Everything you need to know about the Spotify IPO

Here is the rundown of everything you need to know about the company, the upcoming IPO, and how you can trade Spotify shares.

Joshua Warner @JoshWarner_IG
Analyst, London

Publication date : 2018-03-16T16:19:00+0000

Source: Bloomberg

‘The future is markedly different from the past’ – Daniel Ek, co-founder, chief executive and chairman of Spotify.

The music industry entered the new millennium with little optimism, as sales continued to follow a decade-long trend of fizzling out. People were still listening to music, but increasingly weren’t willing to pay for it. Piracy was the single biggest threat to the industry, and the risk was growing as music became digital.

In 2003, Apple introduced the go-to model that would help the music industry get in shape for the digital era, by launching iTunes in tandem with its third generation iPod. Gone were the days of CDs and poor quality MP3s. People could purchase, download, and then instantly listen to a wide array of music.

Read: Will Apple be the first $1 trillion company?

Spotify, founded in Sweden, was launched only five years later, and its founders had a very different vision. The music industry had seen revenue plunge 29% between 1999 and 2008 to $16.9 billion, and it would slump another 15% to $14.3 billion before returning to growth in 2015, as Spotify’s streaming model began to gain momentum.

Industry sales have now grown three years in a row thanks to paid streaming services. The 2017 IFPI Global Music Report showed that download revenue declined over 20% in 2017, while streaming revenue rose by over 60% - the largest growth in eight years, that saw streaming overtake downloads, accounting for 59% of global digital revenue.

As Spotify prepares to launch an unconventional initial public offering (IPO), let’s have a closer look at the company, the offer and how to trade Spotify shares.

What is Spotify?

Ten years on from its launch, Spotify stands as an instrumental player in getting the music industry back on its feet, and has carved out a large share of the market in the process – claiming to have almost double the number of premium subscribers compared to its closest competitor: Apple’s rival streaming service, Apple Music (which was launched in the middle of 2015).

Spotify has an ‘access-based’ model which allows users to stream music on demand across different devices. It has a free service which is supported by advertising, and a premium service built around subscriptions. This differs from predecessors like Apple’s iTunes, that use a ‘transaction-based’ model where customers purchase and own the music.

Facts about Spotify

Monthly active users grew 29% in 2017 to 159 million
Premium subscribers grew 46% in 2017 to 71 million, representing 44.7% of its total customer base
Spotify operates in 65 countries, having recently added Israel, Romania, South Africa, and Vietnam
Spotify’s biggest national market is the US, with Brazil, the UK, and Sweden also being significant
Spotify has over 35 million songs, and 2 billion playlists in its music library
It has contracts with the likes of Universal Music Group, Sony Music Entertainment, Warner Music Group, and Merlin, which collectively controlled 85% of music streamed on Spotify in 2017
At the end of 2017, nine years after it was launched, Spotify had paid out 8 billion euros to rightholders and the music industry

Spotify files for IPO on New York Stock Exchange

Spotify Technology SA filed plans in late February 2018 to list shares on the New York Stock Exchange (NYSE).

Find out more about other upcoming IPOs for 2018

What is different about Spotify’s IPO: it’s a direct listing

There is a big twist with Spotify’s IPO. It is being referred to as a ‘direct public offering’, or DPO.

Businesses going public tend to expect high growth over the coming years and require cash in order to carry out their strategy, raising large amounts of funds through an IPO that it could not otherwise raise. The other primary reason is for the private owners and early investors to cash out, which is poignant in Spotify’s unconventional IPO.

Spotify will not issue any new shares under its ‘DPO’ and the only shares available will be from existing investors. Theoretically, all the shareholders could look to sell all of their shares on the day, or all of them could decide to sell none at all. In reality, it will be somewhere in-between.

‘We will have no input if and when any registered shareholder may, or may not, elect to sell their ordinary shares, or the prices at which any such sales may occur’ – Spotify.

Banks assist companies undertaking a typical IPO by establishing a price range for shares when a stock debuts, giving the market a starting point on how much the business will be worth when it goes public. This provides some stability and surety that prices don’t plunge from the first day of trading.

‘Sales of substantial amounts of our ordinary shares in the public market following our listing on the NYSE, or the perception that such sales could occur, could adversely affect the public price of our ordinary shares and may make it more difficult for you to sell your ordinary shares at a time and price that you deem appropriate’ – Spotify.

