2017 IPO Prospects: Spotify Delays Again

Music streaming company Spotify has been thinking about its IPO for a while. A year ago, analysts were expecting it to take the plunge in 2017. But recent reports suggest that the company may be delaying the IPO again, as it works on improving its operations and financials.

Spotify’s Financials

Stockholm-based Spotify was founded in 2006 by serial entrepreneur Daniel Ek and Martin Lorentzon. The two founders took two years to develop the streaming app, which was launched in 2008. Since its release, the app has seen rapid adoption. Spotify operates on a freemium model allowing users to listen to music along with ads for free or to opt for a $9.99 a month subscription that offers ad free music streaming.

Last week, the company announced that it had 50 million paid subscribers. Subscriber base has grown from 30 million in March 2016 to 40 million in September 2016. Including the free subscribers, Spotify has more than 100 million users on its platform. Compare that to Apple Music’s 20 million paid subscribers in December 2016, from 13 million in April 2016 and 17 million in September 2016.

But despite the increasing number of subscribers, Spotify is still not profitable. Spotify ended 2015 with revenues of $2.8 billion and a loss of $194 million. More recent financials are not known.

Spotify has grown through venture and debt funds. It has raised $1.56 billion in venture funds from Asset Management Partners, Baillie Gifford, D.E. Shaw & Co., Discovery Capital, Goldman Sachs, GSV Capital, Halcyon Asset Management, Lansdowne Partners, Northzone, Rinkelberg Capital, Senvest Capital, Technology Crossover Ventures, TeliaSonera, Alexandre Mars, AFSquare, Fidelity Ventures, Lakestar, The Coca-Cola Company, 137 Ventures, Accel Partners, DST Global, Kleiner Perkins Caufield & Byers, Founders Fund, Sean Parker, Horizons Ventures, and Li Ka-shing. In March 2016, it raised $1 billion in convertible debt and was valued at more than $8 billion.

Spotify’s Profit Focus

As part of the profit focus, Spotify is now evaluating a higher premium-based subscription service. Being dubbed a Hi-Fi service, the new paid option will be an option available to existing Spotify Premium subscribers. It will cost the users an additional $5-$10 a month and would grant them access to additional features such as lossless high fidelity streaming, a free vinyl, discounts on vinyls, and concert tickets. If successful, the Hi-Fi service could help improve average revenue per user and translate to better margins. With the increased adoption of Lightning and Bluetooth headphones, especially after Apple’s move away from the jack, many believe that there will be an increasing demand for lossless audio. Spotify is clearly trying to address that demand.

Spotify’s IPO Delays

Many believe that Spotify has delayed its IPO as it tries to improve its financial metrics. Spotify is targeting a valuation of $11 billion-$13 billion and given the current market conditions, that may be a difficult number to hit this year. Unlike two years ago, when the market was valuing companies on the basis of their users and business models, investors appear to be more realistic now. The growing number of Unicorpses suggest that profitability economics of business models are given due justification in arriving at valuations.

Spotify can claim a reasonable valuation only if it can show a path to profitability. Right now, with its license deals, that seems to be a stretch. Spotify is rumored to be looking at achieving profitability through renegotiating its license agreements. Currently it operates on a variable pricing-based licensing agreement where it pays a royalty based on the number of track plays. It is looking at shifting to a fixed model instead. The increasing number of subscribers does offer it leverage to negotiate such a deal. Currently Spotify pays nearly 55% – 70% in royalty to the big three labels – Universal Music Group, Sony Music Entertainment, and Warner Music Group.  A lower fee would surely be helpful in attaining profits.

Spotify’s Debt Problem

Besides high costs, Spotify is also dealing with a costly debt problem. Last year, Spotify had taken loans of $1.5 billion that came with very strict covenants. The terms of the loan expect Spotify to pay big premiums in case an IPO is delayed over a year. The first year loan came at an interest rate of 5%, but for every six months thereafter till the stock lists, the interest rate will keep going up by 1%. Additionally, the longer Spotify delays the IPO, the more shares it will need to give to its creditors when it lists. The one year anniversary for the $1 billion loan is almost here, and Spotify is looking at a minimum of $50 million in interest payments.

The above problem may warrant a rushed IPO, but Spotify realizes that a low valuation will not be helpful to the company in the longer run. Spotify must have also learnt a lesson from its rival Pandora’s (NYSE: P) listing. Pandora went public in 2011, is yet to turn in profits, and continues to languish. Pandora ended last year with revenues of $392 million, a net loss of $90 million. It had a total user base of 81 million of which only 4.4 million were paid subscribers. Pandora earns its revenues through ticketing and advertisements as well. Its stock is trading at $12.47 with a market capitalization of $2.9 billion. Not exactly a great role model for Spotify!

Photo Credit: Andrew Mager/Flickr.com

This segment is a part in the series : 2017 IPO Prospects