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Apple Music Passes Spotify to Take the Streaming Lead in the US

Motley Fool Staff, The Motley Fool

In this segment from MarketFoolery, host Mac Greer and senior analysts Taylor Muckerman and Jason Moser untangle the latest news from the world of streaming music. Spotify Technology (NYSE: SPOT) may still have a solid lead globally, but Apple (NASDAQ: AAPL) is now No. 1 in its home market -- not a shock. Meanwhile, though Chinese e-commerce giant Tencent (NASDAQOTH: TCEHY) and Spotify are tied together by fairly large mutual stock holdings, Tencent plans to create a new public company in this space.

The question now is where all three, and the rest of the segment -- including Pandora (NYSE: P) -- go from here? Are pure plays a good investment, or should investors stick to companies like Apple or Amazon (NASDAQ: AMZN)?

A full transcript follows the video.

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This video was recorded on July 9, 2018.

Mac Greer: Let's start with the music wars. Apple's streaming music service gaining ground on Spotify. According to Digital Music News, Apple Music has surpassed Spotify in U.S. subscribers. Spotify still has a big lead globally. Jason, that's not all. The plot is thickening. Tencent is now announcing it's going to spin off its music service into a U.S. IPO. This is where it gets really confusing -- Spotify owns about 9% of Tencent, while Tencent owns 7.5% of Spotify. What does that mean?

Jason Moser: It's a mouthful. This is really shaking out to be a very interesting space for a number of reasons. I don't think the Apple Music news is any kind of surprise. We saw that trend back at the beginning of the year. Domestically speaking, it makes a lot of sense. Apple holds a big share of the smartphone market here domestically.

When you take that out and look globally, that's where I think this gets really interesting. Android is by far and away the most dominant operating system globally. When it comes to Apple Music, the question for me is, how do they grow beyond the domestic market? The reason why I ask that is, I don't think there's much incentive to use Apple Music if you don't have an Apple device. I mean, I have an Apple device and I don't even use Apple Music. I think there are a lot of options out there, and Spotify certainly has a great reputation worldwide. They've been able to grow their member base at very impressive clip.

I wonder if, at some point, we don't see Apple trying to gain more share by perhaps selling some more low-end or cheaper iPhones to get those devices out into people's hands. I think, if you want to grow Apple Music, you're going to have to get those Apple devices in people's hands.

The nice thing for Apple is, they're not going to depend on Apple Music for their success. That's just one of the many things that they offer. I think that goes to that greater point we talked about earlier today. It's different if you're a pure-play in this business vs. if it's just part of your offering. Apple, Amazon, Alphabet, they're not just music companies. Spotify, right now, it's a music company. They're going into podcasts and talk shows and stuff like that, but they're very content-driven. It's really interesting to see how this is shaking out.

Taylor Muckerman: If you're looking at Spotify, it's very much an international story. You're talking about 70 million paying subscribers globally, I think around 170 million monthly active users, which includes the freemium side of things. This business, still not even in Russia, India, countries like that, but they're talking about moving into those countries. I think there's a lot more growth, when you're looking at music apps in particular, for Spotify.

Greer: How about the Tencent piece of this, this Tencent IPO in the U.S.? Is this something that excites you? And, what about that Tencent relationship with Spotify, where they each own a part of each other?

Moser: I don't know that I get too worked up over the Tencent side of it, but I do think it's pretty interesting from a Spotify perspective, in that you have two pretty big players in this space teaming up, it seems like, to gain more share. That's going to make it very difficult for something like an Apple Music to really gain meaningful traction.

If Spotify is able to continue to pick up global share, markets especially like China and India and whatnot, those are the big opportunities out there. For me, it's neat to see those two big players in the space teaming up to potentially grow the offering and grow the audience.

What gets lost in here -- I mean, what do you do if you're Pandora at this point?

Greer: Woof.

Moser: I mean, that was the name in this space just four years ago, five years ago.