How much is Spotify worth?

‘The public price of our ordinary shares, upon listing on the NYSE, may have little or no relationship to the historical sales prices of our ordinary shares in private transactions…the public price of our ordinary shares may be volatile, and could, upon listing on the NYSE, decline significantly and rapidly’ – Spotify.

Spotify’s valuation consistently increased under private transactions in 2017, and reached a peak in January at $132.50 per share, valuing the business at about $23 billion.

Private sale prices more than doubled during the year-long run up to IPO

2017	High	Low
Q1	$56.25	$37.50
Q2	$85.00	$46.25
Q3	$95.00	$65.50
Q4	$125.00	$81.50
2018
Q1 (to 22 Feburary)	$132.50	$90.00

Who owns Spotify?

Unlike a traditional IPO, the existing Spotify shareholders will all be able to sell their shares when the company joins the world’s biggest stock exchange, as they will not be subject to the traditional lock-up agreements that usually prevent existing shareholders (particularly insiders of a company) from offloading their stakes too quickly – which typically depresses a stock price.

Therefore, Spotify’s existing owners are free to sell shares on day one, and the amount they choose to sell will dictate the liquidity in the stock.

The two co-founders of Spotify, Daniel Ek and Martin Lorentzon, have managed to keep control of 80.4% of the company, despite raising private equity over the years.

Shareholder	Ordinary shares (%)	Beneficiary Certificates (%)	Voting Power
Daniel Ek	46.8m (25.7%)	162.3m (42.8%)	37.3%
Martin Lorentzon	23.6m (13.2%)	216.9m (57.2%)	43.1%
Other shareholders	Ordinary Shares (%)		Voting Power
Sony Music Entertainment	10.2m (5.7%)		1.8%
TCV funds	9.6m (5.4%)		1.7%
Tiger Global	12.2m (6.9%)		2.2%
Tencent	13.4m (7.5%)		2.4%

Spotify: a blend of music, technology and social media

‘From the age of four, my life was about music and technology — never one without the other.’ – Daniel Ek.

Spotify’s strategy is to build a ‘two-sided music marketplace’ for both users and artists, powered by data, analytics, and software. For listeners, it is all about personalising their experience. For artists, it’s about providing them with the tools they need to promote and engage with audiences.

Global monthly active users increased every quarter throughout the three years to 2017, starting at 68 million in 2015 and climbing to 159 million. The growth in premium subscribers followed a similar trend, climbing from just 18 million at the beginning of 2015 to 71 million at the end of last year.

Although the company’s user base has consistently grown over the years, Spotify is still making loss.

Financial performance (in EUR millions)

	2015	2016	2017
Revenue	1,940	2,952	4,090
Gross profit	226	401	849
R&D	136	207	396
Sales	219	368	567
General/admin	106	175	264
Operating loss	(235)	(349)	(378)
Pretax loss	(225)	(535)	(1,233)

Paying royalties to the music industry is by far Spotify’s biggest expense, and included in its cost of revenue. Importantly, Spotify renegotiated deals with the four major firms that hold the rights to the majority of music in its library at the back-end of last year, lowering the cost.

Unsurprisingly, Spotify’s premium subscription service is considerably more profitable than its ad-supported service. In 2016 and 2017, 90% of total revenue came from premium subscribers.

Revenue and profitability of services (in EUR millions)

	2015	2016	2017
Premium
Revenue	1744	2657	3674
Gross profit	257	436	806
Ad-supported
Revenue	196	295	416
Gross (loss)/profit	(31)	(35)	43

Spotify’s competition and market share

‘We compete for the time and attention of our users across different forms of media, including traditional broadcast, satellite, and internet radio (iHeartRadio, LastFM, Pandora, and SiriusXM), other providers of on-demand music streaming services (Amazon Prime, Apple Music, Deezer, Google Play Music, Joox, Pandora, and SoundCloud), and other providers of in-home and mobile entertainment such as cable television, video streaming services, and social media and networking websites.’ – Spotify.

Market share chart

Who manages Spotify?

