Needless to say, I had no idea what I was doing. I read a couple of stock-market books, but nothing really clicked.

Then, after graduating and joining JPMorgan’s Private Bank, I stumbled upon the Buffett shareholder letters and became completely hooked. I read the entire archive on Berkshire’s website in less than a week (I got very little work done that week) and then devoured anything I could find related to Buffett, Berkshire and value investing. It felt like I had discovered a new religion.

For the first time, I knew exactly what I wanted to do with my life: become a professional stock-picker following the Buffett principles of value investing. I could not believe people got paid to do something so competitive, entertaining, and intellectually stimulating.

So I spent the next nine years laser-focused on finding my way into a job in public equities. I navigated through the private bank, fixed income, rates and credit, and sell-side equity research. During the pandemic, after building a bit of a following on Twitter, I decided to post my anonymous resume to see if it would lead to anything. To my surprise, it worked marvelously. I landed at a place where I thought I could spend the rest of my working days: a fundamental hedge fund.

A bit more background about myself is likely overdue. I realize some of you don’t know much about me, and up until now you’ve been reading the thoughts of an anonymous person on the internet. You deserve more.

I recently came public on Twitter, something I had been meaning to do for a while. My name is Francisco Amador. I was born in Caracas, Venezuela, grew up there, and moved to the U.S. after graduating High School to study in Worcester, Massachusetts. I have lived in the U.S. ever since — Massachusetts, Texas, New York, and most recently Florida — and I consider it home.

My ties to Venezuela, the past 17 years since I’ve left, have slowly disintegrated as the country’s political, economic and social crisis deepened. My family was forced to leave in 2010 as it was no longer safe to live there. Most of my friends did the same1. At some point, without making a conscious decision, I stopped believing I would ever see my home country return to anything resembling prosperity.

Life, as it turns out, doesn’t really work out exactly as you plan it. January 2026 brought with it two completely unrelated events that significantly altered my future.

On January 3^rd, Venezuelan Dictator Nicolas Maduro was extracted from his home by U.S. Military forces and taken to a prison in Brooklyn. Nobody, no matter what they tell you, expected something as wild as this to ever happen. It seemed like a scene straight out of Call of Duty. I spent the better part of that night looking at videos of bombs going off in Caracas in complete shock.

Three weeks later, I found out that the hedge fund I was working at was going through major structural changes, which meant I had to look for a new job. That news also caught me completely off guard. I had worked with people I liked and admired, could look at almost any company that interested me, worked remotely with unusual flexibility, and was well compensated. I didn’t think that I could recreate that setup anywhere else.

Those two totally unrelated events forced a question upon me that I had not seriously asked myself in 15 years: was my life’s work really supposed to be public markets investing? For the first time, the answer was not an resounding yes.

This led me to look for the real answer. I realized that if I was being honest with myself, I was content at my previous role, but I felt like something was missing. I wanted to work on something with a clearer sense of purpose, a bigger challenge, more human interaction, and a chance to build something durable. Public markets no longer seemed to offer that in the same way. The space had become intensely crowded. I was struggling to find enough truly exciting ideas that could generate great returns. Working from home as a public-market investor could also become a lonely pursuit.

Perhaps most important, I had learned firsthand that building a durable business around stock picking is, to put it politely, a very tough proposition — there is something mildly ironic about spending your life analyzing some of the world’s best businesses but also choosing to work in one of the hardest ones2.

My one-time dream of running my own public equities fund had been smashed to pieces. The more I thought about what to do next, I realized it had to successfully pass four filters:

1. Give me a real sense of purpose

2. Present a big challenge where I could have meaningful impact

3. Put me in a position of responsibility alongside a high-performing team

4. Play a game where I could have a real edge

So I started brainstorming.

I thought about doing something in the music space, where I had built somewhat of an expertise. Maybe acquiring music catalogs? No, prices were too high, too many players crowding the space, and not enough assets where I could generate good returns.

I thought about joining a live events company that I had invested in as the head of M&A and Strategy. Interesting, sure. But that didn’t give me the sense of purpose I was looking for.

I thought about scaling what I had already been doing on the side through Sleepwell: investing in private companies and startups, where sourcing is harder, relationships matter, and you can have a more direct impact as an investor. That felt closer. But I didn’t have enough track record or deal flow to build something meaningful.

All of these paths were interesting, but none of them felt inevitable. Meanwhile, I kept coming back to Venezuela.

For the first time since I left in 2009, the outlook looked meaningfully different and more positive. Still uncertain, still messy — but no longer hopeless. I decided to study the opportunity more seriously. I looked at historical analogs: countries that opened up after decades of isolation or dysfunction, and what happened afterward to GDP growth, capital formation, stock-market returns, foreign investment, and private-equity outcomes. Vietnam. Russia. Poland. Peru. Panama.

My conclusion was simple: Venezuela was likely facing a once-in-a-generation opportunity — not only to rebuild, but to generate superior investment returns along the way for those best positioned. The only question was how to play it.

Around that time, I was fortunate to meet Vicente Zavarce, a Venezuelan tech founder who had built Yummy, essentially Venezuela’s Uber with a SuperApp angle. He invited me to participate in the company’s current investment round. I went through the numbers, studied the thesis and concluded it was an attractive opportunity and direct way to get exposure to Venezuela. So I went ahead and invested.

As I looked more closely at the details of the round, one detail jumped out: the lead investor was a fund called Arqos Capital, which had been investing exclusively in Venezuela since 2019 with an institutional structure. I had never heard of an institutional investment platform focused solely on Venezuela, much less one that had been doing it for that long.

Venezuela was literally uninvestable — a communist dictatorship under US sanctions, OFAC restrictions, expropriations and no rule of law — most institutional investors were prohibited from investing in Venezuela. So I decided to learn more and try to get in touch.

A week later I spoke to Daniel Rottenberg, the Founder and Managing Partner, after my dad put us in touch. Daniel had an impressive background: he was Venezuelan, lived in the US since he was 14 years old, went to Wharton and HBS, worked at Lehman’s proprietary trading desk and Everest Capital focusing on Emerging Markets and Distressed assets.

He then launched his own EM Hedge Fund and then pivoted into Venezuela Prime Real Estate in 2019. To put this in context, this was during the worst of a socioeconomic and political crisis: water and food shortages, electricity outages, hyper-inflation, mass emigration. His thesis was simple but deeply contrarian: buy Prime Real Estate in Caracas for scrap (a fraction of replacement value), an irreplaceable asset that could generate good cash flows in dollars, with limited downside, and at some point, in any sort of stabilization scenario, it would be worth a lot.

As Daniel and I got to know each other, I told him I was considering raising a small fund to invest in Venezuelan private companies, similar to Yummy. He was encouraging, but also warned me of all the headaches I would face: fundraising, structuring, legal, compliance, sourcing, due diligence and operating a fund in Venezuela was a indeed steep hill to climb.

Then he proposed a different idea: I should instead join him at Arqos and lead its private equity and venture capital efforts. It caught me off guard, and I said I would think about it.

Over the next few days, the opportunity started to feel obvious. Arqos had a real first-mover advantage (only one other fund had been investing in Venezuela), it was likely the best positioned investment platform in the country, it had a great reputation, network, track record and an ability to source and look at the most important and attractive deals in this upcoming recovery phase. Daniel had offered me a fast-track into the front seat of investing in Venezuela. Importantly, it passed my four filters with flying colors.

There was no way I could pass on it.

Over the past month, I’ve been making the transition from fundamental public markets investor to private investor in Venezuela, which is as polar opposites as it gets in the investment world. The learning curve has been steep, humbling and exciting. I’ve been spending time in Caracas, meeting founders and operators, and speaking to international investors that want to understand how to invest in the country. The opportunities we’re looking at are not only incredibly interesting investments, but they have the potential to have a real impact in the economy and people’s lives.

I hope to put the lessons and experiences I learned in public markets to good use and make a small contribution to the rebuilding phase of my home country. That also means I will be moving back to Venezuela after 17 years in the United States.

Sleepwell will live on as a content platform and as a vehicle for selective, high-conviction investments. But most of my time from here on will be dedicated to Venezuela and Arqos. I hope to report back with the mistakes, lessons, surprises, and stories from the ground.

I couldn’t be more excited about what the future holds.

The back-catalog – especially the deep catalog older than 10 years – is essentially a toll road for 25%+ of the world’s best, most listened to and most culturally relevant songs. That business simply cannot be replicated. You cannot replicate the masters to the songs that The Beatles recorded at Abbey Road between 1962 and 1970. The main costs associated with the back catalog are royalties that must be contractually paid to artists, which in many cases are as low as 15-25%. The catalog grows without requiring much, if any, incremental capital, having very attractive and increasing returns on capital. This business makes up ~2/3 of UMG’s revenue and an even higher portion of their profitability (possibly as high as 90%).

The back-catalog has gained share over time1, as consumers opt for familiarity in a world of content abundance. It also benefits directly from growth in total music subscribers and price increases taken by the platforms. This is an intellectual property business with recurring revenues and long-dated life. It will not last forever (e.g., very few people listen to 1920s music), but it will generate value for a very long time.

The second business within UMG is quite different. The New Release business, also known as frontline, is a highly competitive, low-margin and low-return business with little differentiation. Artists still seek and need help to maximize their chances of breaking out, whether through a label or distributor, as well as a broader team that provides support — managers, lawyers, publicists, creative directors, social media/marketing, etc. Most importantly, artists have many options at their disposal and typically their biggest need is cold hard cash, which is a commodity. They can record songs from home, build a following through social media and promote their music through those channels. Artists have gotten smarter and more educated. The really talented ones tend to get a lot of deals on the table and have gained significant leverage over time. The Beatles had zero leverage in 1962. An independent artist in 2026, with 50K followers and a trending song on TikTok has a lot of leverage and options to chose from.

Today it’s rare for a talented artist with a big following to give up their masters when signing with a record label. Instead, they license their music (existing and/or future recordings) to labels or distributors for a pre-set period while getting a cash advance to cover their cost of living and future recording costs. Most artists are just going with the highest bidder, which also means the winning bid is typically getting the lowest return. There are other considerations at play, such as personal relationships, brand, reputation, label roster, and capabilities, but these are mostly secondary.

This shift from an ownership model to a rent model has resulted in labels losing power while artists gained power, and it has made the labels a structurally worse business compared to the days when artists had no option but to sign to a label and give away their masters in perpetuity. Just look at the cost of goods from the major labels (mainly artist costs in the form of royalties paid) and how they have come down in the past 10 years (-700bps for UMG). This rent business, known as distribution or licensing deals in industry jargon, is a low-margin business, typically around 10-20%.

Put these two together and you get two opposing forces playing off each other under the UMG hood: an excellent business, with franchise value, whose value doesn’t get properly recognized by the market; combined with a mediocre business, that mostly gets them penalized. All inside a big black box.

This is the core of the issue at UMG.

UMG also isn’t helping itself, as they’ve lost market credibility. Investor communication and disclosures have been poor, capital allocation has been mediocre, and they seem to be focused far more on market share and shiny press releases than an adequate return on their investments — their investor presentations always begin by reminding investors that they dominate the Top charts, but at what cost?

UMG has been aggressively signing superstars, such as Taylor Swift, without much indication of what the returns on those advances are. These deals require massive advances, additional resources (artists of this stature demand immense attention), and are likely to have below average economics. They’ve also been acquiring other labels and large catalogs without much indication of expected returns. For such an acquisitive and capital-intensive company, UMG reports no organic growth, ROIC or return hurdle metrics.

Since 2020, UMG has spent almost €6B EUR across artist advances, catalog investments, M&A, and capital expenditures, which is more than 2X their average equity during that period. Yet, investors have no idea what kind of return this capital has garnered.

I believe Bill Ackman’s plan has a lot of merit – especially on the capital allocation, balance sheet and improved investor communication front – but I don’t think it’s enough.

My Suggestions for UMG

I think best strategy for UMG going forward to maximize value is to recognize the reality that they’re facing and optimize each of the two businesses discussed.

Here are four suggestions:

1) Communicating more clearly to the market the value of the back-catalog, by sharing transparent data and information on how it performs and how much cash flow it generates, along with establishing a clear framework on how the excess cash flows will be used and returned to shareholders via dividends and/or buybacks (when it trades below intrinsic value).

2) For the frontline business, clear return thresholds must be established, and market-share focus must be completely abandoned. 1 percent of additional market share is meaningless if it destroys shareholder value. Investors originally bought into the notion that UMG was a capital-lite business, which has been proven wrong. Artist advances, catalogs and label acquisitions are the equivalent of Capex in this industry. UMG should become more selective with the artists they sign and make sure each one is subject to a clear ROIC framework. The same framework applies to catalogs and label acquisitions. UMG should also communicate to the market what the ROIC metrics of the New Artists and other business units are, as well as reporting total company ROIC and organic growth.

3) The merchandise business should be divested and converted into an IP licensing business, where UMG licenses the artist’s NIL (Name Image and Likeness) and a third party bears the cost of manufacturing and distribution. This business is currently detracting value from UMG, as it generates €800-900M at a low single digit EBITDA margin (likely unprofitable when fully cost burdened).

