20/03/2018
Save the date – April 3 – Spotify is going public. The company has ruffled some feathers by choosing to cut investment bankers out of the process. Instead of an Initial Public Offering, they are going public via a Direct Public Offering. We thought we’d put together a quick blog post explaining the company and the different way they have chosen to go public.
The Company
Spotify is a company most people have heard of, and with 159 million users, a lot of people have used. Founded in Sweden in 2006, the music streaming service was created at a time when Napster and free music downloads were ravaging the music industry. Despite giving millions of people a reason to pay for music again, the service comes under constant criticism for not paying artists enough – the company claims it pays out between $0.006 and $0.0084 per stream.
Fending off challenges from Apple Music, Google Play Music and Youtube – Spotify remains the market leader is music streaming. It is estimated that Spotify has a 36% share of the music streaming market, with Apple Music in second spot with 17%. So, they are a clear market leader with an established user base and brand. The big question is, can they maintain this advantage?
Financials
Despite being the market leader, Spotify is not (yet) a profitable company. In 2017, the company had revenue of 4 billion Euros and still had an operating loss of 378 million Euros. The company makes money in two ways. The first, it has about 70 million premium subscribers that pay a monthly subscription fee. This accounted for about 90% of revenue in 2016 and 2017. The second way Spotify makes money is advertising to approximately 90 million free users. The company believes there is a lot of space to grow this advertising revenue as it continues to take market share from radio advertising.
The biggest expense for Spotify is paying for rights and paying royalties to artists. In 2017, this totaled 79% of revenue. There is further pressure on both Spotify and Apple Music to pay artists more for their music, with artists like Jay-Z, Taylor Swift and Thom Yorke of Radiohead leading a movement against these music streaming companies.
An important part of the financials for Spotify is a $1 billion loan they took out in 2016. Without getting into the weeds, to clear the debt off their balance sheet before going public, Spotify worked with their debt holders to convert all of that debt into equity (i.e. an ownership stake in the company). So the company currently holds no debt. However, if the company isn’t public by 2 July this year, then the creditors have the right to unwind the transaction and convert their equity back to debt. This is a long way of saying – Spotify have the incentive to become a public company ASAP.
Opting for a Direct Listing
Given this incentive to list as soon as possible, Spotify have chosen to take an interesting route to becoming a public company. In fact the way they are listing is so rare, that the New York Stock Exchange had to change their rules to allow it to happen.
Normally, a company will team up with an investment bank and sell shares to investors prior to the date they float on the public market. This gives the company the opportunity to raise money and for most companies it is the main reason to go public. Having an investment bank assisting and selling shares also means the price will be pretty stable when it is first publicly traded. However, Spotify are choosing to go with a ‘direct listing’ where all the current shareholder’s stock in the company becomes publicly tradable. There is no investment bankers involved, no additional money raised nor is there any starting share price.
What does this mean? It is surprising that Spotify are passing on the opportunity to raise money to fund company operations and growth. It does mean Spotify will be able to save paying the investment banks a few million dollars in fees. One thing to watch is how much stock the founders sell. Usually for company founders there is a 3-6 month ‘lockout period’ where they are not allowed to sell their shares. However, if a company does a direct listing then this rule does not apply. It would be a warning sign if we saw the founders sell their positions ASAP.
For investors, it means we should expect some strange price action in the early days. The price will purely be set by supply and demand, with no starting price anchoring investors’ starting positions. Over the long term though, it won’t mean much. Spotify will end up being just like any other company listed on the New York Stock Exchange.