Daniel Ek sits at the helm of the business as chief executive and chairman, with Martin Lorentzon holding the title of director, along with seven other individuals. Other members of the management team include:

Barry McCarthy as chief financial officer
Katarina Berg as chief human resources officer
Seth Farbman as chief marketing officer
Alex Norstrom as chief premium business officer
Gustav Soderstrom as chief research and development officer

In total, the entire board was paid $28 million in compensation in 2017. Ek was paid a salary of $440,281 for the first half of 2017, but has since taken no salary. Instead, he receives an annual bonus if he meets certain targets. The first bonus of $1 million was paid earlier this year, despite falling short of reaching some milestones.

Goldman Sachs & Co, Morgan Stanley & Co, and Allen & Co have been recruited to assist Spotify with certain aspects of its listing, and Ernst & Young is the company’s auditor.

What next for Spotify: Daniel Ek’s vision to democratise the music industry

‘The old model favoured certain gatekeepers. Artists had to be signed to a label. They needed access to a recording studio, and they had to be played on terrestrial radio to achieve success. Today, artists can produce and release their own music. Labels, studios, and radio still matter, but in a cluttered landscape, artists’ biggest challenge is navigating this complexity to get heard. We believe Spotify empowers them to break through.’ – Daniel Ek

Spotify sees several areas for growth, and whilst its premium service is driving revenue at present, it sees a lot of value and opportunity within the ad-supported market, which is particularly popular with the key 18-34 age group. Its premium subscribers feed through from the free service, which Spotify can also extract data from.

Competing for advertising is also a very different game to competing for subscribers. Spotify believes there are still plenty of users to poach from terrestrial radio, which is a $14 billion market in the US alone. A total of $28 billion is spent by advertisers on radio each year, providing an important place for ad-supported services in Spotify’s strategy.

Spotify saw a 51% increase in revenue from its ad-supported service in 2016 before growing it a further 41% in 2017.

The premium service is improving rapidly. Growth is consistent, and churn reached its lowest level toward the end of 2017 at just 5.1%. About 40% of subscribers that leave rejoin within three months, 45% rejoin within six months and 50% rejoin within 12 months.

Spotify has five key elements to its growth strategy. The first is to continue research and development as well as acquiring businesses to enhance its offering, having invested in the likes of Mighty TV, Niland, Sonalytic, Soundtrap, and The Echo Nest Corp.

The second is to keep expanding into new geographies. Tencent Holdings became a shareholder after agreeing with Spotify that both firms would acquire minority stakes in one another late last year, forging a relationship between the Swedish streaming giant and the largest online music services company in China, Tencent Music Entertainment Group.

The company will also continue to invest in its advertising business, having introduced new products like sponsored playlists and a self-serve audio advertising platform. The fourth is to implement more initiatives for artists to keep them on-board, and the last aim is to expand non-music content like podcasts and short videos.

Streaming is still in its infancy, and offers a potential market covering the 3.6 billion internet users around the world, a figure that will only continue to grow over the coming decades – and Spotify holds a stronger position than any to capitalise.

What threats does Spotify face?

‘We really do believe that we can improve the world, one song at a time.’ – Daniel Ek

With rights representing Spotify’s biggest cost (up to 79% of revenue in 2017), its relationship with the record companies that monopolise the music will be decisive in determining Spotify’s profitability, and is one of the biggest threats facing the firm over the medium to long term.

Digital music companies and record companies are somewhat inter-dependent on one another, and both hold significant influence over one another.

While music needs a platform and a platform needs music, the likes of Universal Music (owned by Vivendi), Sony Music (Sony Corp) and Warner Music (Access Industries) have more options as to where to lease their libraries than Spotify has to source rights over massively popular music. Some deals can be short-lived too, with Spotify stating that license agreements typically last for only two years and do not renew automatically.

Ek might want to open up access to music to the world, but that will ultimately be decided by the access Spotify can retain to what is a very concentrated industry, that hands control to just a handful of companies. Spotify needs to become bigger than the labels and take control from the labels if Ek is to achieve his ambitions.

Spotify is about technology just as much as it is about music. In a rapidly changing environment that sees it taking on the biggest company in the world, the big players in the tech space that aren’t already considered significant rivals could prove to be a problem in the future. Facebook, for example, has recently signed licensing deals with Universal Music and others in a bid to retain more users watching music videos which are currently redirected to its biggest rival, Alphabet's YouTube.

Although dividends were not expected to be paid from the off, investors should be prepared to wait for any form of payout, with Spotify stating that ‘we do not expect to pay dividends or other distributions on our ordinary shares in the foreseeable future.’