4) UMG should recognize AI as both an opportunity and a threat. This is the Innovator’s Dilemma at play. Blindly saying that they will benefit from this disruption and taking a confrontational stance against it is delusional and bad strategy. That mindset means they are destined to repeat the same mistakes of the Piracy era, when labels thought that consumers would always prefer to buy CDs and their response was suing everyone who opposed them. Although there are potential ways UMG can monetize these new innovations — such as by licensing the music for training, inference and prompts — it’s also a fact that these tools are already driving the cost of producing new music to nearly zero, and saving artists, producers and songwriters an immense amount of time in the creation workflow. The inevitable result is that the number of songs (even excluding the pure “AI-slop”) uploaded to streaming platforms will continue to increase exponentially, UMG may not get compensated commensurately for this, competition will intensify, and artists will gain even more leverage. UMG should take a more collaborative stance with these platforms instead of a confrontational one. UMG should also consider establishing a Corporate Venture Capital arm, where they can invest behind the most promising technologies, partner with startups, learn from them and be at the forefront of technological progress.

The opportunity at UMG is not just about fixing what’s broken, but about unlocking the extraordinary value that’s already there, hiding in plain sight.

I’m a business analyst and active investor in the music space (Spotify, UMG, music catalogs and a private live events company), an independent artist, and an executive producer in various music projects. A lot of my views have been formed by speaking to a number of artists, producers, songwriters and music executives from my network — varying from small independent acts to artists with tens of millions of listeners on Spotify.

By then, Beatlemania no longer looked like a pop craze. It looked like a force of nature. From a distance, their rise could seem inevitable.

It was anything but.

“You don’t know how lucky you are, boy”

— Back in the USSR, Lennon/McCartney

I grew up with The Beatles in the background. Not in an obsessive way, and not because my parents were huge music people, but because they were my dad’s favorite band when he was a teenager. Their songs were always around on our family road trips. I enjoyed them, but for years I did not fully buy the claim that they were, almost by consensus, the greatest band in history. The praise felt slightly exaggerated.

Then I started reading their story, and the hype made a lot more sense.

It is hard to grasp The Beatles’ impact on modern pop music without understanding the context: where they grew up, how they learned to play, what the music business looked like at the time, how unusual their songwriting model was, and how often they chose the unconventional path.

The Beatles were musical geniuses, tremendously hard workers, witty, charismatic, charming, and not afraid to defy conventions. They also had a chemistry that bands almost never have. That chemistry was earned the hard way. In 1961 alone, they played 341 gigs, essentially one show a day.

Still, talent and work ethic are only part of the story. The other part is harder to talk about because it makes people uneasy: luck. The Beatles were not merely great. They were also the beneficiaries of an astonishing number of near-misses, timing breaks, accidents, and improbable encounters. Not enough to explain their success, but enough to make that success possible.

Liverpool Kids

John, Paul, George, and Ringo grew up in Liverpool. What is lesser known, is that they were they from different neighborhoods, ages and schools. The fact that those four found one another at all was not inevitable. Even before the band existed, each of their lives contained many fork-in-the-road moments that easily could have erased the Beatles before the Beatles were ever formed.

At age five, John Lennon was nearly taken away by his father, a merchant seaman, to live in New Zealand without his mother’s consent. John’s mother, Julia, intervened and John had to choose who to stay with. He chose his mother, but he was raised by his aunt and uncle given his mother’s financial instability and relationships with other men. That wound ran straight through his emotional development and, later, shaped his songwriting.

Ringo was almost comically unlucky before he became wildly lucky. He was practically born sick, and the doctors told his mother on three separate occasions that he had less than six months to live. He spent much of his childhood in a hospital bed. He suffered peritonitis and fell into a coma, and spent a year in recovering. Later he contracted tuberculosis and was again confined to the hospital for a long stretch, missing so much school that teachers were sent to the hospital, including a music teacher. It was during that period that he became obsessed with playing drums after playing around with various percussion instruments, and later joining the hospital band. Against all odds, Ringo soldiered on, recovered, and became Liverpool’s best drummer, though not at first for the Beatles.

When Paul was a teenager, he got his girlfriend pregnant. He decided to marry her, partly out of conviction and partly under family pressure. Three months into the pregnancy, she miscarried. If Paul had become a father at 19, the story almost certainly looks very different.

In 1960, Britain abolished National Service just as the Beatles were coming of age. They barely missed the cut. A two-year stint in the military would have almost certainly scattered them or delayed them long enough for the moment to pass. Instead of becoming the Beatles, they might simply have become another Liverpool cover band that never quite got anywhere.

Deported From Hamburg

Up to this point, The Beatles were still basically a scrappy rough club band from Liverpool. Suddenly, a local club owner and promoter had been booking Liverpool bands in the Red Light District in Hamburg, and a band dropped out on the last minute. So he asked the Beatles if they could fill in. The offer was for three months away from home, and they jumped at it.

The almost missed that chance too, the booking required a full band, and at the time they did not have a drummer. The night before they left, they persuaded their friend Pete Best, a half drummer at best, to join them.

Hamburg became the perfect and brutal training ground. They played six- to eight-hour sets, seven nights a week, in front of drunks, tourists, sex workers, and anyone else wandering through the Reeperbahn. They slept in a filthy room behind a cinema. There were no showers. There was also plenty of booze, pills, sex, chaos, and fighting.

Then the trip blew up. George was deported for being underage. Paul was deported after being accused of trying to set a building on fire. The engagement ended abruptly. On paper, it looked like a disaster.

In reality, it may have been the making of them. Hamburg is where they were forged into a real band. The hours were punishing, but they gave the Beatles the stamina, tightness, stage presence, and sheer professionalism that later stunned Liverpool. By the time they returned home, they had become impossible to ignore.

“Guitar Groups Are on Their Way Out”

Brian Epstein never wanted to be a music manager. He came from a well-off Jewish family of businessmen in Liverpool. His real passion was the theater. His day job was running NEMS, a record store, which he did superbly.

One day, a teenager walked into NEMS asking for a record called “My Bonnie,” which the Beatles had recorded as Tony Sheridan’s backing band. Brian did not stock it, but his policy was simple: if customers asked for a record he did not have, he ordered it. Then more people came in asking for the same one.

That was enough to make him curious. He found out that this oddly named local group was playing in a nearby bar, the Cavern, and went to see them for himself.

He was floored, not just by the music but by the electricity in the room. Right after the show, he offered to manage them and promised to get them a record deal. That promise required extraordinary commitment on his part: time, money, persistence, and a willingness to look slightly ridiculous while almost everyone else dismissed the band.

This was not the streaming era, where an artist can upload a song and potentially find an audience on their own. In the early 1960s, if you were not signed to a label, you were effectively invisible. Labels controlled the studios, the manufacturing, the distribution, and the crucial relationships with record shops and radios.

Brian set off to London and knocked on every door he could. He had some advantage because of his NEMS connections, but the answer was still mostly no. Decca, one of the most powerful labels in Britain, famously rejected the Beatles with the line: “Guitar groups are on their way out.”

That verdict makes more sense once you remember what the industry looked like at the time. The standard model was a solo singer recording songs written by professional songwriters, often backed by hired musicians or a supporting group. Labels mostly followed that formula because it worked so no one questioned it.

The Beatles fit none of it. They had no clear front-man. They all sang. They wrote their own material. Their name sounded strange. They were from Liverpool at a time when the center of gravity for British music was still London. To industry executives, the whole package looked awkward and hard to categorize.

The labels were not necessarily stupid. They were looking at a genuinely unusual act and trying to process it through an old framework. It was a risk they weren’t willing to take and they simply could not see what was in front of them.

The Road to Abbey Road

George Martin was never supposed to sign The Beatles.

The classically-trained musician was a former military turned music producer and Record Executive. He was the head of A&R at Parlophone, the smaller EMI label best known at the time for comedy records and novelty material. EMI itself was one of Britain’s most powerful companies (along with Decca they held an impressive 80% of the market-share), and in 1962 Martin was close to leaving after one too many clashes with senior management.

Brian had already tried EMI once and been turned away. The initial response was blunt: the company had enough groups of that type already. But he managed to get a second, unexpected chance.

This time Brian changed the pitch. Instead of selling the Beatles only as a band, he emphasized Lennon and McCartney as songwriters. Fortunately, another EMI executive, Sid Colman, was interested in signing them, not as The Beatles but as Lennon-McCartney, the songwriting duo. Brian shrewdly asked Sid to help him secure a recording contract for The Beatles, and he assured him he would get their Publishing1 in return.

Colman started to pull some strings to get Brian a meeting with an EMI A&R executive. By pure timing, George Martin happened to be the only one available that week because the other two were on holiday. During the brief meeting, the two men chatted for a bit. Brian was surprised that George had never heard of The Beatles. George was surprised that they were from Liverpool. Brian played two songs he had on a record for George to listen to, and then he left. George wasn’t too impressed.

In another part of town, Sid Colman was playing some of the songs Lennon and McCartney had written to another colleague. Kim Bennet. Kim listened carefully to a song called “Like Dreamers Do” written by Paul, which blew him away. Sid told him it was available to use but only if The Beatles got a record deal. Kim happened to be not just a workaholic but a highly persistent man. He went off to EMI to try to find them a deal. He spoke to every A&R man he knew at EMI, but none of them were interested.

Three months after George met with Brian to discuss The Beatles, his employment contract was coming up. He was determined to negotiate with his boss, Len Wood, that he was entitled to receive producer royalties in future records given his producer role. Len, a tough negotiator, didn’t budge, to which George said “I’ll have to leave EMI then”, and Len replied: “Be our guest”.

Fortunately, George couldn’t leave, as he needed every penny of his salary since he was going through a divorce. The experience left a a bit of a sour taste on Len, who subsequently had a routine meeting scheduled with Kim Bennet. Kim once again, tried to push them to sign The Beatles, even offering him that his department would pay for the recording costs. Len agreed, and decided George Martin could take on the Group that everybody else had passed on. He was to not only sign them to his label, but also be their producer.2

And so after a series of chain reactions, side-motives, holidays, rivalries, timing quirks and persistence, The Beatles finally got their recording contract.

Genius or Lucky?

Luck is not the opposite of merit. It is the intangible thing that decides who gets a shot in the first place. It shapes the field long before effort, discipline, or genius can express themselves.

The Beatles were not proof that genius makes luck irrelevant. They were proof that genius needs openings, and that luck, on its own, is never enough. They kept turning lucky breaks into monumental ones because they were unusually prepared, unusually driven, and unusually able to capitalize on narrow windows when they opened. A fascinating manifestation of compounding.

None of this diminishes what The Beatles accomplished. On the contrary, it humanizes their achievements. Personally I think it makes greatness even more awe-inspiring, not less, because it required both brilliance and a thousand things going right enough.

The real miracle was not the hand they were dealt, but how they played it. History handed them improbable moments, but it also handed them pressure, exhaustion, instability, and repeated opportunities for everything to fall apart. What made them The Beatles was not simply that luck found them. It was that, time and time again, they were ready to face it when it did.

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A large part of the source material for this piece came from the book Tune In: The Beatles - All These Years, Vol. 1, by Mark Lewisohn. This book is considered by many as the most comprehensive Biography of The Beatles. Volume 1 covers their life up to 1962, just before their major breakthrough. Volume 2-3 are still being worked on.

For anybody interested in learning more, I highly recommend it.

It’s been a while since I’ve done a deep dive on this space (which long time readers know I follow closely), so now seemed like a good time to sit down and have a long-form conversation on this topic.

We discussed the growth prospects, the basics of streaming royalties and intellectual property rights, my experience as an independent artist, the labels, the streaming platforms, potential for price increases and of course, AI (saved the best for the end).

You can listen here (or on your preferred podcast platform):

Spotify:

Apple:

YouTube:

I hope you enjoy it and I’m hoping to put something in writing soon regarding this fascinating sector (suggestions welcomed). I’m very pleased it’s been getting more attention recently, was ignored for way too long!

Please feel free to reach out with any questions or feedback.

As always thank you for your continued support, we’re now over 5,000 subscribers strong and growing! And please share the podcast or newsletter with anyone you think could be interested.

Sleepwell

Always happy to discuss anything on Twitter @SleepwellCap

The best brands in the world have a mindshare of distinctive positive associations that come from decades of cultivating their image. This stems from making high-quality products, clever marketing, and methodical merchandising. This moat is intangible, and although it’s impossible to measure exactly, it’s incredibly valuable: it’s the biggest competitive advantage that many brands possess. Warren Buffett understood this when he invested in Coke, Lou Simpson when he invested in Nike, and Bernard Arnault as he built his LVMH luxury empire.  

Luxury brands are not like regular brands though. They possess a different set of qualities and follow different rules, almost opposite to traditional business.

What makes Rolex Rolex? I think is a question worth exploring because it probably comes as close as anybody else to a globally recognized luxury brand. That is not a small feat. It’s neither intuitive nor obvious the amount of effort, time, sacrifice and thoughtful strategy it’s taken them to get to this level.

To analyze how they achieved this through first principles, we first must define exactly what we’re solving for.

What is a True Luxury brand?

