Spotify makes its stock market debut

Spotify makes its stock market debut

Press release as received by Girl at the Piano from Hargreaves Lansdown

Spotify launched directly onto the New York Stock Exchange today, with the shares initially changing hands on the public market for $166 a pop, significantly higher than the $132.50 which was the highest price previously paid for the shares in private transactions.

The company has chosen the unusual route of a direct listing on the New York Stock Exchange, so we can probably expect a bit of a choppiness in the price throughout the remainder of the US trading session.

Laith Khalaf, Senior Analyst, Hargreaves Lansdown:

‘Spotify is floating on the stock market at a pretty inauspicious time for the tech industry, which has been rocked by the Facebook data scandal and now potentially faces greater regulation as a result. Donald Trump’s tweeted attacks on Amazon don’t help lift sentiment towards the sector either.

Despite the downbeat mood music, Spotify shares changed hands on the market at a substantial premium to the highest price previously paid in private transactions, indicating significant investor demand for the stock. It’s still early in the US trading session however.

The attraction of the music-streaming service probably lies in Spotify’s strong market share and rapidly growing revenues. It may be some time before Spotify actually turns a profit though, as the company is resolutely prioritising growth over profit, and will be channelling money into investing in services and building further scale.

Unlike its main competitors Apple and Amazon, Spotify is focused on music streaming, so it doesn’t benefit from the network effects of a wider ecosystem. However the company has already carved out a dominant role, and has demonstrated its ability to leverage scale by renegotiating agreements with music labels, boosting its gross margin from 12% to 21% since 2015.

Spotify comes with a great story, a strong brand and a robust growth profile, but with its fair share of risks too. Investors should ensure any investment in Spotify doesn’t make up an over-sized part of their portfolio, and that they appreciate the potential downside as well as the company’s growth prospects.’

Spotify pros and cons

In case you missed it over the Easter period, here’s our take on the pros and cons of the investment case for Spotify.

Pros:

• The Freemium business model creates a growing stream of paying subscribers, with 60% of Premium users starting as ad-supported subscribers.
• It costs Spotify around €9 to recruit a new Premium subscriber, but the company breaks even provided the subscriber stays for 12 months, and the average value of a subscriber over their lifetime is currently €25.
• Strong revenue growth from €746m in 2013 to €4,090m in 2017, which is expected to grow to between €4,900m and €5,300m in 2018, with the prospect of further expansion in both existing markets and new geographies. Spotify also stands to benefit from greater smart phone penetration in developing economies.
• Spotify reckons it has over 40% of global market share in streaming, which puts it in a strong position when bargaining with music labels.
• Spotify is investing heavily in its user experience and its data tools for artists, which should help it grow further.
• The management are key shareholders in the firm, aligning their interests with those of other investors.
• Spotify has a direct way of monetising its user base and isn’t reliant on the vagaries of purely selling advertising – in 2017 Spotify’s Premium subscription service generated 90% of the company’s revenues, with advertising making up just 10%.
• The company is debt-free.

Cons

• Spotify currently doesn’t turn a profit which means investors are paying up for future earnings potential.
• Just four music companies control the rights to 87% of the music streamed on Spotify, so it has a very concentrated supplier base, which is a risk.
• Amazon and Apple are not competitors to be taken lightly in terms of resources or innovation. Unlike Spotify these companies also produce hardware like the iPhone and Amazon Echo which can come pre-loaded with their own music-streaming services.
• Technology and celebrity can both be fickle beasts, as evidenced by Snap’s recent share price fall on the back of one fairly innocuous Kylie Jenner tweet. Spotify stock is also vulnerable to the kangaroo court of social media if it happens to displease one of the recording artists in its catalogue, though such setbacks are likely to be short term.
• Around 2 million users have managed to supress Spotify’s ads without paying for its Premium service. Spotify will no doubt be addressing this specific issue, but this kind of widespread fraud nonetheless represents a threat to revenues.
• Spotify’s founders are still keeping tight control of the company by supplementing their shareholdings with new beneficiary certificates which give them additional voting rights, handing them greater power than their already large shareholding dictates. That may well allow them to stay true to their vision, but it means everyone else has less of a say in how the company is run.
• The company admits it has identified weaknesses in its financial reporting, which raises concerns it could mis-state its financial position. Spotify says it has implemented measures to solve this problem, but the fact these failures occurred in each of the last three years suggests the company has struggled to get to grips with the issue. Financial mis-statement is a serious matter because it can lead investors to buy or sell shares based on inaccurate information, and can also result in fines from regulators.

Summary

Like many tech companies Spotify comes with an exciting growth story and a few hazard signs too. Investors considering buying shares should take a long term view and ensure their holding is only a small part of a well-diversified portfolio.