Why I’m Staying Away from Spotify Technology SA

I love music, and unless I’m in a meeting chances are pretty good you can find me with my earphones in. 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.

This is good for business, as some of the biggest tech names around offer streaming music, including Apple Inc. (NASDAQ:AAPL), Amazon.com, Inc. (NASDAQ:AMZN) and Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL). Pandora Media Inc (NYSE:P) is also well-known, and the largest of them all, Spotify Technology SA (NYSE:SPOT), just went public on Tuesday, April 3.

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

The History of SPOT

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% coming from advertising.

Most musicians are definitely not fans of Spotify because of how little it pays them, but while they may not bring in much individually, the company itself does with its large base of users. Recently management said they think revenue could grow 30% this year to $6.6 billion, but they also expect to lose $409 million. In fact, SPOT has reported a net loss every year since it was founded 10 years ago. The company is clearly taking the AMZN 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.

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

Spotify will not raise any money using this approach, and there was also no broker underwriting it, helping build a book of potential of 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 made the true price of the stock more difficult to determine before going public, and more important there was no broker buying shares to keep the stock from dropping after the initial 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 could sell as much as they wanted as soon as they wanted once SPOT started trading. That opens the potential for some pretty serious selling.

Still Too Much Risk in Spotify Stock

The shares did pull back on their first day of trading — opening at $165.90 and closing just above $149 — but overall the DPO was successful. SPOT now has a market cap of about $26 billion, which is higher than its last private raise.

The thing with valuation, though, is that it’s difficult to put a true number of Spotify until it figures out how to make a profit and stop bleeding cash. In the prospectus, management said it could be a long time before the company turns a profit — and possibly even never.

To come close to profitability, SPOT will need to lower its costs while also keeping up its robust subscriber growth rate. This may sound achievable, but when there is still competition from Apple, the world’s largest company, and Amazon always lurking around the corner, the goal becomes a lot more difficult.

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 will continue to be a customer, but my advice is to watch the trading action over the next few weeks to see how the market reacts to this unique IPO process.

Matthew McCall is the founder and president of Penn Financial Group, an investment advisory firm, as well as the editor of FUTR Stocks and the ETF Bulletin. Matt just launched two new investment advisories focused around the “next” generation investing theme. His trademark three-prong investing approach targets the mega-trends old Wall Street is missing out on. Click here for more information on the “NexGen” Experience.

Article printed from InvestorPlace Media, https://investorplace.com/moneywire/2018/04/staying-away-spotify-technology-sa-spot-stock/.

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