Luxury has a very broad definition. It’s subjective, emotional, personal. Look no further than the replies to this Tweet, where I asked people: What are the most successful American luxury brands? The list was long: Tesla, Apple, Crocs, Nike, Patagonia, Coach. I should have been more careful in my choice of words, but I meant true luxury. I don’t think any of those brands fit the definition of true luxury.  

Luxury is a spectrum. According to Brunello Cuccinelli, there are three types of luxury brands. If we imagine a pyramid, at the top is true or absolute luxury, in the middle is aspirational luxury, and the bottom accessible luxury. The top is where only the very best of breed sit and there are only a handful of them for any given category. Those that sit below can only dream of one day becoming part of that prestigious club. In the words of RH’s Gary Friedman, climbing the luxury mountain is incredibly hard, and has rarely been done. What separates the top from the bottom is having traced their own path for a very long period of time.

A true luxury brand has the following characteristics:  

• An obsession with high quality and craftmanship. It innovates and surprises, but always stays true to their core image.

• It’s exclusive and scarce. Products are hard to get. Consumers make a deliberate effort to get their hands on them, not the other way around.

• It evokes a certain status in the mind of consumers (both the buyer and the general public). This could be wealth, refined taste, appreciation of culture or history.

Rolex is worthy of study for various reasons. First, I have a personal bias towards watches. They’ve always fascinated me, maybe it has something to do with the engineer inside me or the aesthetics of a great looking watch. Second, Rolex is counterintuitively one of the best known brands in the world, and also one of the least known businesses. A lot has been written about luxury businesses, especially LVMH, but Rolex is extremely secretive and its business remains mostly a mystery. It's not a public company, quite the opposite in fact: it's owned by a foundation which operates as a non-profit. Third, it’s one of the very few companies I can think of that climbed the luxury mountain — and this was almost by accident.

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Climbing the Luxury Mountain: A Short History

Rolex was founded by Hans Wilsdorf and his brother-in-law in 19051 as Wilsdorf and Davis, specializing in making wristwatches in the UK. Three years later they came up with the Rolex name because it was short, easy to pronounce in any language and they thought it sounded similar to the sound of winding a watch.

The idea of going into wristwatches back then was controversial. At the time, pocket watches were the norm. People did not associate wristwatches with good timekeeping nor were they fashionable, and the most accurate watches in the world were pocket watches. Wilsdorf addressed this by certifying his wristwatches with the the Kew Observatory in the UK (which certified marine chronometers for the British Navy), thus making the first wristwatch to be awarded with this certificate.

After successfully proving he could produce precise wristwatches, Wilsdorf moved on to water resistance. He recognized that, unlike pocket watches, wristwatches were a perfect companion to be used in water sports. He devised a clever storytelling PR stunt to market this feature to consumers.

Mercedes Gleitze was famous for being the first person to successfully swim across the English Channel, so Wilsdorf asked her to wear a Rolex the next time she attempted it. This time she didn’t make it, after 10 hours in freezing water she couldn’t continue due to numbness of her extremities. But that didn’t matter. Wilsdorf ran a full-page ad showcasing that a Rolex watch withstood 10 hours in the freezing cold English Channel water while perfectly keeping time.

After successfully producing and marketing a waterproof wristwatch, Wilsdorf went on to make a watch that would power itself; what is known as an automatic or self-winding watch. For this Rolex invented the weighted rotor (using the wrist’s movement to accumulate elastic energy to power the watch), which effectively became the industry standard in watchmaking.

As years passed, the brand became more and more popular given their superior quality and timekeeping accuracy. They introduced two new models which would become so iconic in their design that almost every other watch brand copied it: the Datejust and the Submariner. The latter was the first “Professional” watch2, designed specifically for scuba diving, given its high depth ratings. Later on, Rolex would introduce other iconic models well-known to this day such as the Daytona (chronograph for car racing), GMT-Master (two time zones for pilots), and Sky Dweller (annual calendar for travelers).

At this point, Rolex didn't sit in the top of the luxury mountain. In the 1970s you could buy a Rolex for $200, or about $1000 in today’s dollars3. Some of them you could even fetch at a discount. Back then it was considered a high-end purchase, mostly justified by its high quality and precision. Also keep in mind there was no other way to keep time; these were considered high-tech instruments.

Then came the crisis. In the 1970s the Japanese brand SEIKO invented the first quartz watch, which was orders of magnitude more precise than mechanical watches, backed by a battery4. The entire Swiss watch industry almost got decimated as a result, given that their main competitive advantage and reputation relied on accurate timekeeping. A lot of brands disappeared during this time, as they couldn’t compete. Rolex instead, saw an opportunity. First, they developed their own quartz watches to compete with the Japanese, and second it shifted its product positioning to luxury by producing 18 karat gold watches and aggressively raising prices5.

How Rolex Represents True Luxury

Rolex lives and breathes the three attributes of a luxury brand like no other. To get a better understanding of what it takes to build this moat, let’s explore some of the strategies the company employs.

Quality: The Perpetual Pursuit of Excellence

It’s an understatement to say that Rolex has an obsession with quality. This goes back to the early days of Hans Wilsdorf. The three manufacturing tenets that he implemented 100 years ago (precision, waterproof, self-winding) are still at their core today. Here are a few examples of the processes that take place in their watch making.

Rolex uses only the best materials in the world. Not only that, but they went as far as building their own foundry. Here they make their own patented metal alloys and precious metals, including three types of gold and their famous 904L stainless steel, which is aerospace grade level of durability. They have a laboratory filled with world-class experts in materials engineering, friction, lubrication, wear, chemistry and physics. Oh, and Rolex employs two Nobel Prize winners in their team.

Rolex quality control goes to an extreme. They are fully vertically integrated, making all their components in-house and put to the highest standards. Their waterproof test places watches into pressurized tanks that simulate the guaranteed depth rating of every model with an additional 10% margin for regular watches and 25% for dive watches. The 24-hour accuracy test photographs watches and exactly 24 hours later it’s photographed again, if the images are not microscopically aligned, they’re sent back for revision. They invented a machine that opens and closes the bracelet clasp 1000 times per minute. The finishing phase, which includes polishing of the case, is done 100% by hand. They have a proprietary machine that tests diamonds and stones to make sure they’re up to their standard and aren’t fake6. They also have machines to test their own machines. Is that obsessive enough?

Rolex consistently pushes the boundaries of innovation. After making a pretty good dive watch with the introduction of the Submariner in 1953, Rolex didn’t stop. An average scuba diver rarely goes below 100 feet, while the first Submariner was good for 300 feet (100 meters) of depth. Rolex doubled, then tripled the depth rating in the subsequent models.

In the 1960’s they partnered with the U.S. Navy and the French exploration company COMEX, to develop professional watches exclusively for deep-sea exploration. But they ran into a problem. To reach extreme depths, divers spend days in an underwater chamber that is pressurized using a mixture of oxygen and helium for breathing7. Helium, for those that flunked chemistry class, is the smallest element in the periodic table. This meant that the gas was able to enter the watch through the edge between the crystal and the bezel. During the decompression stage8 as the divers ascended back, the outside pressure decreased and the high pressure helium inside the watch made the crystal pop off like a champagne cork.

While other watchmakers struggled to solve this, Rolex devised a simple solution: create a unidirectional valve that would operate only when the pressure outside was lower than inside the chamber, thus the helium gas could automatically escape during the decompression stage. They called it the Helium Escape Valve.

Things didn’t stop there though. Rolex kept pushing the depth rating, quite literally to the limit. The Deepsea Challenge was introduced last year and has a maximum depth rating of 36,090 feet (11,000 meters), or equivalent to the deepest point in the ocean, the Mariana Trench. To put into perspective the pressure at these depths, it's 16,000 pounds per square inch or 1000X the atmospheric pressure at sea-level. In fact, the watch accompanied James Cameron on his expedition there, hanging right outside the submarine9. There’s literally nowhere deeper you could take the watch (at least on this planet).

The result of this obsession with quality is a simple yet powerful promise that consumers can trust: anyone buying a Rolex knows that the watch will be working perfectly fine decades from now, when they decide to pass it on to their child.

Exclusivity and Scarcity: The Waitlist

I have a challenge for you. Go into any Rolex boutique, ask if they have any watches available for purchase and I think you’ll be both surprised and out of luck. Pretty much all their products are out of stock. You’ll have to join a mythical “waitlist”10, as you explain to the Sales Associate why you’re worthy of owning a Rolex.

Think about this for a second. The roles have reversed: instead of a salesperson chasing you down and trying to convince you to buy something, you have to be the one convincing them to sell it to you!

It wasn’t always like this. There were always a few models in high demand that were hard to get, like the Daytona. But today it’s totally different. On the supply side, it’s mostly an outcome of the strategy employed by the Rolex CEO known as shrink to grow, where Rolex reduced and optimized its retail footprint while production has only increased somewhat. Rolex also periodically will discontinue certain models, making them even more desirable in the aftermarket.

More importantly, the demand has far outstripped the supply (which includes both new and used models). This is testament to the Rolex marketing strategy, as well as a general increase in public interest for high-end watches over the last few years.

One of the most basic rules of luxury is that you always sell less than what is demanded. The book The Luxury Strategy explains it nicely:

“A luxury brand must have far more people who know it and dream it than people who buy it.”

This is a very simple concept, but incredibly hard to follow with discipline. What makes it so hard is the natural desire for companies to chase growth (exacerbated if you’re public), which in the short term would cause a quick spike in sales, but in the long term can impair the value of the brand. It’s also why investing in marketing and advertising is so important, no matter the circumstances. Rolex was quite aggressive in stepping up marketing investments during the Great Financial Crisis, while others were pulling back. They have always worked with the same advertising agency achieving consistency and effectively delivering a clear message.

The outcome of this strategy is also reflected in the value of secondary market prices for most Rolex watches, which typically trade above retail value — sometimes as high as 100%.

Making this even more impressive is the fact that Rolex sells over 1 million units per year, at an average $13,000 per watch. For context, the legendary Birkin and Kelly handbags from Hermès sell about 1/10 the number of units at similar price points. There’s really not anybody else selling those kind of volumes at those price points in Luxury, which is mind-blowing.

Status: The Promise of Timelessness

Status in luxury is typically associated with money. But buying a Rolex (or any watch for that matter) isn’t necessarily about the “flex” of showing it off. There are many legitimate reasons why one would buy a Rolex: to celebrate the birth of your newborn, a fascination with the craft of watchmaking, the design aesthetics, the history it represents, a potential investment. Maybe you’re into scuba-diving so you want a Submariner. Or you love racecars so you want a Daytona. These pieces carry a lot of sentimental value for people, and to many it’s more like a piece of fine art.

Rolex has spent decades cultivating their image and reputation. They are very selective with who they partner with and always strive to be associated with excellence, in both performance and character.

Rolex’s partnership with golf began in 1967 with Arnold Palmer, and was soon followed by Jack Nicklaus (still to this day a Rolex ambassador). The company’s commitment to the sport has been persistent, sponsoring the major tournaments and best players. In tennis, their sponsorship began over 40 years ago and their relationship with Roger Federer goes back to 2001.

Rolex also tailors their products to a very important set of customers: collectors. They do this by creating limited edition pieces, off-catalog pieces, discontinuing some models, and paying homage to historical pieces, such as an anniversary piece that celebrates the original model with a twist.

Collectors are the biggest supporters and marketers of the brand, and high-profile auctions make for excellent PR for Rolex. These are only possible given the heritage and history behind the models. For example, in 2017 one of Paul Newman’s watches (a Daytona) famously sold for $18 million, which brought even more popularity to the entire Daytona model lineup. A brand that hasn’t been relevant as long as Rolex and has no heritage simply cannot replicate this.

The Rolex design ethos is such that it always stays true to their original design code, while simultaneously making slight adjustments and improvements (sometimes without telling anyone). It’s this strategy that assures that it never goes out of style. You can be pretty sure that if you buy a watch today, it will still look quite fashionable decades from now.

That said, predictability is not always the name of the game. Every now and then they do something completely unexpected. Recently, they announced a watch with a jigsaw puzzle on the dial, emojis instead of the date and words of affirmation instead of the day. Notably, this model is called the Day-Date, and neither are featured on this specific model. Needless to say, it was quite controversial and created a ton of buzz.

How much is Rolex Worth?

It’s an interesting thought experiment to think how much Rolex would go for if it were a public company. Let’s look at some numbers.11

According to Morgan Stanley, Rolex has a ~30% market share in the Swiss Luxury watch market, which is more than the next five competitors combined12.

Rolex sells roughly 1.2 million units per year, at an average wholesale value of $8,050 plus some other revenue items (like servicing, repairs and parts) we arrive at somewhere between $10-11+ billion of revenue per year.

It’s fair to assume that Rolex has a 30-40% operating margin. This is higher than both LVMH’s Jewelry and Watches Group and Richemont’s Specialty Watchmaker’s Segment (both ~20%) since their watch portfolio skew to smaller, less exclusive brands (on average). The majority of the profit pool sits in the Top 5, which gives Rolex much higher margins (not to mention their immense scale). Also recall that Rolex is fully integrated, which saves on costs.

If we apply an Hermès /LVMH/Ferrari like historical multiple of 30-40X on earnings13, this means Rolex is conservatively worth more than $100 billion. I think 20X would be a steal for a company of this caliber and would rarely trade in that zip code. And if it were public today, looking at current multiples, would probably be worth twice that amount.

