Spotify is the biggest music streaming company out there, and many investors are eager to get in on the action when and if it eventually goes public.
In this clip from Industry Focus: Tech, Motley Fool analysts explain what we know about Spotify's financials, when it might go public, and why all the reports and speculation we have so far point toward Spotify going public with a direct offering instead of working with investment bankers and raising capital.
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A full transcript follows the video.
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This video was recorded on Dec. 8, 2017.
Dylan Lewis: The piece of yours on the site that I saw that got me thinking along this line was some comments that were made by Jimmy Iovine, the Apple Music chief, about the music streaming space, specifically Spotify.
Evan Niu: Yeah, he was more or less suggesting that they're in trouble because the streaming music business is not really a great stand-alone business. I've stressed this in articles before, there's lots of industries that just aren't great businesses, and sometimes they can be better off served by larger companies that have this as a side business that they don't need to rely on for profits. Spotify is a stand-alone pure play on music streaming, and the economics of music streaming just aren't great. It's really hard to build a stand-alone business on this, even though Spotify is huge and by far the most popular paid streaming service in the world. So, they're definitely doing very well at executing, but if the financials don't look great, there's not much you can do if the economics just aren't there.
Lewis: And we're going to talk about the numbers there. You look at the user growth that they've shown and some of the top line growth that they've shown, it's very tempting. This is one of those companies that has been the subject of rampant speculation, I think going back even to 2015, about when they will go public. Hopefully, on this show, we might ease investors' gumption or enthusiasm about this company, because I think you and I both see a business that's going to struggle long-term. For folks who aren't super familiar with Spotify, it's a music streaming platform. They offer both an ad-supported and premium account model. The premium accounts cost $9.99-14.99 a month. That catalog that they offered gives you access to tens of millions of songs. If you have a premium account, you can download them and listen to them offline on your device as well. Recent insider private trades have valued the company around $16 billion. I've seen that, were they to go public at some point in 2018, which seems pretty likely, they would be going public at some valuation around $20 billion or so. Looking at the financials that we have for them, we were lucky enough to get something, looking back at 2016, they put up about $3 billion in revenue. Looking at some of the price to sales figures that we've seen in the past year or so for some of these companies going public, not crazy at that valuation, but certainly a little bit rich, Evan.
Niu: Right. I think one thing that's also important to consider is, all of the reports that we're seeing about Spotify's potential IPO suggests that they're looking at doing a direct listing, which is very different than the way that most companies go public. Most companies, when they go public, there's an IPO, they raise a bunch of capital, they issue a bunch of shares, they work with investment bankers. A direct listing basically bypasses all of that, and they just take their shares and list them on the New York Stock Exchange or the NASDAQ or wherever they choose to list. Then, the shares start trading.
So, there's a couple of pros and cons to this approach. It's simpler, it's more direct, and they basically get to avoid all these fees that companies typically have to pay investment bankers. There's no roadshow, there's no dilution to existing shareholders. But the risk is, without the guidance of these bankers that typically crunch these valuation numbers for you, the market is kind of on its own to figure out what this company is worth. Obviously, when you talk about IPOs, we always talk about valuation, right? But if you're doing a direct listing, there's no set valuation, the shares are just there, and what is the market going to do with them? So, so far as that $16 billion number that you just mentioned, that was the most recent private transaction. But if they go public through this direct listening, that number doesn't really mean as much because it's really all just up to the market at that point, of what the market is willing to pay. So, there's a lot of risk of a lot more volatility, because there's a lot more uncertainty. So, there's pros and cons, but not many companies go this route. But it's an interesting approach. I do think it's interesting, because they're not raising capital, but Spotify probably needs capital. They did a $1 billion convertible note offering in early 2016. You have to think it's probably about time to run another capital raise at some point. It's interesting that they're not looking to raise capital, even as they might go public soon.
Lewis: Yeah. One of the things that has led a lot of people to think that they will be going public soon is some of the debt that they raised recently, I think about a year or a year and a half ago, where it basically had this escalating interest rate on convertible debt notes the longer the company stayed private, so a lot of people looked at that as a shot clock for the company's public issuance, thinking that, not only are they probably going to go public anyway, but now they have a financial incentive to go public, because the longer they hold out, the more they're going to be paying back to some of these people for access to that capital.
Niu: Right. And as you mentioned, they're losing a bunch of money, so you would think they would need more at this point. Or soon, at least.
Dylan Lewis owns shares of Apple. Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.