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Spotify Direct Public Offering

March 27, 2018
Editor(s): Gavin Cheng
Writer(s): Abrar Samen, James Lee, Kaavya Jha

Spotify is a service that conveniently streams music, video and podcasts to millions of users around the world. The breakthrough and game-changing nature of Spotify has not only changed the way users listen to music, but has also given rise to fierce competition in Apple Music, Google Play, Amazon Music and more. As of December 2017, Spotify had 157 million monthly average users, with 71 million premium subscribers (Spotify, 2018, p.1).

Spotify is opting for a simple and direct market listing on the New York Stock Exchange (NYSE).  In their prospectus to the Securities and Exchange Commission (SEC), registered shareholders are able to resell up to 55,731,480 ordinary shares on exchanges such as the NYSE. Listing on public exchanges will allow Spotify to raise funds from markets through rights issues or placements, as well as provide existing investors with increased share liquidity. Specifically with Spotify’s direct public offering (DPO), substantial underwriting fees and lengthy reporting requirements can be avoided.

However, there will be no underwriters to facilitate initial market trades. With share transactions ranging from $37.50 to $125.00 per share in the year ending 31 December 2017, high volatility in trading volumes and prices are expected in the coming weeks as buy and sell orders are sent out. Another worry is that significant shareholders comprising key management personnel and employees have elected to subscribe the large majority of their shares. If their intention is to liquidate all holdings to the market, it may be a sign that Spotify is in for some tough times, although Daniel Ek, one of its founders, has subscribed less than one-third of his total shares

IPOs in the technology sector

In the last few years, Snapchat, Pandora and Twitter have participated in IPOs. The table below highlights the key statistics.

According to Statista, average premiums in 2017 in the US technology sector is 30.2%. Snapchat and Twitter both exceed the average premium amount, with Twitter more than doubling it. This would have been a huge concern for Spotify had they considered to IPO instead of DPO. Spotify has many similarities with Snapchat and Twitter in that they are primarily social platforms, with their main source of revenue coming from their user base, which is subject to high uncertainty as trends come and go. It is therefore difficult to come up with an accurate valuation of Spotify. This may lead investment bankers to severely under-price the IPO to ensure a large take-up of the shares offered to reduce their potential underwriting risk. Most likely, this would lead to a premium well above the sector average.

However, in a traditional IPO, a primary aim of the listing company is to raise funds from investors. In this case, proceeds of sale of shares will not be received by Spotify, but by registered shareholders willing to sell to the market. Spotify is simply listing on the exchange to ensure its shares can be publicly traded. With different objectives in mind, Spotify’s approach will circumvent costs associated with underwriting and potential under-pricing of shares. Short term price fluctuations and potential illiquidity may be of little consequence for future equity raisings as by this time, markets will have ample historical data to reasonably price Spotify shares.

Spotify Long Term

Spotify has focused their strategy on innovation and long-term engagement over short-term financial loss, and have utilised innovative technologies to collect and analyse behavioural data to tailor recommendations and playlists to user preferences. There has been huge reported growth in revenue, with revenue reaching approximately 4 billion euros in 2017, up from approximately 2 billion euros in 2015. However, at the same time it experienced net losses of 230 million euros in 2015, increasing to approximately 1.2 billion in 2017 (Spotify, 2018, p.96). Royalty and distribution costs made up a large proportion of cost of revenue, and are “complex” and “difficult to estimate” (Spotify, 2018, p.19). Spotify has been attempting to “secure favourable licensing terms”, and in 2017, have renegotiated some of their contracts with major labels (Spotify, 2018, p.117).

Current growth rates suggest that users will continue to flock to Spotify. This is aided by their focus on technology, which has helped personalise user experience, with playlists such as “Discover Weekly” recommending music based on users’ tastes. Such technology is in accordance with their strategy of boosting growth and user engagement, but also serves the added purpose of influencing which artists and songs appear on user searches or recommendations. This may give Spotify some leverage over music record labels and publishers with regards to their user exposure, allowing Spotify to cut royalty fees and renegotiate existing contracts.

Competition

As of yet, Spotify remains the largest streaming services globally, surpassing apple streaming services by about 35 million paid subscribers in September 2017.

From the period March 2016 to September 2017, the number of paid subscribers for Spotify and Apple Music have grown at a rate of 4.4% and 5.2% per month respectively. Pandora, which pioneered the streaming music industry, is no longer a strong competitor as net losses continue to mount (Pandora, 2018), and active users have started to drop off (Statista, 2018).

Spotify has the advantage of focusing solely on music streaming. As a competitor with loyal customers with curated playlists, user retention is high. However, Apple has long been successful in the technology industry, and can leverage broad expertise and funds to enhance their market position in the music streaming industry. Although Apple Music has done well to improve their market position from their launch date in June 2015, Spotify still wields a strong influence over the market. As long as Spotify is able to navigate key relationships, such as those with famous celebrities and labels, the future looks bright for the tech giant.

Will the Spotify DPO be successful?

Spotify’s unique approach to become a listed company is fraught with danger, but numerous in benefits. With specialised expertise and fascinating technology, Spotify has become the leader in their industry, and is expected to maintain their position in years to come. With an outward focus on growth opportunities and a subtle approach to cutting costs, Spotify will likely produce stronger financial results. However, the timing of the DPO is questionable and may raise questions about management’s intentions and suspicions regarding Spotify’s current financial health. Despite this, we anticipate large scale take-up of their stocks after the first few weeks of listing.

The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ, our Partners and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.