Spotify Chief Executive Daniel Ek has persuaded more people to pay for music online than anyone besides Steve Jobs and Jeff Bezos. On Wall Street, his business may be a tougher sell.
Spotify aims to go public in the second half of next year, say five people familiar with the plan. In March, shortly before its 10th birthday, the Swedish company raised $1 billion in convertible debt from investors who valued the company at more than $8 billion. Its also lost money in each of those 10 years. Companies awash in red ink can make it in public marketsAmazon.com, Teslabut its hard to hang a business on music streaming. This is just a tough sector, and that is skepticism Spotify will have to overcome, says Mark Mahaney, an analyst with RBC Capital Markets. The company declined to comment for this story.
Eks company is great at what it does. Spotify dominates paid streaming, with more than 30 million customers, most paying $10 a month for a library of millions of songs. Last year sales almost doubled, to $2.2 billion. (Pandora, which has about 80 million users, reported sales of $1.2 billion.) So why the losses? Well, Spotifys expenses start with commissions to the music industry, which last year totaled more than $1.8 billion, according to public filings. Record labels bank about 55 percent of Spotify sales, and publishers also get cuts. The largest checks go to the big three labels, Universal Music Group, Sony Music Entertainment, and Warner Music Group.
While Ek has spent much of the past 18 months trying to negotiate the labels checks below 50 percent, the labels argue that Spotify is already paying less than market rates, say three people familiar with the talks. Apple pays labels 57.5 percent of sales from its streaming service, Apple Music. Talks appear to have stalled, even though the labels each hold undisclosed minority stakes in Spotify. The companies declined to comment on the negotiations.
The labels cant really afford to take their music off Spotify, says Michael Doernberg, CEO of ReverbNation, which runs an online ad service and database for bands and also manages some musicians. Spotify accounts for more than 10 percent of the labels revenue and expects its total revenue to rise 50 percent this year, says a person familiar with the matter.
Still, the labels have a couple of advantages. Spotify faces competitive pressure from Apple Music, Amazons Prime Music, and YouTube. Spotifys initial public offering is harder to pitch with the negotiations unresolved. And theres some IPO time pressure: Marchs $1 billion funding round included terms that allow investors to convert their stakes into shares at a 20 percent discount to the IPO price, and the discount will grow larger over time, says a person familiar with the terms.
Even if the labels accept lower fees, investors have reason to be skeptical. Online music services have a poor record of long-term profitability, and Spotifys rivals are often loss leaders for their corporate parents. Pandora, which went public in 2011, has struggled to turn a profit and is trying to move into concert promotion. Last year its gross margin was about 47 percent and Apple Musics 40 percent; Spotifys is 25 percent at best, says a person familiar with the numbers.
Spotify spent $250 million on research and development last year, focusing on improving its softwares analysis of listener behavior and upping revenue from audio ads. Its also experimenting with video, having ordered episodes of a dozen original, music-themed TV series, with producers including Def Jam Recordings co-founder Russell Simmons and actor Tim Robbins. Spotify wants to turn into a broader experience, says ReverbNations Doernberg. It gets at a fundamental concern about the physics of the music business. There is a growing belief that these companies burn bright and burn fast.
The bottom line: As it prepares for an IPO, Spotify is working to add more customers and features to grow into its $8 billion valuation.
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