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Spotify IPO Frightens Music Industry and Wall Street

Spotify new rectangleSpotify has 70 million paid subscribers plus tens of millions more ad-supported users. But as a deeply unprofitable company, its future is far from certain. That has many in both the music industry and Wall Street investors worried, as the music streamer inches closer to its first public stock offering.

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 Spotify is just months, if not weeks, away from its first public stock offering at a valuation as high as $19 billion.  Many of  its investors are ready to cash out and, in the not too distant future, the money-losing company will need the cash this offering will generate. 

But the reasoning behind the unusual manner  in which Spotify is choosing to go public - forgoing the usual IPO for a direct stock offering  - is seen as a red flag by some in the investment community.  “This is not a story of problems in the IPO market,” according to Kathleen Smith, a principal at Renaissance Capital and manager of IPO ETFs. “It’s a problem with Spotify’s valuation.”

We've written before about how at least $1 billion of Spotify's funding came with onerous terms that makes going public ASAP essential. 

Under the terms of that deal, Spotify must pay 5% annual interest on this $1 billion debt, adding 1% more every six months for a total of up to 10%.  Investors can convert their debt to equity at a 20% discount of Spotify's IPO share price, and if there is no IPO within a year (a deadline which may have already passed), their discount increases 2.5% every extra six months. Additionally, the new investors can sell their shares just 90 days after the IPO, well before the 180 day lockup for Spotify’s other investors and employees. 

Ouch.

Of course everyone is also worried about how much money Spotify is losing every year. Leaked financials show an annual net loss of $568 million in 2016.  Who wants to invest in a money losing company with no clear path to profitability.

MORE:  Spotify Has 4 Paths To Profitability, None Are Good For Labels Or Artists

Then there is the $19 billion valuation that recent private Spotify stock trades have reportedly been based on.  That's a dangerously high hurdle to jump.

Also worrying both Wall Street and music execs is untried nature of a direct offering.  Venture Beat called it "a move driven by need and opportunity."  Smith agrees: "There is an issue with Spotify, and they are trying to solve the problem by selling their shares publicly in an unorthodox manner. The strategy is not fully baked.”

The Music Industry Is Worried Too

The major labels stand to make tens of millions of dollars on the Spotify stock options the hold, so why would they be worried? Not only would a botched public offering cost them millions in lower stock prices, a shaky Spotify threatens the massive  streaming revenue that the recorded music sector has begun to rely on.  Estimates suggest that 17% of all major label revenue comes from Spotify, and than number is rising. 

image from pmcvariety.files.wordpress.comWhat if Spotify's rush to the markets fails? “That’s a pretty bad scenario,”  a major-label executive who has worked with Spotify for many years, told Variety. “The music industry is back to growth, and you can feel investors saying, ‘Let’s take another shot at music.’ If it crashes and burns, Wall Street and the investment community might say, ‘Even this second chance didn’t work’ and become paranoid.” 

Even less convinced that there smooth sailing ahead for Spotify  is music attorney and frequent Hyepot contributor Chris Castle. “There are some companies that just aren’t supposed to be public, and I think [Spotify is] one,” he says. “They’ve grown by seeding their business with venture money and their topline is considerable, and there’s nothing to suggest they have any intention of getting their costs under control. If they’re trying to say that they can’t run their money-losing business without having those expensive offices in the World Trade Center, OK, but don’t come crying to me about royalty rates.” 

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