From its early roots in Stockholm, Sweden, Spotify AB (Spotify Inc. in the United States) has grown to become a tectonic force in the music industry — a true market disruptor in the way it transformed the consumption of music. Since its inception, the firm has managed to dramatically increase its paid-membership service, as opposed to its free service rife with advertisements. Daniel Ek, the company’s CEO, recently tweeted that “40 is the new 30. Million.”, referring to the streaming service’s recent milestone of 40 million paid users, compared to 30 million in March 2016. The firm has 100 million total users, both free and paid. Spotify’s largest competitor, Apple Music, lags behind with a mere 17 million users.
As Spotify grows, it is increasingly under pressure to file for an initial public offering, which is the first time a private company’s stock is opened to the public to purchase. According to Bloomberg Businessweek, the company plans to go public in the second half of 2017 with a valuation of $8 billion. The pressure to go public largely stems from a recent round of financing — $1 billion in convertible debt, which is a debt security that can be converted into the underlying company’s equity at the financiers’ discretion.
This new round of debt was issued by a group consisting of the private equity-firm TPG, the hedge fund Dragoneer Investment Group, and Goldman Sachs. The Wall Street Journal reports that the debt’s interest rate will increase the longer Spotify waits for an IPO, and investors are entitled to a 20 percent discount on shares if they decide to convert their debt into equity. Yet, to improve its margins before an IPO, Spotify will have to grapple with its net loss of $200 million last years despite revenue doubling to more than $2 billion, and the firm thinks it has found a solution.
A Music Industry Super Brawl
As Spotify anticipates its IPO, its chief focus is on restructuring its music rights. According to public filings, Spotify’s commissions to the music industry totaled $1.8 billion last year, with 55 percent of its currently paid to record labels and artists and an additional 15 percent to music publishers and songwriters. The major record labels — namely Universal Music Group, Sony Music Entertainment, and Warner Music Group — each hold undisclosed minority stakes, forming a conflict of interest as CEO Daniel Eks attempts to lower the labels’ checks to around 50 percent. Lower sales to labels would encourage Spotify’s chances of profitability with an IPO on its horizon.
Spotify currently operates on a short-term month-to-month basis with the labels. With long-term negotiations underway, there is insight into the positions of both sides of the table. On Spotify’s side, the streaming service has a couple advantages. Additionally, Spotify has offered additional data and promotion to artists and has hinted at the possibility of a limitation on the length of time one can remain a free user for. As the labels all hold minority stakes in Spotify, they have a vested interest in seeing the streaming service succeed. Spotify also has some special treats it can offer the labels. The labels, and notably artists such as Adele and Taylor Swift, have taken issue with Spotify’s availability of its complete catalog to free users. There has been discussion about giving the labels the ability to restrict certain new releases to the paid tier. However, Spotify is concerned that doing this will drive consumers to free platforms, such as YouTube.
Finally, Spotify holds a key position as a mainstream consumption platform and a major source of revenue for record companies — the largest source of sales for recorded music in 2015. After struggling from declining sales of CDs and digital downloads, US record companies, posting revenues of $3.4 billion in the first half of 2016, are increasingly pivoting toward streaming services, giving Spotify greater leverage in negotiations.
The record labels also maintain a certain edge over Spotify. Online streaming services have tended to create losses for corporate parents, as evidenced by the struggling Pandora, which went public in 2011. Spotify also faces competitive pressure from its rivals in the industry: Apple Music, Amazon Prime Music, YouTube. Whereas these other services can lean on their respective corporate parent, Spotify does not enjoy such a luxury. Ultimately, with discussions centering on amending Spotify’s free service aspects, compromises will have to be made, and Daniel Ek and his team will have to balance the firm’s need for increased profit margins with its relationships with record labels and artists.
The Times They Are A-Changin’
Whatever happens with Spotify, it is clear that consumers can expect changes in the months before an IPO. Spotify seems to be increasingly ambitious in its projects. Spotify’s recent partnership with Tinder, integrating a user’s music taste into their dating profile, is a recent example. A single song, dubbed an ‘anthem’, is chosen to represent one’s personality on the dating app. Spotify has also worked with another dating app, Bumble, to work on a similar idea, displaying what users have been streaming. These recent developments are part of Spotify’s goal to provide a broader experience to users. The company spent $250 million on research and development last year, including the purchase of a dozen original music-based TV series. It’s evident that Spotify does not envision itself as part of the general trend in the music industry — to soar and plummet fast — rather seeks the means to ensure its survival.
However, with the pressure on, this series of negotiations seems to be a key test for Spotify’s leadership and for its future on Wall Street. Despite this pressure, Spotify has other options besides Wall Street. A possible acquisition by Facebook is not even off the table, according to the investment firm GP Bullhound, a partial owner. Overall, an $8 billion dollar valuation is hard to live up to, especially in an industry notorious for its lack of profitability, but Spotify seems to have the drive to forge a permanent position in the music industry. Hopefully for Daniel Ek and the rest of his team, Wall Street feels the same way.