With technology shares apparently undergoing a weak patch, the successful flotation of Spotify this week is welcome. Is it time for investors to tune into the music streaming service?
Swedish music streaming service Spotify went public on Tuesday – a decade after the company was formed. This listing is important for a number of reasons. It comes at a time when technology shares have seen a period of weakness, especially the high profile FAANGs (Facebook, Apple, Amazon, Netflix and Google –owner Alphabet) – and it has been a success. Spotify’s shares also listed in an unusual way. Because there was no requirement for the company to raise new money, Spotify came to market via a “direct listing”. This cuts out investment banker fees, so shareholders save money. Many of Wall Street’s major banks are probably looking on with concern. This precedent may lead other tech companies to list by that route, cutting out extortionate fees for their services.
This method also avoids restrictions on current holders selling their shares, as IPOs usually have a lock-in period. Investment banks tend to support an IPO by buying shares if the price falls below the initial offer price. There is also no “Greenshoe option” which allows underwriters to sell investors more shares than originally planned should demand prove to be higher than expected.
Direct listing also makes it difficult for a prospective long-term shareholder to buy a significant stake in the business. This is easier in an IPO where investment funds can agree to buy chunks of newly issued shares in the pre-IPO process, as limited shares may be on offer in the weeks after the direct listing. Discussions also occur between investors and investment banks during an IPO process that help in the determination of the final pricing of the shares. This means the company has more control over the listing process – and its pricing – but could lead to a degree of volatility in the price following the listing.
Spotify shares opened at $165.90, up nearly 26 per cent from a reference price of $132 set by the NYSE late on Monday. The stock ended the session at $149.01, valuing the world’s largest streaming music service at $26.5bn.
But there is one big issue for investors in this company that has been given a valuation of almost $30bn – it isn’t actually profitable and profits do actually matter, even in the tech sector. In 2017 Spotify generated an impressive $4.99bn in revenue, up from $3.6bn in 2016. Its number of paid subscribers also soared by 46 per cent, with monthly active users (MAUs) up 29 per cent. Yet the company was substantially loss-making. Last year it went $1.5bn into the red, although $1bn this was due to a non-recurring expense from a transaction with Chinese internet group Tencent. Its operating loss widened to $461m in 2017 from $426m in 2016.
One major issue for the business is that it does not own the content that it provides. It will also be difficult to produce this content in the way, for example, Netflix does. The video-streaming service plans to spend £4bn this year making original content, which is relatively easy in the TV business, but the music business is much more challenging. Players in the music business – Universal Music, Sony Music, and Warner Music – will have a lot of price leverage over Spotify. This implies that following the Netflix model with company-owned content will be difficult, if not impossible.
Competition is also increasing – and its rivals are catching up fast. These include Apple Music, Google Play Music, Amazon Music, YouTube Music and Pandora. Spotify remains the market leader, with 71 million “premium” subscribers, which includes users who have given the company a credit card number for a free trial. On a comparable basis, Apple Music service has 46 million subscribers – but the maker of the iPhone has many devices in operation around the world to use and distribution networks for its streaming service. However, one strength of Spotify is that it is “platform neutral” and can be used on many more devices than just Apple.
Share structure signficance
One big negative for shareholders also appears to be forming into a trend in tech listings. Spotify went public with a dual-class share structure that left its founders with total control over the company. Spotify's founders, Daniel Ek and Martin Lorentzen, have 80 per cent of the voting shares, so investors essentially have no say in the way the business is run. This may or may not be a bad thing. The two men are obviously talented, but the fact investors have little real influence is certainly a major risk factor. As the company filing said: “As a result of this ownership or control of our voting securities, if our founders act together, they will have control over the outcome of substantially all matters submitted to our shareholders for approval, including the election of directors.”
There is a chance that margins can be boosted by the further scaling of its advertising business – indeed management is targeting margins of 30 per cent to 35 per cent for the longer term, up from 21 per cent last year. Deal could be struck with artists for exclusive content. The music market is now growing again too. US music sales jumped 17 per cent last year, the fastest rate in 23 years. This was substantially powered by streaming services, so the market does appear to like its product.
Investors will need to take all of this into account before making any decision whether or not to buy the shares.
But whether this week’s listing has undervalued or overvalued the company, it will remain an important event for the tech sector. This successful floatation could encourage other companies – particularly in the tech sector – to list on stock exchanges. This could lead to a new wave of tech champions to take on the mantle of the FAANGs. These include Uber, Lyft, Airbnb and WeWork – all of which may list later this year. The success of the direct listing of Spotify has helped underpin these expected tech floats. This can only be a good thing for markets.
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