Too bad you can’t invest in the company, and I would argue there’s really no comparable publicly traded company out there14. It's not for sale either, rumor says Buffett even tried to buy it once and failed!

What about buying an actual Rolex? I think there’s probably some decent correlation, but you’re likely to vastly underperform the intrinsic value of the underlying business, which spits of insane amounts of cash and requires little capital to grow. I think at the very least the performance of their watches should keep up with inflation, while certain pieces could trade more like coveted pieces of art.

There’s some interesting stories of people who’ve done pretty well investing in watches. My dad actually bought a Rolex GMT Master in 196715, right out of High School, for about $200. That watch is worth about $20-30,000 today or about a 9% annualized return over 56 years. Certainly not bad!

Closing Thoughts: What’s Next for Rolex?

A few predictions for how the next few decades at Rolex will look like (spoiler: more of the same).

• It will stay private and owned by the Hans Wilsdorf Foundation.

• Its model lineup will look very similar. Yes there will be a few surprises, tweaks, and improvements along the way, but aesthetically it won’t change much.

• Like clockwork (pun intended) it will exert its pricing power and raise prices ~6% per year. Production will also increase, but always less than the demand.

• The only part of the value chain that they don’t control is the selling. I think Rolex could eventually take their retail distribution in-house and go full DTC. This would let them keep more control of the inventory, demand, the selling experience and who their customers are.

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Acknowledgements:

This writeup would have been impossible without the work of a few watch experts. I want to especially thank Ben Clymer at Hodinkee, who’s written extensively about Rolex and was featured in an excellent Business Breakdowns podcast. This piece borrowed a lot of information from his work. The Luxury Strategy is a great book to understand how Luxury works and strategies employed. Also my friend Eric Boroian, has taught me a lot about how to think about Luxury generally. Finally, Jose Pereztroika of Perezscope is probably the person who best knows the history behind the Sea-Dweller.

Interesting Sources for Further Reading/Listening:

Hodinkee — Inside Rolex

Business Breakdowns — Rolex

Perezscope — History of the Sea-Dweller

The Luxury Strategy on Amazon

Brunello Cuccinelli Interview

Talking Watches with John Mayer: Part I and II (if you want to see a real watch collector)

Interview of LVMH CFO

Other Sources:

Morgan Stanley Annual Swiss Watcher Report

Rolex Website

Bob’s Watches

The Rolex Magazine

Last week I made a wild accusation:

I realize this is a controversial comment, as is anything that involves comparing someone to Buffett. And that was kind of the point, I knew some people would be ticked off by this (sorry!) but I think it’s healthy to question your most closely held beliefs — like “Buffett is the best investor in the history of time” which I know many people hold.

For those who don’t know, Mark Leonard founded Constellation Software (ticker: $CSU.TO) in 1996, with the purpose of acquiring small Vertical Market Software (VMS) companies. To say the least, it has been wildly successful in its clearly-laid out strategy. VMS is the opposite of enterprise-level software, which tends to be horizontal and industry broad-based – think Salesforce or Excel. These companies exhibit characteristics of very good businesses: they are leaders in a niche market which tends to be oligopolistic, have high margins, low capital intensity, high switching cost, recurring revenues and strong free cash flow. Because most are small and there are tens of thousands of them (many of which CSU is in close contact with), it makes for an attractive rollup strategy with not too much Private Equity competition.

Many people read ‘serial acquirer’ and will pass on the investment without blinking. I would encourage to look twice here. CSU is not the typical acquisitive company: it pays only in cash, rarely issues debt, has never issued stock (for acquisitions nor employee compensation)1, is extremely focused on return on investment2 and most uniquely: it’s extremely decentralized in its M&A practice, which is done at the business level as opposed to HQ. This means they’ve been able to scale up their transaction volume to ~100 per year, a number that is unheard of in a typical serial acquirer strategy.

So back to my wild claim.

Where did I get the idea to say this? I’ve been doing work on CSU the past few months and recently was going over some transcripts of their Annual Meeting3. As I was reading a section where Leonard was explaining their capital allocation process, I thought “wow, this guy is really good, probably as good as, or even better than Buffett”. This was nothing more than a gut reaction, not backed by anything tangible. But then I recalled that CSU stock had compounded at very high rates of returns for the first 16 years since IPO, so I asked myself how would it compare to Berkshire’s first 16 years?

The Duel: Buffett vs. Leonard

I honestly had no idea what the results would look like, I remembered BRK had some really high returns in its early days, but CSU was clearly going to put up a tough fight. It was probably a close match.

But I was wrong. Here’s what it actually looked like:

• Berkshire compounded at a 24.7% return for its first 16 years (1965-1980), a 34X

• Constellation compounded at 35% for its first 16 years (IPO–today), a 122X4

What about outpeformance vs. the index? Certainly we’re talking about different market environments, so it would be helpful to see who generated the most alpha.

From 1965-1980, the S&P returned 7.1% (annually, incl. dividends), so Berkshire’s alpha was 17.6%. Pretty incredible!

From 2006-2021 (YTD), the S&P returned 10.8%, Constellation outperformed by 24.2%.

Holy. Mark Leonard won again.

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Investing Role Models > Investing Heroes

I’m not poking at or discrediting Buffett here, that would be incredibly stupid from a no name investor like myself. Granted, this is not exactly a physics problem either; it’s nothing more than a thought experiment and I recognize we’re dealing with an 🍎 to 🍊 comparison5. Buffett has a 70+ year run, which no other well-known investor that I know of comes close to, even less so with the rates of returns he’s achieved. That’s part of what makes him who he is. Time will tell how long Leonard’s streak will go on for, but it will surely be fascinating to watch closely.

I do think it’s interesting (and funny) how some people get really ticked off when you make a well-grounded claim or criticism against Buffett. He’s become a God-like figure to many people, who essentially worship him. I don’t think this is healthy. Personally, this would prevent me from questioning him, thinking on my own, and closely studying and learning from other great investors, especially those from other disciplines.

Which brings me to my next point. The whole idea behind this was not to pick on Buffett, but to shed some light on who Mark Leonard is, what he has achieved so far and try to convince a few people to pay more attention to him. It’s almost irresponsible not do so at this point! 

“We try and avoid the worst anchoring effect which is always your previous conclusion. We really try and destroy our previous ideas.”

Charlie Munger

Many years ago, I was introduced to the investing world thanks to Buffett. I was hooked instantly after reading his shareholder letters. He shortly became my investing hero, but over time I realized I was idealizing him to an extreme. So I decided it was best to have him as an investor role model instead, and I’ve added more investors to that list over the years.

Of course I still pay close attention to him, but the way I listen to him is now different: I’ve learned to question him, to not follow his every move or advice (imagine staying away from tech because he does!), to grab on to his ideas that resonate with me, and to learn from other investors who I have a high regard for.

Remember, even Buffett who had Benjamin Graham as his hero, didn’t emulate him: he migrated from flipping cigar-butts to buying-and-holding quality, and he found other investing role models like Phil Fisher, Tom Murphy, Henry Singleton and of course, Charlie Munger.

Be flexible, learn from different investors and think for yourself. 

Disclosure: The author owns shares of Constellation Software and Berkshire Hathaway. Not investment advice.

“What I didn’t know when we launched to consumers in 2008 was that audio — not just music — would be the future of Spotify. This opportunity starts with the next phase of growth in audio — podcasting… all with the goal of becoming the world’s number one audio platform.”

That same announcement included the acquisition of Gimlet and Anchor. Since then, Spotify has acquired multiple studios (The Ringer, Parcast), signed big names to exclusive licensing deals (Joe Rogan, Dax Shepard), acquired a podcast ad-tech and Machine Learning recommendation startup (Megaphone, Podz), and made an entry into Live Audio (Locker Room, now Greenroom1). During that time, Spotify became the #1 Podcast Player in the US and 61 other countries.

Last week, Spotify announced the acquisition of Findaway, an audiobook distributor. This is notable because it gives Spotify an entry into the fast growing audiobook industry, and is a natural next step after podcasts. It’s become clear that the company is taking seriously their mission of going after all the major audio verticals to capture the most ear-share and becoming the audio browser of the world. 

To understand the acquisition and strategy, we need to look into the Audiobook ecosystem. Audiobooks share some similarities with podcasts and surprisingly some with music too. They also have unique characteristics which may give the company a bigger toolkit and framework of how to push forward with their Audio First strategy and help creators grow and monetize their audiences.

Audiobooks – Part Podcast, Part Music?

500 million people listen to Audiobooks, a market that is expected to grow from $3.3 billion in 2020 to $15 billion in 2027 – a 24% CAGR2. Audiobooks make up ~10% of the total spoken-word audio share, with podcasts over twice that amount and radio still dominating at 50%, yet at a declining rate.

Aren’t Audiobooks Just a Type of Podcast?

An audiobook is simply a recording of the reading of a book. On the surface, it’s easy to assume that audiobooks are in a sense a long-form narrated story similar to storytelling podcasts, but the similarities basically end right there. Audiobooks are a derivative of a book, which was intended to be consumed in written form natively. This means that the author needs to find a way to make the finished product appropriate to be consumed in a different medium, which means finding the perfect voice and sound.

Importantly, an Audiobook typically takes years to make, and logically longer than just a book. This is very different than a podcast which has a pre-set consistent release schedule, for example on a weekly basis. Many authors spend years working on one book and that’s the only one they’ll ever write. It is indeed a very high production product, and the best books can carry a lot of value in them (educational or entertainment) which can be digested in a handful of hours, not to mention extremely long shelf-life. This is an important distinction when it comes to monetization (more on this later).

Creating an audiobook is not an easy task. Rarely does the author become the narrator of their own book, the voice and storytelling aspect is hugely important, so typically the author will hire a narrator that fits the style of the book. This person is a professional – reading something for seven hours straight with a consistent rhythm, energy and tone is hard! – and for that they typically charge a couple thousand dollars. After various recording takes, the audio needs to be edited and mastered for optimal sound to finally get distributed to all the retail platforms monetize. The finished product has to be perfect, because once it’s published it’s inherently difficult to make any changes (a lot of people download audiobooks instead of streaming them). And on top of that think of the process of translating them to other languages.

The Audiobook Industry – We’ve Seen This Elsewhere

The book and consequently the audiobook industry, also share some similarities with the music industry: The author (artist) needs a publisher (label) to help with editing (recording), marketing, manufacturing, distribution etc. which then gets released as physical books (CDs, vinyls) and eBook platforms like Kindle or Apple Books (Spotify, Apple Music). 

The similarities don’t end there.

Just like in music, a handful of gate-keepers (publishers and labels) dominate the industry, especially for the big titles (think NYT Best Sellers). This is very different to podcasting, where no single creator or publisher controls a large enough part of the market to have outsized power and demand their own terms.

Like music, the legacy book industry business model suffered greatly from the mass adoption of the internet in the late 90’s and early 2000’s. Piracy wasn’t as common as it was in music, but new ways of distributing (Amazon and eBooks) forced publishers to shift their business models. 

Given how fast and aggressively Amazon moved into the space (and the decline of the physical book store), the eCommerce retailer was able to capture a very large part of the entire market, first in physical and later in eBooks. This left publishers in a difficult spot dealing with Amazon, which basically had most of the leverage and called the terms. For authors, it was an even worse situation because they faced an industry dynamic where the middle-man was powerful and the retailer even more, controlling the majority of the market. As a result authors had to stick to whatever terms were set for them, and this meant watching each intermediary take an outsized bite before they got any little money that was left. Self-publishing was the only alternative option, either by going directly to the retailers or hiring an aggregator that would distribute books on your behalf, but this also meant a lower chance of success.

Another problem was that there wasn’t an option to self-publish an Audiobook, unless you went straight to Amazon which owns Audible. That was until Findaway came along.

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Enter Findaway

Findaway was founded in 2004 originally as a developer of audiobook hardware (competing with CDs) and later on offering an alternative to Audible for audiobook distribution (which is exclusive to Amazon). Today it is the largest audiobook distributor in the world. As an audiobook distribution platform, it works with publishers, authors, and retailers, helping them through the entire process from audiobook creation to distributing and monetizing. Its catalog spans 325,000 titles from large publishers to self-published authors. It also offers creator tools, such as a marketplace to find narrators.

Its role is similar to a distributor in music (CDBaby, Believe) and a hosting platform in podcasts (Anchor, Megaphone, Podbean). Because there are so many platforms for consuming content, it doesn’t make sense for creators to upload their content individually to each one and then manage them separately, so distributors help fill this administrative gap. Generally speaking, creators (musicians, podcasters, authors) want maximum exposure to capture as much audience as possible.

Findaway makes money by taking a 20% share of all the royalties they collect from the retail platforms on behalf of customers. So for example, if Audible pays out a 25% royalty to authors for every sale of an audiobook, Findaway keeps 5% and pays the remaining 20% to authors and/or publishers. Because of their size, they are also able to negotiate higher rates than independent authors would otherwise get on their own if they were to negotiate directly.

The Elephan-zon in the Room

It will come as no surprise that Amazon is the largest bookseller in the world by an order of magnitude. This includes physical books through Amazon.com, eBooks in Kindle and audiobooks with Audible. Some reports suggest Audible has a 90% market share in some verticals3 and more than ⅔ in the eBook and online physical books market.

