Michael Baxter examines the imminent arrival of Spotify to the markets.
Spotify IPO: will the music business save the company that saved it?
Spotify is doing things differently. Its shares are due to begin trading on April 3rd. But the company is not raising money, neither is it forking out a fortune in fees to banks. Instead, it’s going direct, out go roadshows, no banks underwriting the float. The IPO is designed solely to create liquidity in the shares so that existing investors can sell their shares more easily.
These days, the private funding market is so sophisticated that listing shares is not ‘the essential’ it used to be. But it is worth remembering, the stock market exists as a way to help companies raise money, whether it is directly, or simply by giving early stage investors an exit route. Critics of the stock market would do well to remember this, it is a vital part of supporting innovation.
But the question is, will Spotify be a good investment?
The music business
According to a report produced last year by the IFPI - International Federation of the Phonographic Industry - the music industry is coming out of a crisis. The report did not put it in those words, but I don’t think you can interpret the numbers any differently. In 1999, global recorded music revenue was $23.3 billion. By 2011, it was down to $14.8 billion. In my dictionary, that is what you call a collapse.
Hands up if you don’t know why? Umm. I don’t see many hands. Well, let’s face it we all know why. It is called the internet and piracy.
But from 2011 onwards, things began to change: the industry began to grow again. And in 2016 - I don’t have figures for 2017 yet - global recorded music sales saw their fastest growth rate since at least 1997, when the IFPI began tracking the industry. In fact, 2016 saw a 5.9 per cent growth rate. As for the reason, I shall borrow words from the IFPI itself: “There is no doubt that streaming is the key driver of growth, with the number of users of paid subscriptions having broken the 100 million mark and continuing to rise.”
In 2016, digital made up precisely a half of global recorded music sales and returning once again to IFPI: “Streaming has been the clear driver of this growth, with revenues surging by 60.4 per cent. With more than 100 million users of paid subscriptions globally, streaming has passed a crucial milestone. It makes up the majority of digital revenue.”
And within the music streaming service, Spotify is the titan, for once even Amazon and Apple are also rans.
In 2016, Spotify had 48 million paying users - just under half of the total market. In 2017, growth was phenomenal, with 71 million paying users by the end of last year.
Do you see what I mean? The music industry was collapsing, this process has been reversed by music streaming, and Spotify is around half the reason for that.
The entire music industry should pay homage to Daniel Ek, CEO, and his two co-founders, they have done more to save the music industry than all the record labels between them - he has even done more than Simon Cowell, or Stock, Aitken and Waterman!
But Spotify has a problem - it is paying out more money than it can truly afford in licenses and royalties. Its gross margin is just 20 per cent. Despite the impressive growth in the number of paying subscribers, and a 39 per cent growth in revenue in 2017, up to €4.09 billion, losses increased from $349 million to €378 million.
That’s no good, increasing revenue, leading to greater losses, points to a problem. The company that saved the music industry is being forced into ever greater loss making by the music business.
For its part, Spotify says: “We set out to reimagine the music industry and to provide a better way for both artists and consumers to benefit from the digital transformation of the music industry. . .Spotify was founded on the belief that music is universal and that streaming is a more robust and seamless access model that benefits both artists and music fans."
But the IPO documentation also says: “We have incurred significant operating losses in the past, and we may not be able to generate sufficient revenue to be profitable, or to generate positive cash flow on a sustained basis. In addition, our revenue growth rate may decline.”
To add to its woes, some artists are suing the company, Wixen Music Publishing alleges that Spotify has used thousands of unlicensed songs from artists including Neil Young, Stevie Nicks, and the late Tom Petty.
Spotify also faces competition from Apple and Amazon who may be willing to operate music streaming as a loss leader.
Case for the bulls
Spotify’s big opportunity is to build upon its massive clout and renegotiate its commercial deals with the record labels. Given its importance, the odds are good that Spotify will pull it off, but for the best part of this century, the music industry and labels have applied a head in the sand approach to the internet, and such blinkered thinking may ultimately cause Spotify’s doom, but as a result create their own doom too.
No one seems quite sure of the valuation, but if shares trade at the kind of rate that they have been going for privately, a $20 billion valuation is possible.
Would Spotify be worth that? It only needs to improve its margin by a dollar a month per user, that’s less than ten per cent, to see an extra $1 billion in profits. You don’t need to squint your eyes by much to see how a $20 billion valuation could be justified.
It may boil down to whether the music industry has the vision to save the company that is saving it, by recognising that music streaming is its best hope, and that music streaming must be profitable.
PS. There is another interesting point about Spotify - there is a view that we are seeing the beginning of the end of ownership - car sharing, decline in property ownership, but that music streaming could be how it begins.
These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees.