Seeking Alpha

Pim Keulen's  Instablog

Pim Keulen
Send Message
I started trading on a permanent scale five years ago. My goal is to create a stable portfolio over a period of time, whichs generates good stock- and dividend returns. I have a fundamentel approach towards investments decisions. Further, I have a broad experience in tax- and legal advisory... More
My company:
My blog:
Pim Keulen's Instablog
View Pim Keulen's Instablogs on:
  • Netflix Buying Spotify - An Unrealistic Idea Or Actually A Good Match?

    In this previous article, I discussed why Google (GOOG, GOOGL) is not likely to acquire Spotify anytime soon. Besides Spotify's lofty valuation, I found that Google and Spotify are not a good match from an organizational point of view. On the one hand, Spotify runs a subscription-based service. In 2014, subscription fees represented 91% of the company's total revenue. On the other hand, Google's YouTube platform is an ad-supported streaming service. Further, an acquisition of Spotify would likely be the end of Google's own Google Play Music All Access.

    Based on these three arguments, I concluded that Google and Spotify are not a good match and that an acquisition of Spotify by Google is probably never going to happen. After writing the article, I started thinking about a suitable candidate to take over Spotify. Likely contenders are Apple (NASDAQ:AAPL) and Facebook (NASDAQ:FB). However, Apple recently introduced its own streaming service called Apple Music and Facebook is working on the introduction of its own music streaming service in the future as well.

    How about Netflix (NASDAQ:NFLX)? The idea of Netflix buying Spotify came up while reading Netflix's Q2 earnings report. Netflix reported strong net subscription and revenue growth in the second quarter of this year. The market was quite enthusiastic about Netflix's results considering the 18% pop of its share price the day following the announcement. It is fair to say that both Spotify and Netflix are growth companies. Therefore, I decided to research the idea of Netflix buying Spotify. Is such an acquisition unrealistic or actually a good match?

    Organizational fit

    One of the reasons why I found Google an unlikely contender to buy Spotify was the bad organization fit between the two companies. In case of a bad organizational fit, an acquisition is probably not going to be realistic or successful. Therefore, I start my research idea with an analyses of the two companies' businesses.

    Netflix is one of the world's leading subscription-based video streaming services. The company has operations in the United States and internationally. Netflix has over 60 million paying subscribers in over 50 countries. The company's subscribers can watch over 2 billion hours of television shows and movies. For content, Netflix acquires a content license from the owner of the video content. Normally, Netflix agrees to a fixed fee and period for the use of the content. Further, Netflix is engaged in the production of its own original series and movies. The company also plans to release some of their original movies in cinemas. For Netflix, it is all about scale. With fixed fee content licenses and fixed production costs for original content, increasing the number of subscribers is key for the development of the company's profitability.

    Spotify is the world's leading subscription-based audio streaming music service. Spotify offers a free ad-supported streaming music service as well. The Sweden-based company runs operations in 58 countries all over the world. Spotify has over 75 million total active users and over 20 million users of Spotify Premium, the company's subscription-based service. The Spotify library accounts for over 30 million songs. Spotify pays royalties to the owners of the music rights based on the total number of streams. According to this article, Spotify charges music right owners 30% of total net revenue (after sales tax) for its services. Therefore, the company's gross profit grows along with the growth of net revenue. Recently, Spotify introduced video streaming in the United States, United Kingdom, Sweden and Germany. This new service will include original non-music video content.

    Considering the nature of Netflix's and Spotify's business, I find that the combination of the two actually makes sense. Netflix is a dominant player in the video streaming business and Spotify is dominant in music streaming business. The combination of the two companies will be able to compete with companies like Apple, Google, Amazon (NASDAQ:AMZN) and other large technology companies. These companies offer both video and music services. These companies all offer video streaming and music streaming compared to Netflix's focus on video streaming. So, from a competitors point of view, Netflix should consider buying Spotify.