What’s different between the Amazon strategy and Findaway, is that Amazon is a closed-end platform while Findaway is open-ended and platform neutral. If you publish your audiobook using Amazon’s tools (known as ACX) you’ll get distributed to Amazon and Apple and then need to find another distributor for other platforms. Authors can also opt for ‘exclusive distribution rights’ where they will only be available in Amazon but get a higher royalty in return. They are also only available in four countries, which limit the potential number of authors that can distribute with them.

Findaway offers a more creator friendly alternative, essentially competing with Amazon ACX (although they distribute to Amazon platforms), sitting between the authors/publishers and the retailer platforms who they partner with and giving authors the tools to create and distribute their audiobooks.

Findaway’s offerings are differentiated, but even now under the Spotify umbrella, it will have a steep hill to climb given the industry dynamics. They will have a few advantages now being a part of Spotify though.

Spotify’s Angle

It’s no coincidence that Spotify entered the audiobook market by buying a distributor instead of buying content, as opposed to podcasting which included both. Given the market dynamics just discussed, it would have been almost impossible to compete head-to-head with Amazon4 or trying to bring in exclusives. Instead, Findaway will give Spotify a very large funnel to fill their audiobook content, while still distributing them to all other platforms, just like Anchor did with podcasts.

From a consumer standpoint, it will give users the convenience of having all of their audio needs in one place, making it easy to search for content and get personalized recommendations. Now that listeners are consuming podcasts on Spotify (and understand it’s an audio-first platform), it will be easy to lead them into audiobooks.

Spotify will offer authors and publishers a more creator-friendly alternative versus the closed Amazon model, while providing the benefit of its massive reach and scale, now approaching 400mm MAUs. This is a big deal, because no company of Spotify’s size has tried to go after the Audiobook market that’s been dominated by Amazon for so long5. My guess is terms with Spotify will also be superior to other platforms (e.g. higher author royalties vs. Audible), which will make authors and publishers more likely to work with Spotify and drive more listeners to the platform.

This more creator friendly approach, from a company with large enough scale, will be a major advantage. We’ve seen some hints of this in the way they’ve approached podcasts such as the Open Access Platform which offers podcasters ways to monetize both on Spotify as well as other platforms, and in their push into advertising which monetizes at a higher rate and is shared with creators. This will mean giving authors the flexibility to monetize in different places, not have them locked into an ecosystem, pay them more and offer free tools .

To be clear, I’m not suggesting Spotify will necessarily directly steal a lot of market share (i.e. listeners) from Amazon. It’s possible, but I think the more likely scenario is that they grow the Audiobook pie all together by introducing millions of people to the concept of audiobooks, much like they have done in podcasting.

Buy My Book or Subscribe to My Book?

Audiobook monetization is unique compared to music and podcasts, which are monetized primarily through subscriptions and advertising (the access model). Consumers demand to have all of the content in the same place and pay for the right to consume it on a recurring basis.

Audiobooks (just like books) are usually a one-time purchase. This makes sense because listeners only listen to a book once and readers recognize the amount of work that goes behind writing and publishing a book, the shelf-life, as well as the value it provides6. This makes people more willing to pay for it on a per unit basis.

Similar to podcasts, it’s likely that we’ll see different monetization models being tested out in audiobooks, but I would expect the traditional one-time purchase/rent to remain the most common. Audible offers a subscription offering based off credits, where the listener gets a certain amount per month that can be used to purchase audiobooks on its catalog, it’s possible Spotify tries a similar model. Offering an unlimited subscription would be somewhat complicated and would have to be priced accordingly7, and most people don’t listen to that many audiobooks per month as opposed to music and podcasts. I would also bet Spotify tries to work with authors to develop podcasts and Live Audio content (such as Q&A) to help them connect more with their audience.

What’s interesting is that this will be the first time we’ll see one-time purchases on Spotify, up until now revenues have only been through subscription and advertising. In the future, this may be something that starts to get tested for music and podcasts, creating new revenue streams. Imagine for example a one time payment to listen to Taylor Swift’s new album one week before its release, or being able to pay your favorite artist directly to support them8.

Lessons for The Music Playbook

I’ve long argued that Spotify’s strategy in music should be focused mainly around the independent market (which makes up ~30%) and working together with the labels to grow the total pie. Just like they’ve done in podcasting and now in audiobooks, acquiring an independent music distributor would make sense for Spotify. This would be a smart way to go after the independent market without stepping directly into the labels toes9, while helping independent artists get discovered and giving them the tools to grow and monetize their fan base. Maybe these acquisitions in the podcasting and audiobook space give us a hint of how they are thinking about music in the future.

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I wrote about the acquisition of Locker Room here:

The Sleepwell Strategy

Spotify's Third Act: From The Locker Room to The Stadium

Ten weeks ago I tweeted this as a response to a question about Spotify’s biggest challenge: Four weeks later, Clubhouse (which I hadn’t heard of back then) went viral and promptly six weeks after, Spotify addressed my concerns by taking an important first step in turning this from a challenge into an opportunity…

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5 years ago · 4 likes · 2 comments · Sleepwell

9

For more background on Music Streaming Royalties, see my piece here

The Sleepwell Strategy

Music Streaming Royalties 101

“Music royalties are a complicated subject” might be the mother of all understatements. In this piece I will try to cover the basics of streaming royalties in the U.S., by walking through the process of creating a song, producing it, distributing it and monetizing it. Each of these steps are important to understand who the players are…

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5 years ago · 20 likes · 10 comments · Sleepwell

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One of the most important investing skills has the following characteristics:

1. It can’t be taught, is learned from experience and you never fully comprehend it

2. The definition is ambiguous and changes from person to person

3. It will make you at times question yourself, look wrong and make mistakes

4. Mishandling it can kill you; using it appropriately enhances your wealth

5. It forms the basis for position sizing, risk management and long-term investing

Investing Conviction is the primary raw material required to hold a stock for the very long term. Many of us have experienced that warm exhilarating gut feeling when we find a company, develop a special insight that comes with extra confidence, and proceed to put our money where our gut is. Nevertheless how that exact feeling develops is hard to pinpoint, let alone describe in detail or grasp your mind around — it’s a very abstract and philosophical concept. Which is exactly why I think it’s worth investigating further.

What is Conviction?

“A firmly held belief or opinion”

— Oxford Dictionary

It sounds to me like this definition applies to religion, politics or an ideology, but certainly not to investing. If you wanted to, you could try it, but you’d likely run into trouble eventually. I think we need a different definition.

One the few hard-set rules in investing is that there are no absolutes. As investors we’re trying to predict something that by its very nature is unpredictable, so we can never state with 100% confidence that something will happen. You could arrive at a 90% confidence level, maybe even 99%. Just be sure not to confuse 99% with 100% because it will come back biting your ass sooner or later — an event with a 1% probability of happening in any given year has an 18% probability of happening at least once over 20 years.1

What we strive to do instead is, after a lot of research and introspection, understanding a specific subject well enough to establish a belief that something is likely to happen with reasonable confidence. Importantly, you have to recognize that there is also a chance that it will not, and that you can never assign, no matter how much you know, an exact probability to that event taking place. It sounds hard and it is!

I spent almost two weeks pondering, trying to come up with my own2 definition of investing conviction. After a lot of circling thoughts, I arrived at the following:

“A differentiated opinion on a company’s long term prospects, with a high level of confidence, achieved after gaining the required knowledge while becoming comfortable with the risks and aware of the consensus view”

—Sleepwell

It’s a bit long, I know. But at least to me personally, it is when I reach this state of mind that I’m comfortable making a long-term concentrated bet on a company.

So how do I get there?

A Framework for Building Conviction

By deconstructing my definition, we can notice that there are a few simple pre-requisites to arrive at the conviction state, which I will call Stages:

1. Deep Work: building your circle of competence and knowledge base, also known as the research stage

2. What Could Go Wrong: recognizing and becoming comfortable with the risks, probabilities and unknowns

3. Most Probable Outcome: establishing a view of the future state of affairs — The Story — that you believe is most probable and gaining confidence

4. What’s In The Price: understanding what the consensus believes today

Let’s explore each stage in more detail.

Deep Work — The Research

This may seem like the simplest stage, but likely it’s the longest and most important one. It’s also never-ending, given that as investors we strive to be constantly learning. The concept of circle of competence is central to this stage: if you’re going to invest in something, you better be sure you understand it well. This has been the biggest lesson Buffett has taught the investment community.

Each person has their own process, but for me this starts by looking at places that interest me and where I am familiar with the product and consumer. This greatly reduces the number of places I’m going to be hunting in. Biotech? A quick easy no for me. Tech? Skiing? Music? I’m all ears! After that first filter and finding an interesting candidate, comes the extensive research to really grasp the industry economics, business model, customer value proposition, competitive advantages, value-chain and competitor landscape, history of the company, management, etc. At the very least you should be knowledgable enough to engage in an hour-long intelligent conversation with someone who knows the company or industry really well.

Writing your thoughts is also a helpful exercise during this stage. It’s important to realize that you undoubtedly will come with a pre-existing opinion—it’s human nature. You must be careful not the let this go its way by just finding confirming evidence and making that view even stronger, as it may not be the correct one. On the contrary, you must try to approach the problem with a fresh and flexible mindset and recognize that the more you learn, the more you should adjust your beliefs and change your assumptions (write them down as you go!). You want to do the opposite of what the dictionary definition of conviction says, that is don’t become an ideologist.

I had a revelation on the importance of doing the real work on a company a few years ago, after reading one of Andrew Walker’s great pieces. He handsomely made the point of why doing the research yourself is so important: You can’t borrow conviction!

Andrew explains it succinctly:

“If I spend weeks doing work on an idea and post it on here, someone could read the idea, say "wow, that's interesting, I agree," buy the stock, and generate the same returns as me. For a long time, that struck me as unfair, but increasingly it doesn't bother me. Over the long run, I think a person who "steals" ideas will do substantially worse than a person who develops their own ideas simply because the "idea thief" won't have conviction in the idea, and that will lead to incredibly sub-optimal trading.”

This is truly the cost of long-term investing. If you put in the required effort to understand a company, you are more likely to hold the stock over the long-run and make better decisions. Think about it, if you’ve done the work and the stock sells off 30%, you are more likely to make the right decision than someone who just copied you — whether that is buying more, holding or selling. You know the story intimately so any incremental information you’re more likely to use to your advantage than someone who doesn’t know much.

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What Could Go Wrong? — The Risks

As you’re doing Deep Work on a company, you will undoubtedly start forming a view and (should also be) thinking about the potential risks. A high-conviction investment for me is, first and foremost, one that has limited downside or low risk of impairment. This is especially true because I tend to make those investments sizable in my portfolio. As someone who was trained in fixed income-land, I prefer to start by approaching a company with the question “what could go wrong?” instead of the opposite optimistic question of all the possibilities of how it could go right (which most equity analysts start with)3. This is what Charlie Munger calls the invert, always invert mental model, and it’s very applicable here.

Essentially, you should be well aware of the main risks, which could be many, and handicap the probabilities of those events taking place — while acknowledging that there’s also completely unpredictable things you aren’t thinking of (unknown unknowns). The more Deep Work you do, the more aware you become of the likelihood of those events happening and decide if they are remote enough for you to be comfortable to make an investment. Again borrowing from Munger, if you can state the opposing argument better than your opponent, that’s a good test that you’ve thought about the problem.

For example, with Spotify which is a large position for me, I’m very aware and comfortable with the main risks: 1) Label relationships 2) Big Tech competition 3) Podcasting strategy 4) User growth saturation. There’s many more, but these are the most discussed and I believe I’ve spent valuable time doing the work, speaking to people with opposing views, and deliberately thinking through each one of them and their probabilities. This idea applies to every single company out there, there’s no such thing as a company without risks.

Most Probable Outcome — The Story

Simultaneously as you’re thinking about the company’s risks while doing Deep Work, a story will be forming in your mind of how things are likely to play out in the future. Once again, the more work you do, the more visible it becomes. This story will form the basis of your opinion on the company, but itself should be an output built upon a series of inputs or key value drivers. These are the assumptions that you make, built from the knowledge you’ve acquired.

Personally, I prefer simpler stories where most of the value is derived from 2-3 variables instead of 10, and where I can build my assumptions related to those inputs with reasonable confidence. Some of the best long-term investments shared this characteristic, a few simple inputs that drove the majority of the value over the years — Big tobacco comes to mind here: pricing power, regulatory barriers and brand loyalty. Boom! 20% compounded annual returns for 50 years (no, I did not own this one). On the other hand, there’s a reason why I’ve never invested in an oil & gas exploration company: I have no idea where the price of oil is going which is precisely one of the biggest value drivers.

These inputs, based on your assumptions, should spit out an outcome: The Story. This is essentially your best educated guess of how the company will look like in a future point in time. This includes (not extensive) how the industry and total market will grow, how the competitive dynamics will play out and most importantly what the economics of the business will be like.