Greer: So dominant.

Moser: But you go through Capital IQ and look at Pandora's financials, I've said this before, they're some of the worst financials out there. It goes to show, it's not always about being first. It's about, sometimes, being second and learning from the mistakes of your predecessor.

Muckerman: I think they're just resting on their laurels. You look at Spotify partnering up with Hulu in April to offer a joint membership for $13 a month for Spotify and Hulu. They've partnered with Cadillac. I've heard rumors that they might start talking to airlines, to be able to use streaming of Spotify on airlines to expand their brand a little bit. So, I think there's a little bit more innovation there on the customer acquisition side.

Greer: I use Amazon Music Unlimited and I'm just pleased as punch. That's an incredible service.

Muckerman: I haven't gotten into that yet.

Greer: Oh, it's great.

Moser: Do you pay for the subscription?

Greer: Yes, I pay.

Moser: I have Amazon Music that I get with the Prime membership, and even that's OK. Now my music preferences are maybe a little bit different. I pull a lot of the live music I want to hear online anyway. I don't have a Spotify membership or a Pandora membership or anything like that. But I think that just goes toward that greater point. As a pure-play in this business, it's really difficult. The economics of the music business are really hard. If you're something like an Apple or an Amazon or an Alphabet, it's really nice to have that as just one facet of this overall offering, as opposed to relying on that one trick.

Greer: I want to ask you guys about Spotify. When I was on vacation, I was talking to my brother, and he asked me about Spotify the stock. When my brother asks me about stocks -- I've worked at The Motley Fool for almost 20 years, so I've heard a lot. So, he says, "What do you think about Spotify the stock?" I gave him my standard answer. "Uh, I don't know." So, what should I tell my brother about Spotify the stock?

Moser: For me personally, I'm not quite on board with wanting to own the stock. I'll say, I hear from a lot of people in the industry and users themselves, Spotify seems to have a great reputation in this space, from a user interface perspective and from a content perspective and whatnot. To me, the economics of music are so tough, and music is so individual. Everybody likes their own thing. I would rather own a part of a music offering that was part of something greater. That's my cop-out for saying I'll just own Amazon and be done with it.

With that said, I do think, if you're looking for a pure-play winner in this space, I think Spotify is probably the front-runner right now. I'm just not convinced it's actually worth investing in.

Muckerman: Yeah, I'd have to agree. The market, you're looking at streaming, almost 40% of music revenues globally. There's still some room to grow on the streaming side, to be sure. But even though it's a small competitive market, I don't know if I'm going to buy into a pure-play. In an industry that was so recently disrupted by streaming, who knows what's next around the corner?

Moser: You look for things like pricing power and switching costs, obvious competitive advantages. As time goes on, perhaps there's a switching cost to Spotify, in that you don't want to change your entire music life over to some other provider, if that's the way you listen to music. But, I don't see that this company has a whole heck of a lot of pricing power, to be honest.

I do like the fact that they're branching out into other content, so it's not just music. I think that's where they have a really good chance of becoming something more. We've seen over time -- Sirius XM is a good example of a company that, at the very beginning stages of Sirius XM, nobody gave them a chance whatsoever. They had the benefit of Howard Stern really helping spearhead the beginnings of that company. Now, they have a subscriber base of 30 million or more happily paying. The big question out there is, when Stern leaves, how many of those people stay? Certainly, I don't know that I do.

Greer: There's only one Howard Stern.

Moser: Then that comes back to the pricing power. I might stay if they make it worth my while. And by making it worth my while, I mean, cut that subscription in half. The economics make it really difficult.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Jason Moser owns shares of Apple. Mac Greer owns shares of GOOG, Amazon, and Apple. Taylor Muckerman owns shares of GOOG and Amazon. The Motley Fool owns shares of and recommends GOOGL, GOOG, Amazon, Apple, Pandora Media, and Tencent Holdings. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.