    The combination of Netflix and Spotify could realize synergy benefits as well. Like in most cases, the combination is likely to be more efficient in terms of corporate, marketing and salary expenses. However, the benefits from complementary strengths probably more important. One of Spotify's biggest advantages is to pursued users of its free ad-supported service to subscribe to its $9.99 per month Premium subscription-service. Currently, only 20 million out of a total of 75 million Spotify users (or 26%) are Premium users. However, Premium revenue accounted for 91% of Spotify's total revenue in 2014. Only 26% of Spotify's users earn 91% of the company's revenue. Therefore, it is important for Spotify to not only increase the number of total active users, but grow the percentage of Premium subscription users as well. Adding paying users to a subscription-based service is one of Netflix's strengths. For example, Netflix added 3.2 million new subscribers in the second quarter of this year alone. Netflix's experience to lure users into a subscription service could be a big advantage for Spotify.

    Another strong argument for Netflix to buy Spotify is Spotify's latest attempt to enter the video streaming business. At this time, Spotify's video streaming business is still quite small. However, with over 75 million active Spotify users compared to Netflix's 65 million active users, Spotify may become a new competitor for Netflix. To eliminate the potential threat of a new competitor, Netflix could consider buying Spotify before its video streaming business takes off. However, taking away a competitor is not the only argument for Netflix to acquire Spotify. Netflix could use Spotify's platform, original content, license deals and user base on behalf of its own streaming platform. Here are two interesting cross-selling ideas between Netflix and Spotify. First, Netflix could add music videos to its content library and become a serious competitor of Google's YouTube music channels. Or the company could start offering exclusive Netflix previews on Spotify's video streaming platform in order to convince Spotify users to take a Netflix subscription as well.

    Overall, I am positive regarding the organizational fit between Netflix and Spotify. Both companies could easily be complementary to each other's businesses. However, there are possible threats to the combination of Netflix and Spotify to consider as well. Netflix is an American-based company, while Spotify is an Sweden-based company. It is no secret that American companies are managed in a different way than European companies. The difference in culture might be challenging for both companies to overcome. Further, Netflix generally agrees to a fixed license fee while Spotify pays a variable royalty fee to the owners of the content. Therefore, Netflix's scale benefits are larger than Spotify's scale benefits, because the license fee is a fixed amount instead of a variable fee. Netflix's gross margin will grow exponentially compared to a more straight growth for Spotify.

    Financial aspects

    Another important part of the potential acquisition of Spotify by Netflix is the structure of the deal. Spotify is worth $8.53 billion based on the company's latest financing round. In order to acquire Spotify, Netflix has to come up with a sum of at least $14.1 billion. At least, this is the rumored price Spotify asked from Google in March of this year. Given the latest valuation, Spotify could easily ask for a higher sum than the initial price tag of $14.1 billion for Google.

    Unlike technology giants like Google and Apple, Netflix has limited cash available. Based on Netflix's latest earnings report, the company has only $2.8 billion in cash and short-term investments available. A significant sum of this money will be used for investments in future growth and original content. Netflix's lack of cash makes an acquisition of Spotify more complicated. In order to come up with the required funds, Netflix could decide to a large bond offering, issue new shares or a combination of the two.

    I prefer Netflix to issue new shares, because of the company's relatively high valuation. Netflix's current market capitalization is around $49 billion and trades at $115 per share. Let's assume that Spotify is worth $15 billion. In that case, Netflix needs to issue 130 million new shares in order to finance the acquisition of Spotify. Not all new shares have to be placed on the open market. I believe it is likely that Spotify's founders will be interested in holding a share in the new combination. Next to Spotify's founders, all three major record labels hold a stake in Spotify as well. It is uncertain whether Sony (NYSE:SNE), Vivendi (OTCPK:VIVEF) and Warner Music will be interested in a Netflix stake. These companies tried to cash in their stake in Spotify last year.

    Overall, there are some financial obstacles that could block a deal between Netflix and Spotify. Given the potential price tag, I cannot imagine a deal without Netflix issuing new shares. Therefore, the deal needs to be approved by Netflix's shareholders as well. Further, Spotify will have a negative effect on Netflix's bottom line in the first year(s) following the acquisition. In 2014, Spotify recorded a loss of $182 million. However, Spotify's bottom line should recover along with the company's subscription-based user growth. Like Netflix, Spotify has great a scale potential and key is growing the number of users. Further, Netflix itself is not very profitable yet as well. The company trades at 200 times last year's earnings per share. Therefore, I do not consider Spotify's poor bottom line as a deal breaker for Netflix at this point.


