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Apple Music, Spotify Lead In Streaming Tunes, But It's Early Days

Apple is a leader in music streaming, but that business is cannibalizing some of its iTunes download sales. (Bloomberg)

Streaming services are eating the music business, with Apple among those taking the biggest bites.

On-demand music streams rose 76% in 2016 in the U.S., while digital track sales fell 25%, digital album sales sank 20% and CD album sales slipped 16%, according to Nielsen.

The Recording Industry Association of America expects to release full-year 2016 statistics in March. But for the first half of 2016, streaming accounted for 47% of U.S. recorded music sales, followed by permanent downloads (31%) and physical media (20%), RIAA said.

It's still early days for the streaming music business, with many more consumers left to convert. Predicting which companies will end up on top has become a parlor game for industry analysts.

Spotify and Apple's (AAPL) Apple Music are leading the charge now in subscription streaming music services, though in Apple's case the streaming business is cannibalizing some of its iTunes download sales.

"On the music front, we are the market leader in digital music," Apple CFO Luca Maestri said on the company's earnings conference call Tuesday. "Obviously now by having the combination of the download business with the streaming service, which we didn't have until recently, we've been able to bring our music business back to growth. We've grown over the last three quarters, and we feel very good about that."

Apple doesn't break out Apple Music sales, but for the December quarter its services business revenue rose 18% year over year, to $7.17 billion, where overall revenue rose just 3%, to $78 billion.

But Spotify and Apple have plenty of competition. A host of smaller players are trying to get heard, and internet heavyweights Amazon.com (AMZN) and Alphabet (GOOGL)-owned Google have streaming music services.


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Online radio channel services Pandora Media (P) and iHeartRadio are rolling out on-demand services. Online radio channels automatically serve up songs based on genre or artist style, while on-demand services play the exact song or album a listener requests.

Meanwhile, Tidal, Deezer, Napster, SoundCloud and others are fighting for table scraps. Tidal, the service run by music mogul Jay Z, received a financial lifeline when Sprint (S) on Jan. 23 announced that it was buying a 33% stake in the company for an undisclosed sum reportedly around $200 million.

Music subscription services passed the 100 million subscriber milestone on a global basis in December, Midia Research reports.

Midia, a music industry blog, estimates that Spotify ended the year with 43 million subscribers, to 20.8 million for Apple Music. Deezer, a 10-year-old company based in Paris, came in third place with 6.9 million subscribers, followed by Napster (4.5 million) and Tidal (1 million). Amazon and Google, at this point, don't make the top five, though it's possible they'll give this market more attention at some point.

"Right now streaming is a two-horse race," with Spotify and Apple galloping ahead, Midia analyst Mark Mulligan told IBD. But Amazon could make it a three-horse race, Mulligan predicted.

Biggest Companies Have Advantage In Streaming Music Biz

The winners in the streaming music business will be those with the deepest pockets, he says.

"Streaming music is at best a low-margin, at worst a heavily loss-leading, business," Mulligan said. "So you burn through cash reserves fast. Especially now with the market being in growth stage, companies have to overspend on marketing and product innovation. So Apple and Amazon have a distinct advantage."

Spotify, though, is expected to make its IPO this year, which will bring a cash infusion.

A shakeout of the weaker players is underway, Mulligan said. Last year, Rdio, Rara and Simfy closed, and he says more will close in 2017.

The battle in the streaming market is between pure plays like Spotify and Pandora and diversified tech giants like Apple, Amazon and Google, Russ Crupnick, an analyst with MusicWatch, told IBD.

The diversified firms don't mind breaking even on a business like streaming music if it advances the company's overall goals. Music is not a core business for Amazon, Apple and Google, but it supports their ecosystems in e-commerce, devices and search, respectively, Crupnick said.

"They can afford to have music just become one arrow in the quiver," Crupnick said. "If Apple Music or Amazon Music Unlimited is not a super blockbuster success, but creates some interest among iOS users or Prime subscribers, that's a success."

MusicWatch estimates that Apple iTunes has about 75% of the music download business in the U.S., which totaled about $2.13 billion last year. So Apple's gross sales in digital downloads were about $1.6 billion in 2016, Crupnick said.

MusicWatch also estimates that Apple Music has about 9 million U.S. subscribers out of 25 million streaming music subscribers in the country. With average revenue per user of about $100 per year, that translates to a $900 million annual run rate in the U.S. alone.

Sour Notes Expected For Pure Play Music Services

Among the pure play music services, Crupnick expects to see a winnowing out of competitors.

"You've got Pandora, Spotify, Napster, Deezer, Tidal, SoundCloud … I don't think we're going to have all of those names out there much longer," he said. "It's going to be increasingly difficult to be a pure play."

With most services charging subscribers $9.99 a month for unlimited access to millions of songs, finding ways to differentiate is key. While some services focus on music discovery and personalization, others offer exclusive content such as early access to new music from major artists and original videos.

Tidal has been big on exclusives, include Kanye West's "The Life of Pablo," Rihanna's "Anti" and Beyonce's "Lemonade."

Apple Music last year secured exclusive releases on such major albums as Drake's "Views" to Frank Ocean's "Blonde."

Recently, Apple has been in talks with Hollywood studios about adding original scripted TV shows to its Apple Music service.

Major artists have complained about the size of their share of revenue from streaming services, but streaming has been good for the industry overall, Crupnick says. Online services can offer music from many more artists than retailers used to offer in their CD sections at the height of the packaged music business, he points out.

But content costs are a heavy burden for streaming services today.

"It's a very difficult business right now, but it's so nascent," Crupnick said. "Nobody is making money at this. For whatever cut the labels are taking, they're making a lot less money than they were 10 years ago or at the heyday of CDs.

"Everybody is suffering. Pandora's not making money, Spotify's not making money, Tidal is bleeding like crazy. But you need to take the longer view. ... We're barely out of the starting blocks."

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