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Will Spotify hit the spot?



After the success of the Dropbox IPO earlier in March, markets are now gearing up for 3 April, when Spotify is set to go public.

In normal circumstances when companies embark on an initial public offering (IPO), the process involves the issuing of new shares in the company in order to raise extra funds to either fund an expansion programme, or to pay down debt. It would appear that Spotify is spurning this particular route and going for a direct listing, which means that the existing private shareholders will make their own private shares available for sale to the wider market.

By going down this route the company is taking a chance on how the shares are likely to be valued, as with no idea of the number of shares set to be available it is going to be much more difficult to set a value for the company.

On the plus side it means that larger investors are likely to find it more difficult to build up a big stake at a discounted price. In the past large investors have had a tendency to mis-price IPOs in order to make sure that they get them out of the door, by marketing them extensively and creating a hype around them, that on the face of it isn’t justified, like Snap.

By listing directly the company removes the big banks and investors from the equation; however it also means any new investors will need to be more forensic when it comes to analysing the internals of the company relative to any early valuation.

Initial indications suggest a valuation in the region of $20bn, which for a company that has yet to make a profit seems rather high, yet as we saw in the case of Dropbox and the opening day spike higher, the fundamentals of a company usually bear no relation to the early movements in the company’s share price.

It is true that Spotify is the Netflix of the audio-streaming world with over 30% share of the market. Apple Music is well back in second place, with Amazon third, but that still leaves it with the perennial problem of how to generate a profit from a turnover that is expected to come in at $4bn on an annual basis. 

Updating the market this week, the company said it expected to generate revenue of around €5bn which would be a slowdown from the growth recorded in 2017, of 39%. For Q1 the company forecasts revenue of up to €1.15bn, an increase of 27%.

The company said it expects to post an operating loss of between €230m and €330m, with around €35m of costs associated with next week’s listing. This is despite expecting to increase the number of paying subscribers from over 70m to over 92m worldwide this year.

The company said it expects the total number of users to increase to 170m from 157m last year. The challenge the company now faces is how to monetise these non-paying customers more effectively, while paying out royalties to the various record labels for content at the same time.

While the free service has advertisements, most new subscribers are already likely to have access to streaming music if they have an Apple device, and while Apple Music isn’t making inroads into Spotify’s global market share quite yet, its deeper pockets mean that it also isn’t susceptible to the same budgetary pressures as its Swedish counterpart, which means it can throw more money at streaming and take a much longer-term view.

The same applies to Amazon which is in third place for market share, which again gathers its revenues from a multitude of different streams, which means that Spotify could find that its ability to generate profit is only likely to get squeezed further. Quite simply, it doesn’t have the scale or diversity of Apple or Amazon and while it currently holds a sizeable lead in terms of market share, profit could be quite a while in coming, given that the more users it gets the more royalties it has to pay.

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