    It started with the spontaneous idea that Netflix could be a serious contender to acquire Spotify. In this article, I researched the idea in order to determine whether Netflix buying Spotify is an unrealistic idea or actually a good match. The arguments in favor of a deal and against a deal are summarized below.

    Arguments in favor of the Netflix/Spotify combination:

    • Both companies have a subscription-based focus.
    • Netflix's strong video streaming presence and Spotify's strong audio streaming presence are two complementary businesses.
    • The combination will be better positioned to compete with companies like Apple, Google and Amazon.
    • The combination will realize financial synergy benefits.
    • Both platforms could strengthen each other in order to grow the number of subscriptions.
    • By acquiring Spotify, Netflix eliminates the potential threat of a new competitor in the video streaming business.

    Arguments against the Netflix/Spotify combination:

    • Two different cultures and management styles.
    • Different approach of buying content licenses.
    • Price tag of over $14.1 billion.
    • Lack of free cash will lead to a more complex structure to finance the deal.
    • Netflix's shareholders need to agree to a deal in case new shares need to be issued.
    • Spotify is not making any profit just yet.

    Based on my research, I find that Netflix and Spotify are a good match from an organizational point of view. However, financing the deal is more difficult for Netflix compared to other technology companies like Apple and Google. Considering the arguments in favor of an acquisition and against an acquisition, I find that the arguments in favor have the upper hand. The match might not be perfect, but an acquisition of Spotify would be very interesting for Netflix and will likely send the company's share price even higher. Therefore, Netflix should consider buying Spotify.

    Jul 17 12:03 PM | Link | Comment!
  • Facebook's Move Towards Music Is Right On The Money

    Two exciting events in the music industry last week and both relate to social media company Facebook (NASDAQ:FB). The company is planning to introduce an ad-supported video service, including music videos. Further, Facebook is rumored to be in early talks of an own music streaming service to take on market leader Spotify and others like Apple (NASDAQ:AAPL) Music. In this article, I will discuss Facebook's latest strategy. I find that the company's move towards music will prove the right move for Facebook and its shareholders.

    Video platform

    First, let's take a look at Facebook's planned ad-supported video service. The service will be a serious competitor of Google's (GOOG, GOOGL) video platform YouTube. Variety already revealed details regarding Facebook's service which will include a suggested videos box. Ads will play between videos. Partners providing content will receive 55% of total ad revenue, comparable with YouTube's usual 45/55 revenue split.

    Facebook's video platform not necessarily focuses on music video's. However, the company does intend to make music video's an important part of the new ad-supported video platform. According to The Verge, Facebook already met with the three major record labels to discuss the new service and revenue split. The labels concern Sony (NYSE:SNE) owned Sony Music Group, Vivendi (OTCPK:VIVEF) owned Universal Music Group and privately owned Warner Music Group.

    In my opinion, Facebook's attempt to involve music video content for its ad-supported video platform is important for the engagement of Facebook users and the success of the platform. Streaming of music video's is very popular in the United States. Total music video streams were even higher than music audio streams in the first half of this year. In fact, music video streaming is even more popular than years 2013 and 2014 (source:

    Given the popularity of music video streaming, including music video's will be important for Facebook and the success of its new video platform. One possible threat for Facebook is the unwillingness of Universal and Sony to participate. Universal and Sony own online music video platform Vevo together with Google. As Facebook's platform will compete with Google's YouTube it is still uncertain whether Universal and Sony will make their library available.

    Streaming service

    While Facebook's music video platform is expected to be announced within a couple of months, it is the company's plan to develop its own music streaming service that really surprised the music industry. Some thought Facebook was among the most likely contenders to acquire audio streaming service provider Spotify. However, the company now has a plan to develop its own music streaming service according to Music Ally.

    The timing of the Facebook's plan is definitely not random. Spotify recently passed a total of 20 million paying users and Apple introduced its own streaming service aiming for 100 million paying users within one year. Considering all of these events, it is fair to say that online music streaming is a hot issue nowadays. From this perspective alone, Facebook's attempt to set up its own streaming service is logical.

