Why Spotify stock is a better buy than Netflix, according to an analyst

Raymond James Analyst Andrew Marok joins Yahoo Finance Live to discuss Spotify stock and the outlook for video and music streaming.

Video Transcript

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BRAD SMITH: Raymond James upgrading Spotify to outperform, noting that the platform remains as the market leader in streaming music with key competitive advantages, despite unchanged challenges facing the business. Here to break this all down is Raymond James internet and digital media analyst, Andrew Marok. Andrew, great to have you here.

All right, so first and foremost, the Spotify kind of bullishness here, how does that continue to hold up, even in the face of an install base that Apple has, a number of users that are on the even Amazon Music services, and how do they continue to kind of outlast that competition from your perspective?

ANDREW MAROK: Great, and thanks for having me on. So what we see in the competitive environment for streaming music is a lot more stable environment than you see, for instance, in streaming video, where content owners are increasingly taking ownership of their content, walling it off, going directly to consumers.

On the streaming media side, the dynamic where the major labels own a significant majority of the content and are also basically dependent on the streaming platform, such as Spotify and Apple Music, to power industry growth, makes that a much more stable contingent. There isn't the price competition that you see in streaming video. It's really kind of on things like product differentiation and network effects.

To that effect, Spotify is the key global scale player in streaming music. They'll compete with Apple Music in many markets, in some markets, some local players that have some specialized local market features. But that global network that Spotify has, the vast opportunity for subscriber uptake internationally, especially, is something that we think that they can continue to chip away at over the next several years.

BRIAN SOZZI: Andrew, there has been a day of reckoning, I would say, that has come to the entire streaming media space over the past few months, a much more greater focus on free cash flow, a much more mindfulness on what's being spent and how it's being spent. Spotify, I would argue, hasn't been-- hasn't found that religion yet. Do they need to find it?

ANDREW MAROK: And I think that's one of the things that predicated our upgrade, is that now, you're correct, this is very much a margin story, a profitability story. And after their guidance on the 1Q earnings call, where they expect gross margins to be relatively flat for the rest of the year, below 2021 final gross margin levels, we think that the bad news is priced into the stock at this point.

And when we look at potential margin outcomes for the rest of the year and into '23, we think on balance, it's more likely that margins get better than they get worse. Some of the drags to margins include things like podcasting content investments. Potential margin benefits include scaling of the advertising business and the scaling of what they call the two-sided marketplace or value-added services that they can provide to artists and labels. We think that they make some progress on that over the course of the next 12 to 18 months, which should start to benefit margins, if not immediately, at least within a time frame to achieve a reasonable return.

JULIE HYMAN: Andrew, it's Julie here. When I look at the streaming music business versus the streaming movie and TV business, what stands out to me is how much Spotify has been able to hold on to its leadership in what is still a competitive market. What's the difference on that front? Apple Music, Amazon, Tencent, we're looking at there, they haven't really seemed to gain the subscriber traction that-- and the leadership spot that Spotify has.

ANDREW MAROK: I think one thing that streaming music has over streaming video in this respect is, there is a degree of platform lock-in when you choose a subscription service. You build your playlists. The service will kind of tune its algorithms to provide good music recommendations and things like that. And once you have that all set up, it's relatively more difficult to switch services to an Apple Music or to an Amazon Music.

Whereas with streaming video, it really is a content differentiation story, where you could watch "Stranger Things" on Netflix one month and then "Obi-Wan" on Disney+ the next month. And you can cycle between those services in a way that we really don't see with streaming music.

BRAD SMITH: OK, so for the spend on Spotify, what they have had to do is to generate their own content on the podcasting side. Do you see the kind of accelerate-- any acceleration towards or add on for that spend in the near future, considering what the rest of the streaming-- broader streaming platforms right now are kind of conveying in that they're already seeing some subscriber slowdowns, which would directly impact the amount that they're able to continue to put back into some of their own capital expenditures?

ANDREW MAROK: Sure, so on the podcast investment front, the company has said that they intend to continue to drive that investment into 2022. And we think that it'll continue into '23 as well. Maybe not as-- maybe not at quite the levels of streaming video, because, really, streaming video, that differentiated content is the engine for subscriber growth.

I think Spotify has a little bit more advantageous position in that they can bring in customers through the music business, which we throw around the term "commoditized" as typically as a negative, but in this case, the presence of the kind of same music libraries across services makes for an attractive subscriber acquisition channel when you bring in and when you layer in the podcasting on top of that.

So you have that kind of medium or the body and the tail in the music to retain the subscribers once you get them on maybe through the head of podcasting content. Or they can just join for music only. I don't think Spotify really discriminates between a music user and a music and podcasting user.

JULIE HYMAN: Yeah, they're worth the same at the end of the day, I suppose. Andrew Marok, Raymond James internet and digital media analyst, thank you so much. And this has brought up an interesting discussion on set as well as to who subscribes to what music service. That will continue at a different time. Thanks, Andrew.