Private sale prices more than doubled during the year-long run up to IPO
|Q1 (to 22 Feburary)
Who owns Spotify?
Unlike a traditional IPO, the existing Spotify shareholders will all be able to sell their shares when the company joins the world’s biggest stock exchange, as they will not be subject to the traditional lock-up agreements that usually prevent existing shareholders (particularly insiders of a company) from offloading their stakes too quickly – which typically depresses a stock price.
Therefore, Spotify’s existing owners are free to sell shares on day one, and the amount they choose to sell will dictate the liquidity in the stock.
The two co-founders of Spotify, Daniel Ek and Martin Lorentzon, have managed to keep control of 80.4% of the company, despite raising private equity over the years.
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|Sony Music Entertainment
Spotify: a blend of music, technology and social media
‘From the age of four, my life was about music and technology — never one without the other.’ – Daniel Ek.
Spotify’s strategy is to build a ‘two-sided music marketplace’ for both users and artists, powered by data, analytics, and software. For listeners, it is all about personalising their experience. For artists, it’s about providing them with the tools they need to promote and engage with audiences.
Global monthly active users increased every quarter throughout the three years to 2017, starting at 68 million in 2015 and climbing to 159 million. The growth in premium subscribers followed a similar trend, climbing from just 18 million at the beginning of 2015 to 71 million at the end of last year.
Although the company’s user base has consistently grown over the years, Spotify is still making loss.
Financial performance (in EUR millions)
Paying royalties to the music industry is by far Spotify’s biggest expense, and included in its cost of revenue. Importantly, Spotify renegotiated deals with the four major firms that hold the rights to the majority of music in its library at the back-end of last year, lowering the cost.
Unsurprisingly, Spotify’s premium subscription service is considerably more profitable than its ad-supported service. In 2016 and 2017, 90% of total revenue came from premium subscribers.
Revenue and profitability of services (in EUR millions)
Spotify’s competition and market share
‘We compete for the time and attention of our users across different forms of media, including traditional broadcast, satellite, and internet radio (iHeartRadio, LastFM, Pandora, and SiriusXM), other providers of on-demand music streaming services (Amazon Prime, Apple Music, Deezer, Google Play Music, Joox, Pandora, and SoundCloud), and other providers of in-home and mobile entertainment such as cable television, video streaming services, and social media and networking websites.’ – Spotify.
Who manages Spotify?
Daniel Ek sits at the helm of the business as chief executive and chairman, with Martin Lorentzon holding the title of director, along with seven other individuals. Other members of the management team include:
- Barry McCarthy as chief financial officer
- Katarina Berg as chief human resources officer
- Seth Farbman as chief marketing officer
- Alex Norstrom as chief premium business officer
- Gustav Soderstrom as chief research and development officer
In total, the entire board was paid $28 million in compensation in 2017. Ek was paid a salary of $440,281 for the first half of 2017, but has since taken no salary. Instead, he receives an annual bonus if he meets certain targets. The first bonus of $1 million was paid earlier this year, despite falling short of reaching some milestones.
Goldman Sachs & Co, Morgan Stanley & Co, and Allen & Co have been recruited to assist Spotify with certain aspects of its listing, and Ernst & Young is the company’s auditor.
What next for Spotify: Daniel Ek’s vision to democratise the music industry
‘The old model favoured certain gatekeepers. Artists had to be signed to a label. They needed access to a recording studio, and they had to be played on terrestrial radio to achieve success. Today, artists can produce and release their own music. Labels, studios, and radio still matter, but in a cluttered landscape, artists’ biggest challenge is navigating this complexity to get heard. We believe Spotify empowers them to break through.’ – Daniel Ek
Spotify sees several areas for growth, and whilst its premium service is driving revenue at present, it sees a lot of value and opportunity within the ad-supported market, which is particularly popular with the key 18-34 age group. Its premium subscribers feed through from the free service, which Spotify can also extract data from.
Competing for advertising is also a very different game to competing for subscribers. Spotify believes there are still plenty of users to poach from terrestrial radio, which is a $14 billion market in the US alone. A total of $28 billion is spent by advertisers on radio each year, providing an important place for ad-supported services in Spotify’s strategy.
Spotify saw a 51% increase in revenue from its ad-supported service in 2016 before growing it a further 41% in 2017.
The premium service is improving rapidly. Growth is consistent, and churn reached its lowest level toward the end of 2017 at just 5.1%. About 40% of subscribers that leave rejoin within three months, 45% rejoin within six months and 50% rejoin within 12 months.
Spotify has five key elements to its growth strategy. The first is to continue research and development as well as acquiring businesses to enhance its offering, having invested in the likes of Mighty TV, Niland, Sonalytic, Soundtrap, and The Echo Nest Corp.
The second is to keep expanding into new geographies. Tencent Holdings became a shareholder after agreeing with Spotify that both firms would acquire minority stakes in one another late last year, forging a relationship between the Swedish streaming giant and the largest online music services company in China, Tencent Music Entertainment Group.
The company will also continue to invest in its advertising business, having introduced new products like sponsored playlists and a self-serve audio advertising platform. The fourth is to implement more initiatives for artists to keep them on-board, and the last aim is to expand non-music content like podcasts and short videos.
Streaming is still in its infancy, and offers a potential market covering the 3.6 billion internet users around the world, a figure that will only continue to grow over the coming decades – and Spotify holds a stronger position than any to capitalise.
What threats does Spotify face?
‘We really do believe that we can improve the world, one song at a time.’ – Daniel Ek
With rights representing Spotify’s biggest cost (up to 79% of revenue in 2017), its relationship with the record companies that monopolise the music will be decisive in determining Spotify’s profitability, and is one of the biggest threats facing the firm over the medium to long term.
Digital music companies and record companies are somewhat inter-dependent on one another, and both hold significant influence over one another.
While music needs a platform and a platform needs music, the likes of Universal Music (owned by Vivendi), Sony Music (Sony Corp) and Warner Music (Access Industries) have more options as to where to lease their libraries than Spotify has to source rights over massively popular music. Some deals can be short-lived too, with Spotify stating that license agreements typically last for only two years and do not renew automatically.
Ek might want to open up access to music to the world, but that will ultimately be decided by the access Spotify can retain to what is a very concentrated industry, that hands control to just a handful of companies. Spotify needs to become bigger than the labels and take control from the labels if Ek is to achieve his ambitions.
Spotify is about technology just as much as it is about music. In a rapidly changing environment that sees it taking on the biggest company in the world, the big players in the tech space that aren’t already considered significant rivals could prove to be a problem in the future. Facebook, for example, has recently signed licensing deals with Universal Music and others in a bid to retain more users watching music videos which are currently redirected to its biggest rival, Alphabet's YouTube.
Although dividends were not expected to be paid from the off, investors should be prepared to wait for any form of payout, with Spotify stating that ‘we do not expect to pay dividends or other distributions on our ordinary shares in the foreseeable future.’