    However, there is another argument why Facebook's focus on music streaming service is important for its business model. This report show that the engagement of teens with Facebook is declining. Online music streaming could be important to breach this trend, because teens are responsible for the recent growth and focus on online music streaming. By focusing on music streaming, Facebook should be able to involve teens with their platform again.

    So, a streaming service is important for Facebook's business model in the long-term. From a financial perspective, investors should not expect a immediate bump of revenue. As I already discussed in this article, record labels earn a higher percentage from streaming revenue compared to the streaming service providers. However, increased engagement from teens should enable Facebook to sell more timeline and video-related ads.


    Facebook is likely to introduce an ad-supported video platform soon. Music video's will be an important part of this service, considering the popularity of video streaming. Monetizing music video's is a good idea for Facebook in order to increase engagement of users and sell more adds. However, it is interesting to see whether Google will allow Universal and Sony Music to make their library available for Facebook's new platform. Participation of the two largest record labels is important for Facebook's new platform to compete with Vevo and YouTube.

    Further, Facebook has a long-term plan to develop its own audio streaming service to take on popular services like Spotify and Apple Music. In my opinion, this audio streaming service is an important part of Facebook's future business model to involve teens with its platform, because teens have been responsible for the growth of online music streaming so far. From a financial perspective, audio streaming is less profitable than video streaming (consider the 25/75 vs. 45/55 revenue split). However, Facebook should be able to sell more ads because of the increased use of its platform.

    Overall, I am very positive regarding Facebook's moves towards music. Within the music business, there is a strong focus on online services. Just consider the introduction of Apple Music and growth of Spotify users. Therefore, Facebook will be able to increase the engagement of its users by offering music services on its own. Naturally, increased engagement will eventually lead to higher revenue from selling ads and subscriptions.

    Jul 09 12:43 PM | Link | Comment!
  • Apple Is Poised To Take Control Of The Music Streaming Business

    Although many releases of last night's presentation were already leaked through several channels, analysts and investors looked forward to Apple (NASDAQ:AAPL) revealing its new music streaming service. Apple indeed introduced a new music service called Apple Music. The service will debut on June 30 and will cost $10 per month after a three months free trial period.

    Apple also announced a new internet radio station called Beats 1 and an online platform for artists to share their latest work with their fans called Connect. Apple does not only want a big slice of the online streaming pie from competitors like Spotify and Tidal, it will also take on internet radio competitor Pandora (NYSE:P) and open source music platforms like the popular service Soundcloud.

    At first sight, Apple seems to have developed a perfect strategy to face its competition in the online streaming business. With the entire iTunes music catalog at its disposal, Apple Music's subscribers will have a lot of titles to choose from. Considering the company's track record, the Apple Music app will be awesome and customer friendly at the same time as well. Combined with a very loyal customer base and a large cash pile to send on marketing, Apple Music should become an important streaming music business in the near future. How important Apple Music will be remains unclear.

    First of all, the company is quite late in offering a music streaming service after dominating the market of music downloads for years. Apple's iTunes still generates significant income, but total downloads are slowing in favor of music streaming services. Spotify already has over 15 million paid subscribers worldwide and other well-funded U.S. companies like Amazon (NASDAQ:AMZN) and Google (GOOG, GOOGL) offer music streaming services as well. Therefore, Apple should prepare for a long fight to take control of the online streaming business.

    In this article, I will discuss topics from within the music industry with respect to streaming services. It is important for investors to understand the ongoing discussion within the music industry, so that they can make a proper evaluation of Apple Music's prospects. In my opinion, this analyses has been underestimated by analysts and investors. Further, I will discuss Apple Music and its fit with demands from within the music industry. I find that Apple Music fits perfectly with the need for more transparency, a fair revenue split and higher royalty payments to music industry professionals.

    Need for transparency

    The industry can no longer afford to spend $5 collecting $1. The efficiency of AMRA is the future.

    Willard Ahdritz, Kobalt (source: Music Business Worldwide)

    One of the most important topics is the need for transparency. Industry professionals, including musicians, songwriters and producers just do not have a clue if their royalty statements are complete and correct. Royalties are normally collected by collecting agencies. These agencies pay the royalties received to record labels, after deduction of expenses of course. Then the record labels pay the royalties to the ultimate beneficial owner of the music rights.

