And we all know TikTok is extremely good at executing, at least right now. Second one on podcast is I worry the advertising market and possibly the entire addressable market is smaller than Spotify believes it is. This would really lower the return on invested capital for all the money that is spent, which is probably pushing, if we're talking about internal investments too, probably pushing $2 billion, including those acquisitions plus internal investments, maybe even higher. so just for examples podcast costs are generally going faster than revenue right now

uh or at least it did last quarter i think it kind of changes sometimes i think this will change as a scale of span but there is really a risk that it doesn't and if you know if we can't scale up span we can't scale up gross margins and that business is worth not much probably nothing so there is a lot of risk on that um yeah we haven't seen either just all execution risk yeah i mean we say all these negatives but we haven't seen that materialized yet because they're growing users they're expanding gross margins on the music side and the advertising revenue is growing at a i mean it's not a blistering rate but it's you know at an impressive rate in my mind especially in this in this uh macro environment yeah i think that's pretty much it yeah those are those are

just the concerns we're trying to track i mean to sum it up it's a complicated investment but we really sum it up as huge long-term tailwind the best product offering great management team that is executed well and trading at a reasonable price versus the you know uh cash we think they can generate um which is what all investments i think come down to all right brian anything else before you want to sign us off i think i think that's it let us know if you like these episodes we're like i said we're going to try to do one of these at the start of each month uh different holdings, why we bought something, why we sold something, try to keep people updated on our actual investments. But that is going to do it. And this disclosure is important because

it really is a holding in the fund. So we want to remind you that we're not financial advisors. Anything we say or discuss is not formal advice or recommendation. We are general partners at Irish Capital. So clients do have positions in the security discussed and securities discussed in this podcast. Thank you all for listening. We'll see you next time.