TheStreet

As a technology business, Spotify (SPOT - Get Report)  is doing a lot of things right. It's building scale with a new business model based on data analytics and an indelible brand.

Yet the Swedish media streamer is more often noted for its shortcomings. Although it was founded in 2006, the business is still unprofitable. And larger technology companies are entering the marketplace.

These factors have kept me on the sidelines, until now.

The music business is changing rapidly. Spotify played a big part in the transformation. Artists can't make what they used to selling recordings so most have jumped to a live performance model. They go on the road, selling concert tickets and merchandise. They license their music to brands, advertisers and digital marketers. Top acts are making more than ever.

Taylor Swift, the country crossover sensation, earned $266 million domestically in 2018, playing gigs and hawking T-shirts, according to a recent story in Billboard. And that was from tour dates that ran from May 8 through October 6.

The changing business of music makes legacy catalogs less valuable. It's a really big deal, because those pricey catalogs have been an Achilles heel for Spotify.

The Spotify music streaming platform officially launched October 2007 with 40 million tracks available to stream. Unlike iTunes, Apple's popular digital music store, Spotify users got unlimited access to every track. The concept took the industry by storm. Subscriptions surged from one million in 2011, to 24 million in 2013, and 100 million in 2016.

But it came at huge cost. The record labels demanded 70% of all revenues.

In late 2016 and 2017, Spotify negotiated new label agreements with its four largest music partners. The new rates improved its gross margins by seven percentage points, according to a research note from D.A. Davidson.

The company was able to generate gross profits of $1.6 billion in fiscal 2018, based on $6.2 billion in sales. Net operating cash flow grew 101%, to $405.8 million.

At the end of 2018, Spotify had 242 million users. It has become the way people consume and share music. It's the way musicians interact with their fans.

Mathew Griffith, an analyst at Davidson, argues that record labels are becoming disintermediated. Their competitive position in the industry value chain is shrinking. He suspects Spotify will move aggressively to vertically integrate into concerts and merchandise, promotion and data analytics.

For example, 30% of music streamed on Spotify is curated by its editorial team or algorithms. RapCaviar, its urban music playlist, has 11 million followers. Landing on the playlist can launch an artist's career.

Spotify does have competitors with deep pockets. Amazon.com (AMZN - Get Report) , Google (GOOGL - Get Report) and Apple (AAPL - Get Report) all have music streaming platforms. However these are all bland, inauthentic, add-on services to larger businesses. And they are not focused primarily on curation, cultural relevance or artists and their fanbases. Spotify is doing a spectacular job of integrating music with video, biography and the explanation of lyrics, an effort that feels genuine and valuable in a way its larger, less focused rivals can't match.

Almost all of the artists who left Spotify for exclusive deals with competitors have returned. From Neil Young to Taylor Swift, the benefits of being on the most popular platform, with the most downloaded playlists, can't be denied.

The Recording Industry Association of America reported in February that revenues in 2018 rebounded 12% to $9.8 billion. Streaming now comprises 75% of that total.

Spotify shares have risen 25% in 2019, and trade at just 4x sales for a market capitalization of $25.9 billion. By comparison, Netflix, the leading video streamer, trades at 9.4x sales for a market cap of $156 billion.

Currently trading around $145, I suspect Spotify can break out of its current narrow range and trade toward $300 in the next few years as recognition of its scalable, profitable model grows.

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To learn more about Jon Markman's stock picks at the crossroads of culture and technology, check out his daily investment newsletter Strategic Advantage . To learn about Markman's practical research in the short-term timing of market indexes and commodities, check out his daily newsletter Invariant Futures.

Jon Markman is editor of the independent investment newsletter The Daily Advantage.