Another key part when you’re crafting a story, is to be well-aware that it’s never a certainty (remember: no absolutes!). Instead, it’s important to think about the likelihood of that view taking place and connecting it with the previous stage of potential risks and downside scenarios. Once you reconcile those, you can have a better sense of the potential scenarios that could play out and guestimate the probability that surrounds them —this also prepares you on how to react as they happen.

There’s also an upside or “optimistic” scenario, which some people underwrite. I prefer to focus on the most likely outcome using realistic and conservative assumptions and any upside from that be a pleasant surprise. On that same note, the really good businesses and management teams tend to surprise you more on the upside than the downside — something to keep in mind.

What’s In The Price? — The Consensus

Investing successfully mostly comes down to what your belief is versus expectations. You could have a perfectly clear view of how a company is going to look like in the future, but if all of that is already in the price, there’s not much money to be made. This is the importance of valuation (you thought I forgot about you value investors huh!).

It’s not about high multiples or low multiples4. You need to reconcile what your story is versus what the market thinks. Some people approach this with a reverse-DCF, which is a helpful tool: playing around with different future assumptions to arrive at the company’s current valuation. Looking at long-term sell-side estimates can be helpful too. Seeing what other investors are saying about the company can also give indication around the sentiment—a quick Twitter search will do wonders here.

For me, what it essentially boils down to is taking The Story I built of how the company’s economics might look like, discount that at an appropriate rate and compare it to the valuation today. This sounds like a simplified model and it’s exactly that. If my estimated value is significantly higher5 than what the market is paying for right now, then I know I’ve built conviction and proceed to invest.

You Now Have Conviction…What’s Next? 

“The first principle is that you must not fool yourself — and you are the easiest person to fool.”

—Prof. Richard Feynman

Congratulations, you’ve achieved conviction! Not so fast, it’s no time to celebrate because that could lead to complacency and that is a dangerous state of affairs. The final step is the hardest: monitoring incremental information that will test your existing assumptions (prove them or disprove them). You need to be able to separate the signal versus the noise: realizing what matters to the investment and what doesn’t, and in the words of Lord Keynes: change your opinion when the facts change.

Patience is key here as well. If your company is executing with focus and the story and your assumptions are playing out, it’s probably best to hold on to the investment. That’s how the big money is made. What I’ve found is that when you spend most of your time thinking about a company’s prospects over the very long run (which at times the market doesn’t), you end up training yourself to become more patient. This will also help you prevent making mistakes such as selling the stock because it ‘seems’ overvalued on current multiples. Always go back Stage 3 and compare (again) what the market is implying today versus your expectations of that future state. Also remember, the best companies grow intrinsic value over time, so their stock is supposed to go up, just not in a smooth up-and-to-the-right-line fashion.

It’s in this last step where you have to find a balance between being both humble and confident. In other words, you must be able to deal with mistakes6 and willing to look wrong. On the other hand, you must trust your own judgement, your framework and the work you’ve done. Selling a stock you’ve held for a long time is a difficult decision; but holding on to it for decades is an even tougher one, because it’s constant and for that you need conviction.

Here’s the Tweet (and response) that inspired the piece

If you’re interested, I also discussed some of this topic and more in this podcast.

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Everybody’s heard of U-Haul🚚, but few realize that it’s part of a holding company called AMERCO which is publicly traded (ticker:UHAL). The company is an American tradition that’s been around since 1945.

AMERCO is composed of three, somewhat unrelated segments: 1) Moving & Storage 2) Life Insurance 3) Property & Casualty Insurance. For the sake of time, I’m going to focus only on the first, which is what they are known for and accounts for 90%+ of revenues1.

An investment in U-Haul relies on three long-term premises that should carry the bulk of the value going forward:

1. U-Haul will remain the indisputable leader in the Do-It-Yourself moving market and increase market share and volume over time.

2. U-Haul will continue to successfully expand its self-storage presence, which is complementary to their moving business and an attractive use of capital.

3. Management will remain shareholder friendly with clear capital allocation priorities and a focus on the very long term.

I will also discuss a fourth driver that has some optionality value and may not be fully priced-in at the current valuation. Let’s move on. 

The Moving Industry: Stressful and Expensive

There are two basic universal truths about moving: 

1) It’s one of the most stressful experiences in life

 2) If you want to remove some of that stress, it’s expensive

Roughly 40mm Americans move each year, with ¾ of them moving in the form of DIY (rent a truck or borrow your friend’s pickup truck) and ⅔ of all moves are local (moving within the same city). There are typically three options when you move. One, you can pay the price of comfort and hire someone else to do it, which can run into the thousands of dollars depending on the distance. Two, you can go the DIY route by renting out a truck and any supplies you need, usually costing significantly less than half of what you would pay for a moving company. Three, if you really don’t want to spend a dime and don’t have much stuff, you can beg your friend to lend you their pickup truck and ask for his help.

U-Haul Moving: Size Matters

U-Haul has a simple mission, which outlines its flywheel:

“Provide a better and better product and service to more and more people at a lower and lower cost”

This is a case of scale economies shared. The better the product U-Haul offers, the more customers it attracts which allows U-Haul to grow in size and share the economic benefits2 with more customers via lower costs, which results in a better product and even more customers. This is similar to the model followed by Costco and Amazon.

There’s little question that U-Haul is the leader of the DIY moving industry, and they got here by staying focused and true to their mission. The numbers speak for themselves: U-Haul has over 23,000 locations and 176,000 trucks commanding a 50% market share in the DIY moving industry. Compared to the next closest competitor, Budget Truck, U-Haul has 25x as many locations and almost 9x the amount of trucks, a difference that has been getting wider as competitors have been retrenching from this business given how difficult it is. For example, Budget has reduced the size of its fleet multiple times in the past few years through a series of restructuring programs. The other two well-known companies, Ryder and Penske, are now more focused on the commercial B2B business (Budget more recently as well).

There’s another unique aspect to this industry, related to size and the critical mass required to succeed: physical network effects. 

Let’s take an example. If you want to move from Marfa, TX to Houston, you will find multiple U-Haul options in Marfa as well as one in Houston that is closest to your new home. If you wanted to use Budget instead, you’d have to go to Odessa (2 hours 40 mins away) or El Paso (3 hours away). Tough luck!

U-Haul provides customers with maximum convenience and best prices, regardless of where they live or want to move to. This applies at the national level, and it’s the main reason why U-Haul has consistently kept taking market share: it has built a network of dealers and trucks for the past 76 years, which gets stronger every year, and it’s practically impossible for someone else to replicate this. It has also built an online network platform of local movers that you can hire in conjunction with the truck reservation and offers transparent pricing and customer reviews. Because of their scale, U-Haul is also capable of offering the best prices to customers3, while still generating a decent profit. Anyone planning compete with them would have to spend an insane amount of capital and time, undercut U-Haul in price while losing money, all while trying to gain the logistical and technological know-how of this complex and capital-intensive business. This should keep competitors at bay and let U-Haul keep increasing volumes and taking market share (10 year revenues have grown at 7%). Importantly, there’s still a lot of runway growth left given they have kept taking share from DIY, and also from people that use moving companies or are borrowing a friend’s truck. The demand for U-Haul’s product has rarely seen any signs of slowing.

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The Self-Storage Opportunity

Self-storage is a natural complement to the moving segment, as the typical moving customer also has storage needs in many cases, so combining the two makes sense. The company recognized this, and for the past 10 years has been aggressively expanding into self-storage, which has grown at a 14% rate, mostly by building storage from the ground up or converting existing properties4. Today, U-Haul owns ~47mm sq. ft. of self-storage (and manages another 20mm), making it a Top 3 player nationally in the industry, competing with the likes of Public Storage and Extra Storage.

There’s a caveat to pursuing this strategy with respect to the income statement: the properties come online with most of the associated operating expenses while generating almost no revenues, which depresses margins in the near-term. Eventually, management will slow down investments in this business and the company will benefit from the associated increase in revenue at very high incremental margins, driving an acceleration in profitability and expanding overall margins of the company given the attractive cost structure of the storage business at maturity.

Management: Focused and Transparent

The company is owned by the Shoen Family, consisting of two brothers: Joe (the CEO) and Mark, both holding 42% of the shares. U-Haul’s management had a rocky history in the 1980s and 90s, but current management has been in place for the past 30 years and manages the company with a very long term view (too long for some) and focuses on the core business. The track record shows it, as they’ve consistently grown revenues over time and increased shareholder value along the way. They prefer to stay under the radar, have no sell-side coverage, don’t play the Wall St. game and have a corporate name that has nothing to do with their main business (a question that comes up in almost every earnings call, management politely refuses).

How do you judge the character of management? You look what they’ve said and their actions. Joe Shoen has publicly given out his personal cellphone number to encourage customers to call him if they encounter any problems with U-Haul. He keeps his head down, wants no media attention and focuses on the customer. He is always worried about the competition, thinking consistently about how to improve the product and being candid about the company’s challenges and opportunities. He spends the week traveling to different U-Haul locations and scouting potential self-storage acquisitions, sometimes visiting as many as 17 states in a week. The company’s biggest luxury is a small plane, in order to get to as many locations as possible (similar to Walmart in the early days), but he insists that two people share a motel room and room service is not allowed. My kind of guy.

Good Business or Great Business?

I estimate U-Haul’s normalized ROIC to be in the area of 10-12%, which is nothing sensational but pretty adequate and certainly above their cost of capital. This falls under the category of a good business, with some caveats. With prudent leverage (which U-Haul has and supports), a business earning a return like this likely increases intrinsic value at a satisfactory rate, especially if combined with good capital allocation. There’s also a nice tailwind from self-storage units maturing and investment slowing down, which will drive ROIC higher. More importantly, what makes me very comfortable with this business is my conviction in its ability to keep earning those returns on incremental capital, given the permanent nature of the business and how hard it is for a competitor displace them. This gives me decent long-term visibility, helps me sleep well at night and any surprises to returns are more likely to be to the upside.

An Option on the Mover Rate

This is probably the most important chart of this piece. U-Haul has been able to grow transactions and keep taking share from competitors despite a consistent decrease in the national mover rate. This means, that any reversal in this trend, a potential post-COVID impact, will be a total boon for U-Haul as it would increase truck utilization and pricing, driving higher revenues, margins and increasing ROIC. We saw hints of this already in the past 9 months (which excludes the full-lockdowns in the beginning of the pandemic): U-Haul revenues increased of 24%, operating margins more than doubled and operating income increased 180%5. At its current share price of $560, the stock is trading at ~14X my estimated earnings for this year.

I believe America will likely be going through a period of housing reshuffling post-COVID, with a prolonged increase (and normalization) in the mover rate as a result. U-Haul is one of the best levered plays to capitalize on this trend.

Disclosure: Not investment advice; the author owns shares of UHAL

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In this piece, I will go over 3 Lessons I learned in fixed income that are especially relevant for equity analysts. I will break each one down in the context of bonds and offer suggestions on applying them when you’re looking at common stocks.

Lesson #1: Never Forget About the Downside

“Equity Analysts are optimists. Fixed Income Analysts are pessimists” —Unknown

The first question a credit investor asks is usually “What can go wrong here?” This is natural because you are lending money to the company, meaning at best you get paid back the principal plus a known interest rate, and at worst you lose most of your investment1. It’s one of those situations where you don’t want any surprises because they only come in the flavor of bad news.

As equity analysts, we tend to imagine the great growth prospects of the company, estimate the intrinsic value and how much upside there is from current prices. This makes our mouth water and that’s not an exaggeration: just the thought of making money activates the same regions in the brain as cocaine does. So it’s certainly tempting, but it also means that 90% of the time we’re focusing on what can go right. On the other hand, you’re completely caught off-guard when something like say, a pandemic, comes along and you never thought about what that could mean to your investment. How many DCFs have you seen with multiple scenarios and probabilities? Not many.

There are no absolutes in investing and the real world operates across a spectrum of probabilities of different outcomes. When we’re analyzing a stock, it’s human nature to focus on the optimistic scenario, which can be dangerous. The left side of the bell curve is sometimes just as probable.

What you can do about it: Stress Test Your Ideas

Here are a few ways you can Stress Test your stocks:

• Make a list of potential events that would cause the company to lose value and the stock to fall: Earnings, revenue or user growth miss expectations. A large customer is lost. Hyper-inflation. CEO smokes weed on a Talk Show. Be exhaustive, you’ll be surprised what you can come up with. Try putting a probability around each one for any given year and how much value you think would be lost. This is more art than science, but for instance we know recessions happen every 7-10 years on average, global pandemics once every 100 years, etc. It’s ok to make wild guesses. Consider in which scenarios you would still hold the stock and in which you wouldn’t.

• Compare your list to the “Risk Factors” section on the 10-K. It’s one of the most boring but also one of the most insightful sections. Highlight the ones you hadn’t thought of.

• A filter I like to use is to ask myself: “Would I lend money to this company for 10 years at market rates?” You’d be surprised how many times the answer to this is No, for a stock you thought about buying. Never a good sign ⚠️

• Look at the company’s bonds, where they are trading and what the price action has been. The bond markets sometimes sees something the equity investors don’t, and this can be very telling (remember they are pessimists). I’ve seen some pretty wild disagreements between a company’s stock and the bonds, such as a stock trading at 50x sales and the bonds at 50c on the dollar.2 This is not a sustainable relationship and something’s gotta give: either the bonds are insanely cheap or the stock is crazy overvalued (and at risk of bankruptcy). The inverse can also be true. AerCap bonds historically have traded at tight spreads (meaning investors think credit risk is low) while the equity constantly trades at single digit PE ratio and below book value.

