Should You Buy Spotify?

I love music, and unless I’m in a meeting, chances are pretty good you’ll find me with my earphones plugged in listening while I work. It’s safe to say we are squarely in the next generation of music delivery, as the digital age means we can take it with us or stream it over the internet wherever we are.

I’ve developed a deeper understanding of NexGen music – the good and the bad – since I moved to Nashville a couple of years ago. I find myself around both aspiring and extremely successful musicians, and of course I will typically turn the conversation to business (both because I’m interested and because I couldn’t carry a tune in a bucket). It has been fascinating to learn just how much the music business has changed over the years with the advent of the iPod and streaming music services. It hasn’t helped musicians, and instead the term “struggling musician” applies to more people than you would think, including many of the folks I know. So while it is great for consumers like us, the world of music streaming is hurting the emerging musicians.

That said, it’s definitely good for business as some of the biggest tech names around offer streaming music, including Apple (AAPL), Amazon (AMZN) and Alphabet (GOOGL). Pandora (P) is also well-known, and the largest of them all, Spotify, goes public next week. The symbol will be SPOT, and the stock will begin trading on April 3.

When NexGen leaders go public, I take notice. In this case, I’m a customer of Spotify and like the service very much, but I won’t be going anywhere near the stock.

The Business

Let’s start with the company, which has 157 million active monthly users in 61 countries. That’s impressive. More than half of subscribers, 71 million, pay the $10 a month premium rate that adds a few features, most notably the removal of advertisements. Most of the company’s revenue, 90%, comes from those subscriptions with the other 10% from advertising. On Monday the company gave its 2018 outlook, with revenue expected to be up by as much as 30% and premium subscribers increasing 36%.

Most musicians are definitely not fans of Spotify because of how little it pays them. When traveling to Maryland last week for meetings with my publisher, I met a girl from Alabama who is a very talented musician. She was flying to Washington, D.C. for a gig, and once again, we got talking business, specifically Spotify and other streaming services. Based on the numbers from mid-2007, it would take 526,316 downloads of a song on Spotify to make just $2,000. If you’re lucky enough to hit the one million download mark, you are entitled to a whopping $3,800. It’s definitely not an easy way to make a living.

Musicians may not bring in much money from Spotify, but the company itself does with its large base of users. Just this week, management said they think revenue could grow 30% this year to $6.6 billion – and they also said they expect to lose $409 million. In fact, Spotify has reported a net loss every year since it was founded 10 years ago. The company is clearly taking the Amazon approach to business, which is spend now for big growth in anticipation of future profits. Amazon has been able to pull it off but keeps expanding into more and more areas. That won’t be so easy for Spotify.

The IPO/DPO

Beyond the bottom-line concerns, Spotify is going public in a very different way. In fact, it’s not an IPO, or initial public offering; it’s a DPO, or a direct public offering. Basically, Spotify is allowing owners of existing shares (which were held privately) to now sell them on the stock market. This is a rare strategy in the world of major U.S. stock exchanges.

In a traditional IPO, a company raises money by offering new shares. That money is often used to fund expansion as growth companies typically burn through cash quickly. Spotify also burns through cash, but it will not raise any money in this deal. There will also be no broker underwriting it, helping build a book of potential buyers or putting some of its own money on the line. This may sound like procedural mumbo jumbo, but it’s important. The lack of an underwriter will make the true price of the stock more difficult to determine before it goes public, and more importantly there will not be a broker buying shares to keep the stock from dropping after the open.

Because there are no new shares being offered, there is also no lock-up period for current shareholders. These lock-up periods normally last for three to six months and force insiders and those involved with the IPO itself to hold on to their shares and not dump them all as soon as the stock starts trading. In Spotify’s case, shareholders can sell as much as they want as soon as they want once SPOT starts trading. The potential is there for some pretty serious selling.

I love companies that are disruptive and do things differently, but in this case I’m not a fan. The bottom line is that there is too much risk with Spotify, at least right now. I will watch it with great interest and let my subscribers know right away if it becomes attractive, but my advice is to watch the trading action for a while before you even consider buying. After the market pullback, there are other NexGen leaders out there with more upside potential and less risk. That’s where you want to be.


Article printed from InvestorPlace Media, https://investorplace.com/moneywire/2018/03/should-you-buy-spotify/.

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