    Apart from all the actions required to get the royalties from the streaming company to the owner of the rights, royalty statements are almost unreadable. Just consider the statement by Elizabeth Moody, Vice-President licensing of Pandora below. Making a distinction between free streaming services and paid subscription services, like Spotify, does not help transparency either.

    While artist do get paid, not all of them understand what happens.

    Elizabeth Moody, VP licensing Pandora (source: Radio & Music)

    Although several articles estimated the amount earned by every play (e.g. this article in the Wall Street Journal), there is still no transparent way to determine whether royalty statements are correct or not. In my opinion, this provides a major opportunity for Apple Music to benefit from the lack of transparency by other streaming service providers. If Apple Music enables a transparent way of reporting royalty payments and pay-per-stream data, record labels and collecting agencies are likely to prefer exclusive licensing deals with Apple Music. This could be a major blow to its competitors as an extensive music library is the most important thing for streaming services.

    Fair revenue share and royalty income

    The ad-funded part for the music ecosystem - that's on-demand, ad-funded - as I've said before, is not something that is particularly sustainable in the long term.

    Lucian Grainge, Universal Music (source: Music Business Worldwide)

    According to Universal Music boss Lucian Grainge, free streaming services are not sustainable in the long run. Grainge probably referred to the distinction between paid subscription royalty income and free streaming royalty income. The Wall Street Journalcalculated that artists earn $0.0068 for every single play by subscription users and just $0.0014 for every single play by free streaming users.

    Naturally, it is a hard sell to industry professionals that royalty income from free streaming services is 80% lower than income from paid subscribers. Therefore, the statement by Mr. Grainge makes perfect sense. The New York Post reported that freemium (free streaming services) represented the smallest slice of the music revenue pie as well.

    I'm not willing to contribute my life's work to an experiment that I don't feel fairy compensates the writers, producers, artists and creators of this music. And I just don't agree with perpetuating the perception that music has no value and should be free.

    Taylor Swift, Artist (source: Inquisitr)

    The music business prefers subscription-based services, because these services pay significantly more in royalties. As a result, labels and agencies are likely to sign direct deals with streaming service providers. Some good examples are the latest deal between Soundcloud and licensing agency Merlin as well as the licensing dealbetween Sony and Spotify. This is where Apple Music is likely to have a competitive advantage over free subscription services in the long run. Apple proved willing to make deals with record labels to come up with a fair revenue share.

    Further, Apple only offers a paid subscription service. This will generate much more royalty income for artists. Like I mentioned before, I foresee that more artists will ban their music from free streaming services and sign exclusive deals with companies that offer only paid subscription services. In the end, this is much more profitable for them.

    Apple Music

    The first signs of transparency and fair revenue share are very positive for Apple Music. Apple Music offers a paid subscription service and no ad-funding freemium service. It is clear that paid subscription services pay higher royalties to artists. Further, the calculation of artists' revenue share is much more transparent for paid subscription services compared to freemium services. In theory, royalty income should be calculated as follows: total subscription revenue -/- Apple Music's revenue share * percentage of total plays.

    I identified two major trends in the music business. First of all, industry professionals have the need for transparent revenue statements and calculations. Second, free streaming services do not pay enough to be sustainable in the future. Based on these trends, Apple Music has the potential to become the first transparent and subscription-only streaming service provider.

    Investors should notice that this is an important competitive advantage for Apple Music compared to other streaming service providers. Because of this advantage, Apple Music should be able to sign exclusive content deals with artists and labels in the future. This draws additional subscriptions and limits the library potential of competitors. A win-win scenario for Apple.


    Considering all of the above, Apple Music could convert its potential advantages into actual competitive advantages and take control of the music streaming business. However, competition is fierce and not likely to give up immediately. One big advantage is Apple's financial strength and its ability to take on competitors for a long period of time.

    Tags: AAPL, long-ideas
    Jun 09 6:26 PM | Link | Comment!
Full index of posts »
Latest Followers


More »

Latest Comments

Posts by Themes
Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.