Lesson #2: The Importance of Reflexivity

“The framework [Reflexivity] deals with the relationship between thinking and reality, but the participants’ thinking is part of the reality that they have to think about, which makes the relationship circular.” —George Soros

Reflexivity in investing is a concept that was popularized by George Soros3. It refers to the way reality (what most investors focus on) can be altered by the very perception of that reality, which means the participants’ thinking is just as important to consider as the facts themselves because they feed off each other🔄. An example of this is the Keynesian Beauty Contest where the best strategy is not determining who is the most beautiful contestant, but who you think people think is the most beautiful contestant.

In fixed income, if a company’s bond falls in price because credit investors think the company is struggling, when the bonds come due the company will have to refinance at much higher interest rates4 and may potentially default if it cannot afford those high rates. The negative perception investors have on the company may have altered the reality the company was facing.

This also applies to macroeconomics. In some ways, The Fed operates as a signaling agent by using various monetary tools to manipulate (i.e. calm down) investor perception and confidence towards the markets and the economy. Go back to June 2020: remember when some investors thought markets were a dead-cat bounce and another selloff would come, considering the dire economic situation? It certainly crossed my mind! Many of us forgot about reflexivity. Broadly speaking, market participants had a different view, we know this since the stock market and bond markets had already recovered almost all of their losses. What we missed was that the perception of investors had an impact on the actual reality, and surely enough economic recovery followed as confidence and sentiment came back thanks to that same perception. This is something fundamental investors often miss: sometimes there is value in the wisdom of the crowd and market prices can alter reality itself.

What you can do about it: Look at Prices and Sentiment

Try to understand the investor perception around the stock, what’s being priced in? Is the current prevailing sentiment optimism or pessimism? What happens to the company if the perception pendulum goes the other way? Will the company lose access to capital markets? Again, more an art than a science, but there’s value in thinking about these questions.

It’s best to find companies that are resilient instead of fragile, meaning less exposed and dependent to the vagaries of financial markets. Let’s take a closer look at a story from the Financial Crisis that offers some valuable lessons. Here we’ll see the difference between owning a resilient bank versus a fragile bank (as a side note: one was “expensive” and the other one “cheap”).

In mid-2008 the world was going through the worst financial crisis in memory. The banking industry was in a fragile state and the government had to step in to prevent a full meltdown by injecting capital into the banks, given the sector’s importance to the economy. J.P. Morgan was perceived to be a safer bank than Citi, which had more toxic assets (mortgages), higher leverage and as a result investors punished the stock more. This meant that Citi had to accept funds from the government at the worst possible time (through the TARP program) and shareholders were permanently diluted by essentially giving away 30% of the company to the Government5 at way below book value. Shares outstanding increased by a factor of 5X, which is why Citi stock still hasn’t recovered from pre-financial crisis levels and probably never will. On the other hand, JPM took the funds in the form of preferred stock, issued some equity to the public markets to prove to the government they had access, and promptly redeemed the preferred shares. The stock is up almost 360% since pre-crisis levels versus Citi stock down over 80%. Resilience and the perception of that resilience, is what saved J.P. Morgan while fragility and the market’s perception destroyed Citi’s shareholder returns.

Another final point on reflexivity: this is one of those times when selling a stock because it fell might make logical sense. If the company has a questionable capability to meet its obligations, and will struggle to raise cash quickly at decent terms because its stock and bonds fell off a cliff, it might be a good enough reason to take your money and run before it gets multiplied by zero. How many value investors would be averaging down in this situation? I’ve been guilty of this. I bet that money could have gone somewhere better when Citi started smelling like trouble in 2008 and it would also have saved you a lot of brain damage.

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Lesson #3: Leverage Rarely Kills, Cash Coming Due Does

Sometimes you’ll hear a phrase like “The company is risky because it’s 5.0X levered!” High leverage above a certain threshold is concerning, but as we’ve noted, there are no absolutes in investing. What may be risky for a highly-cyclical dying video game retailer may be prudent for a mission critical software business that serves utilities and has a 98% retention rate. What really causes a company to file for bankruptcy is not leverage per se, but the inability to meet its obligations6. This is the difference between illiquidity and insolvency. You can be illiquid but perfectly solvent and you can be insolvent but perfectly liquid. The first one is about not having cash available today to pay for debts due today, the second one is about the size of your liabilities exceeding the size of your assets. One can kill you, the other not necessarily will.

In the below figure, take a look at McDonald’s 🍟 balance sheet. Notice they have negative equity (assets<liabilities) mainly because they’ve bought back a lot of shares and don’t require much in capital expenditures. This isn’t necessarily bad, McDonald’s isn’t gonna default any time soon: they generate ~$6B of free cash flow every year and debt and lease obligations are covered by contractual rent payments under their franchisor agreements.

What you can do about it: Focus on the Maturity Wall

“Predictable income streams are much more valuable than volatile ones. Cause you can leverage them…” — John Malone

It’s no secret that John Malone is an expert and proponent of leverage. Charter, the second largest U.S. internet cable provider (which he owns part of), is no exception.

Charter’s leverage ratio (Total Debt/EBITDA7) is ~4.5X, which may sound high to some people and in fact it’s a High Yield rated company. But let’s take a look more closely at their maturity wall:

We can make two quick observations (assuming you know the company):

1. The debt is spread out pretty nicely, weighted average maturity is 13 years

2. Charter generates around $7-8B of predictable free cash flow which comfortably covers all of the upcoming maturities in the next 4 years, and likely will cover 2025 maturities (because it’s growing), also giving them plenty of time to refinance well ahead of the maturity date.

Not all companies provide this chart, but you can find some form of it in the 10-K under the Liquidity and Capital Resources (or Financial Condition) section, called either “Contractual Obligations” or “Commitments”. This will give you a pretty clear picture of the company’s contractual cash obligations for the next 5 years which you can compare to the company’s free cash flow generating ability8 and see if there are any large upcoming maturities in the near-term that may be difficult to meet. If this is the case, you are counting on their access to capital markets and become exposed to financial conditions and perception of the market (remember Reflexivity).

Bonding It All Together

Summarizing everything, the three Fixed Income tools for Equity Investors are:

1. Stress Test your ideas, be exhaustive

2. Look at the price and sentiment, find resiliency

3. Focus on the maturity wall and obligations, size it versus free cash flow

It should be pretty obvious that these are all connected with each other. I incorporate all three in my investment strategy by thinking a lot about the downside scenarios of my portfolio companies, having a good idea of what the market’s perception is and I try to pick resilient companies that have more than enough capabilities to meet their near-term obligations in different scenarios.

This helps me sleep better at night.

“Music royalties are a complicated subject” might be the mother of all understatements. In this piece I will try to cover the basics of streaming royalties in the U.S., by walking through the process of creating a song, producing it, distributing it and monetizing it. Each of these steps are important to understand who the players are. My goal is to give you a decent understanding of what royalties are, how they work, where the money flows and demystify misconceptions; all while trying to not make you fall asleep. A daunting task indeed.

What I’ve learned comes from having studied the industry closely in the past few years and recently getting more involved by investing and working with a few artists as well as beginning my own journey as one.

Let’s begin.

Why are Songs so Complex?

The complexities of the music industry stem from two places:

First, the amount of intermediaries that are involved in the creation, production, distribution and monetization of a song (who therefore need to get paid): songwriters, artists, producers, musicians, labels, publishers, distributors, managers, agents, lawyers, streaming platforms, digital stores, radio, collection societies and the list goes on.

Second, the way music copyright law has evolved and the sloth speed at which it adjusts to changes. Laws are static in nature and not meant to keep up with the fast pace of technology and music consumption habits. For example specific laws that made sense for the sale of CDs make absolutely no sense for streaming a song over the Internet. 

The following is the most important and basic definition of this piece ⚠️

Legally speaking, a song is made up of two separate individual copyrights: 

1) The Composition: the notes, melody and lyrics as they would be written down on a musical sheet. It’s the song in its most stripped down form. Think of this as the equivalent of a movie script describing the scenes and dialogue. 

2) The Sound Recording (or Master): the actual musical recording that gets released to the world and played in all the mediums such as streaming platforms, digital stores, vinyls and the radio. Think of this like the final cut of a movie that is shown in a movie theater and Netflix.

Each one of these halves have different intricacies, laws that protect them and monetize differently. This is also why they are considered two different and separate businesses, known as Publishing and Recorded Music. For example, a concert pays a publishing royalty, but not a recorded music royalty because the artist is interpreting a version of the song, making use of the composition, but not using the literal sound recording that came out of the studio.

Music Publishing derives its name from the historical act of publishing musical scores and nowadays refers to Publishers, which are companies that work with songwriters to pitch songs to artists (who will perform and record them), monetize them, and collect the earnings which are split evenly between the publisher and the songwriter. 

Recorded Music is more commonly associated with Music Labels1. Labels oversee the production of an album, promotion, distribution and monetization of the Master. The Label typically owns the Master (given the financial risk they take) and pays a portion of the earnings to the artist who signed a record agreement.

A Song is Born: Composing, Recording and Distributing

Taylor is a fictional artist who wrote a song called Sleepy Love. Recently heartbroken, she got inspired, found a beautiful chord progression in the guitar and wrote lyrics on top of them. She recorded a voice note and excited, starts to think about how to put it out for the world to hear. The composition of the song has been created and as the sole songwriter, Taylor owns all the rights to the composition of Sleepy Love. Riding the wave of inspiration, Taylor goes on to write another nine songs.

She now has two options:

1. She can be a performer, meaning she will go into the studio to perform and record these songs. She will be the artist which everyone associates the songs with. 

2. She can focus on being solely a songwriter by pitching the songs to other artists who will perform them and record them. In this case, she will stay off the grid as the songs will be interpreted by someone else. 

It becomes clear here that the songwriter and the performer can be two separate entities (thus make money separately) and in fact many artists are really performers and don’t write their own songs. That includes The Weeknd, Justin Bieber, Britney Spears and The Backstreet Boys, who have an army of songwriters that write on their behalf. For example, checkout Max Martin’s resume, a Swedish songwriter you’ve heard thousands of times but never realized it (told you they’re off the grid).

Taylor wants to be a superstar so decides to take the performer route. Now she needs to find a producer, a person who specializes in recording albums — think of an album producer as the equivalent of a director in a movie. The producer will help her conceptualize the album, pick songs and musicians and transform it from a voice note to a professionally recorded song full of instruments, beats, arrangements, samples to make sure the final product sounds awesome.

Mark is a Producer in “Begin Again” — He Imagines The Final Song

The problem is a producer costs money, and so does renting out studio time, paying sound engineers and hiring a drummer and a bass player. If Taylor has the money, she could pursue an independent path, if not she needs to find someone to finance and promote the album. Guess who has money, know-how and the right connections? That’s right, a Label. 

Luckily, Taylor’s uncle is an A&R in Warner Music Group (A&R’s find and develop talent), so he signs her to the Label on a record contract that looks (simplistically) like this:

• Taylor will get a $50K advance (aka loan) to be used for album production costs, promotional videos and living expenses.

• The label in exchange will use the future earnings of the album to recoup the advance (repay the loan) and after fully recouping it, will split the earnings 85% for the Label and 15% for Taylor, in return for financing the album.

• Because they financed the album and took a risk with an unproven work and artist, the Label will own the rights to the Master Recording while Taylor will receive a cut from the earnings it generates2.

• The contract will last for 5 years, meaning Taylor is obligated to work exclusively with the label on songs released during that time, after which she can look for another label (or go independent) to release new songs, but the Label will still own the songs recorded during the contract (and pay Taylor her share).

Taylor signs the deal, records all the songs in the studio and the album gets distributed to all the Digital Service Providers (DSPs are streaming platforms and digital stores like Spotify, iTunes and even TikTok) to start being monetized. The label will also market and promote the songs, through radio and playlist placement, PR, advertising, music videos, artwork and working on the artist’s image.  

Alternatively, if Taylor had the money to finance the album, she could have gone the Independent route (indie) where she would record it herself, skip the label and work instead with a distributor (CDBaby, TuneCore) who takes care of distributing her work to all the DSPs. Distributors exist because it would be impossible for Taylor to upload her songs separately to all the different places (artists want maximum exposure)3 and then have the added complication of having to collect royalties from each one. 

All independent artists work with a distributor while signed artists work with a label who either has their own internal distributor or works with a third-party distributor. In essence, Independent artists take two of the label’s roles into their own hands — recording and promotion — while outsourcing the third, distribution. This is only possible in the Age of the Internet: home studios are easy to setup given cheap software and hardware, promotion can be done through social media and distribution used to mean manufacturing and selling CDs instead of uploading digital songs.

A Song is Streamed: Time to Monetize

The following example applies to streaming platforms, more formally known as interactive (or on-demand) streaming, since users can pick any song to play as long as they pay a subscription (or listen to ads in the case of Spotify). Streaming platforms’ agreements with Labels, Distributors and Collection Societies are highly complex and confidential, but transparency around broad numbers has increased recently to create more awareness for creators. Generally, platforms pay ~2/3 of their revenues to rights-holders4. This payout is split between recorded music and publishing (remember: two different businesses). The royalties are calculated based on a stream-count share, or how much each rights-holder’s songs proportionally accounted for the total number of streams in a specific period of time at a certain jurisdiction. Best to go through an actual example.

Let’s say Spotify has 60 users in the country of Sleepyland and each user pays $10 a month for a total of $600 monthly revenue. Sleepylanders only listen to two artists: Drake and Taylor. During the month of April, users streamed Drake’s songs 75 times and Taylor’s songs 25 times for a total of 100 streams.

From the total revenue pie of $600 for the month, Spotify will take a cut of ~$200 and the other ~$400 will be distributed to rights-holders in accordance with the stream-count share calculation. Drake’s songs will receive $300 (75%) and Taylor’s songs will receive $100 (25%). Notice that I said their songs, meaning Spotify doesn’t pay artists directly (a huge misconception) but rather the intermediaries which are labels, distributors and collection societies. These intermediaries will take their cut and then distribute the money further down the funnel to artists, songwriters and other parties involved according to the contracts they signed.

Now let’s discuss the specific royalties that have to be paid out of Taylor’s royalty pool ($100 in the above chart) for each half of a song: The Composition and The Master (Sound Recording). Each part is treated differently and streaming platforms have different payout schemes for each. The Master is negotiated with and paid to the Labels and Distributors directly, while Music Publishing rates are overseen by the government and paid to collection societies. To complicate things further (ugh sorry), the Publishing royalty is split into two types: Performance and Mechanical, both are paid by streaming platforms to be able to use the Composition.

Performance Royalties are paid when music is played (performed) in public places, such as a Walmart, nightclub or a concert. This applies to streaming also since it’s considered a public performance (someone can play Spotify in a bar). Performance royalties are collected by a PRO (Performance Rights Organization) like BMI or ASCAP and these rates come from blanket licenses that determine the rate that is paid by the DSPs to the PROs and covers all of the works (instead of having to negotiate each individually). The rates are overseen by two judges assigned by the Department of Justice to prevent any antitrust behavior.

Mechanical Royalties relate to the sale of music that’s reproduced through a physical medium such as CDs. The name is historical (and thus confusing), referring to how Piano Rolls would mechanically reproduce music, and now also applies to streaming even though you don’t technically own the song (told you these laws were outdated). It’s a compulsory rate set by a government body called the Copyright Royalty Board (CRB) meaning anyone can use the works as long as they pay the required rate. Royalties are collected by a collection society, typically Harry Fox Agency or the Mechanical Licensing Collective.

The total payout for both performance and mechanical royalties (together Publishing royalties) is around 20% of the royalty pool (again, that’s after Spotify’s take) roughly evenly split for each royalty5. This royalty is paid out to the collection societies, which then subtract their overhead and then pay the Music Publisher’s who works with songwriters and typically splits the earnings evenly. Using the above example, Taylor gets $9 from publishing royalties (performance plus mechanical). She also wrote the song on her own, in the case where many songwriters are involved, this gets divided even further.

For Recorded Music, the use of the Master (Sound Recording) is what is negotiated between the DSPs and the Labels and Distributors. This is what gets most of the media attention (known as the Label agreements) and as opposed to the Music Publishing agreements which are overseen by the government, these are set by the free market thus go through lengthy, complex negotiations.

On the Master side, the labels receive a rate which is around 80% of the royalty pool. After the label gets its share, it is then distributed to all parties that were involved in the sound recording (performers and producers mainly). In Taylor’s case, the Label will take their 85% and pay her the remaining 15%6 resulting in $12 for her. An independent artist, will instead get the Master’s royalties after the distributor’s cut which is typically around 10% (in some cases as high as 25% depending on services offered) and receive $72.

Tying the Blurred Lines Together

When we look at the entire picture7, three things standout: First, labels are taking an outsized bite off the pie (45%); second, Indie Taylor makes a lot more money than Label Taylor (almost 4X) and third, there’s too many people eating from this cake (many not shown for simplicity). What does this mean for the future of the industry?

Labels are still a powerful force in the industry given their capabilities, connections, know-how and ability to invest in and grow their artists. It is unlikely that an equivalent indie artist achieves the same global reach as a signed artist unless they have the combination of talent, substantial capital, the right connections, a professional team behind them (manager, PR, agent) and powerful promotion and marketing tools. Nevertheless, it’s gotten easier to pursue this route and likely will continue to in the coming years. There are companies offering the roles and tools that traditionally labels would do (e.g. some distributors offer promotion) and the lines between players are certainly blurring. Importantly, the power is slowly shifting away from the intermediaries and towards the creators that make the content and platforms that own the demand. This likely means there will be more and better ways to monetize fans while not having to pay as much to the middleman.

One thing is certain: there has never been a better time to be an independent artist and the best is yet to come.

Four weeks later, Clubhouse (which I hadn’t heard of back then) went viral and promptly six weeks after, Spotify addressed my concerns by taking an important first step in turning this from a challenge into an opportunity.

Spotify’s acquisition of Locker Room this week was portrayed by the media in a similar manner as their other small deals: straightforward, stating mostly facts and with no strong opinions or implications about it. It sort of makes sense, it was reportedly bought for $50MM, a small deal for a ~$50B company, and it’s a young startup focused on Live Audio for Sports (what’s that?!). Also there’s the fact that now every Tech company is doing something in the audio space (Twitter pun intended). 

Contrary to this view, I believe this acquisition is a new chapter for Spotify and represents a pivotal moment in their strategy, which I will call Spotify’s Third Act. This marks their official entrance to the Live Audio and Social verticals.

Matthew Ball1 has talked about the Three Stages of Media Services, which I will refer to as Acts (see my beautiful picture above)

First Act — Access: a real innovation in how content is delivered to and consumed by the user

Second Act — Content: focusing on creating unique and exclusive content

Third Act — Platform: not focusing on a single business but building out more expansive features and letting your users create content for you

In the First Act, Spotify single-handedly changed how music was consumed by innovating the access. They called the strategy “Stealing from Pirates” given that piracy was the primary way of listening to music and it was free or more bluntly put: being stolen from artists. Spotify was able to convince people to use their service instead, by either paying for it on a monthly basis or listening for free with ads; in exchange for the convenience of having the entire world’s music catalogue at your disposal. They also convinced people who loved owning their music physically that it was worth renting it out instead. All of this took place while dealing with an uphill negotiating battle with labels and artists. Pretty damn impressive to say the least.

In the Second Act, two things happened. First, it quickly became obvious to them that aggregating the entire world’s music and paying out most of your revenues to labels would not make a very profitable or sustainable business model. Spotify needed a way to build a real differentiator on top of a commodity service. Fortunately, it found itself sitting on top of vast amounts of user data. In order to differentiate its content, it leveraged its data analytics and product capabilities to solve a huge problem in music: Discovery. Playlists (editorial, algorithmic and user created) became one of the main reasons why consumers stuck around and spent more time on the platform; over ⅓  of listening time is spent in Spotify-curated playlists2 and users spend 2x+ more time on the platform versus its competitors. For the artists it became the Holy Grail of music promotion: if your song was included in a relevant Playlist, it was akin to being played in a NYC Radio Station in the 90’s - congrats you’ve made it. For Spotify, playlists became a huge moat and a positive feedback loop: the more people listened, the better it got, so the more people listened, etc. This eventually allowed them to achieve a critical mass of users where they would not be pushed around by the labels anymore. Spotify now represents over 20% of label revenues (and growing) with the relationship now being more symbiotic3.

Second, they realized there was still more they could do, so they decided to go after all of Audio. After successfully testing out Podcasts on the platform, they started acquiring originals and licensing exclusive shows to offer unique podcasting content4 and further diversifying away from labels. So far it seems to be working, many of their original and exclusive podcasts rank well in the U.S. and Global Top Charts. I’m sure you’re wondering so here’s the stat: Joe Rogan is currently #1 in the U.S., Canada, U.K., Australia, New Zealand and...wait for it… #3 in India. This suggests Spotify has a pretty good idea of the value of the content assets they are buying (again leveraging its data) and can amortize the cost of these acquisitions among ~350mm users. Aha! you’ve heard this one before, this is indeed straight from the Netflix Playbook — the former Netflix CFO (Barry McCarthy) and current Co-CEO and Chief Content Officer (Ted Sarandos) sit on the Spotify Board.

With some context in place, let’s now discuss how Locker Room5 will help them expand The First and Second Acts while giving them an entry into The Third Act.

For anyone that follows Spotify closely, this acquisition was not all that surprising. Live has been the natural next step given their large market share in music streaming, podcasting and their “Audio First” strategy. Both of these products are offered on-demand, and both have an obviously important live counterpart to them. In the case of music there are live concerts (off and online) and in the case of podcasts there are live talk shows (and casual conversations). It would have been foolish for Spotify to ignore this big part of the market, even more so after shifting their focus going after all of Audio. We also got a hint thrown at us recently when Live was included as part of their Total Market Opportunity in the recent Stream-On Event.

How does Locker Room enhance Spotify’s Three Acts? Some reasons are obvious, others not so much

The First Act will improve in terms of how the consumer has access to Live audio by leveraging the existing streaming platform and centralizing all of the audio content that users want to consume. It happened with music, it’s now happening with podcasts, and live audio will naturally follow along. Users will habitually associate Spotify with Audio and that will become a huge advantage. Never underestimate the power of focus. 

The Second Act will also go through another major step change. This completely new audio consumption format will create vast exclusive and differentiated content that will put them at another great scale advantage: Live talk shows, Q&As, casual conversations, etc. Remember, Spotify owns (or has relationships with) a big part of the supply: Joe Rogan, The Obamas, The Kardashians, Prince Harry & Meghan, Bill Simmons, podcasters and very importantly: Artists (remember this one for later). 

Additionally, they will focus on addressing the exact same problem they identified in music: Discovery. This happens to be a huge issue with podcasting and even more so in Live audio, especially if you are horizontal, i.e. going after the whole market. How do you recommend something if you don’t know what your users want? Spotify is once again in an envious position: having the data of millions of consumers and an immense amount of content in music and podcasting (live and on-demand) will drive the best personalized recommendations. It will take time, but my bet is both podcasting and live audio go the way of music discovery. 

Back to Artists. On the Press Release there was very little mention of an important piece of the strategy of the acquisition: Live Music. I’m gonna take a stretch here and call this on-live (online & live) to not confuse it with physical concerts (which is a separate opportunity).

To be fair, it doesn’t benefit Spotify to be too vocal on this yet given their relationships with labels. But I am quite confident that this will be tested out soon enough, in many different ways and will create another new form of unique content consumption (First and Second Acts). Think of David Guetta charging for an on-live DJ set (remember people pay to watch gamers playing video games) or Taylor Swift performing songs on-live to promote her new album or to thank her biggest fans (which Spotify knows who they are). Most importantly and often misunderstood: Neither the labels or distributors get any royalties from this! Live performances pay the artist, the venue (Spotify/LiveNation), and other related parties such as Publishers, Managers etc. The revenues would be split mainly among the Artist and Spotify, a bigger pie for each to eat from.

Finally, as it relates to the Third Act, Spotify will finally become a Social Platform. Live will bring users the ability to create content by becoming a part of it through interacting with their favorite artists, podcaster, celebrity, influencer, etc. Social features in Spotify have been historically limited6 pretty much to following friends, saving their playlists and sometimes seeing what they are listening to. Most social interactions take place outside of the platform, a less-than-ideal scenario for Spotify (Instagram Stories, sending playlists or podcasts through messaging, etc.). This is about to change though:

What was once “Matt is listening to Love Story by Taylor Swift” will become “Matt is attending Taylor Swift’s Spotify On-Live Concert” or “Matt is hosting a Q&A Session breaking down the meaning of Love Story — Want to Join?”.

You get the point.

Putting all of this together, this acquisition will strengthen the relationship between the Creator and their Fans by creating more meaningful ways to connect them and eventually bigger, better and more ways to monetize (both paid and ads). It will not only apply to Music, but the entire Audio Market — a large part of which doesn’t even exist yet and is being invented in front of our ears right now.

Welcome to Spotify’s Third Act.

Disclosure: Not investment advice. The author owns Spotify shares and is a struggling musician.

This is an experiment for now and intends to be a place for me to share deeper and longer thoughts about specific companies, industries, investment strategies and psychology.

If I can achieve any of these two objectives, I will consider this a massive success:

1) Sparking interesting discussions around subjects I talk about here

2) Teaching you something about topics I think I have some valuable knowledge on (but always still learning)

Background: I’m an investor who is constantly trying to find investments and strategies that help me sleep well at night, while also trying to learn something new each day. My sector interest is on Music, Robotics, Tech and Financials; with the goal of expanding this slowly. I have a fixed income background which I believe helps me think a lot about the downside. I’m also an engineer & sleep enthusiast. I love skiing, music (playing, composing, recording) and traveling.

Thank you for signing up and please feel free to reach out anytime via Twitter @SleepwellCap or email sleepwell.cap@gmail.com

Have a good night’s sleep!

Not investment advice, entertainment purposes only.

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