Spotify IPO in 2017 Could Be in Trouble

spotify ipoSpotify IPO in 2017?

As much as investors may want to see more huge tech initial public offerings (IPOs) hit the markets in 2017, those bullish on the Spotify IPO will more than likely have to wait until 2018.

TechCrunch reported that multiple insider sources are saying that, despite the company’s initial plan to make Spotify stock available to the public in 2017, the streaming service is now looking toward 2018 as the year to file. (Source: “Sources: Spotify may delay IPO to 2018 as it rethinks licensing deals,” TechCrunch, February 2, 2017.)

The unnamed sources said that the delay was intended to buy Spotify time in order to build up a better balance sheet and work on shifting its business model to improve margins. One of the current obstacles to a Spotify IPO is that the company has accumulated large amounts of debt and has yet to show a path to profitability.

While in the past this has not always prevented companies from going public or even being successful on the market, moods have changed toward putting an emphasis on profitability, or at least a foreseeable future of positive revenue, versus past models that focused on user growth and engagement.

Sources also said that there is a push for a Spotify valuation of $11.0 billion to $13.0 billion, citing the numbers as an “emotional target.” Compared to the last reported valuation of $8.53 billion back in 2015, this new target would represent a significant upgrade for a Spotify valuation. The $8.0 billion valuation is still considered to be the functional valuation, so the company would need to add some serious momentum if it wants to tack on another three to five billion to that figure. (Source: Ibid.)

Spotify IPO Delay

While investors may be hungry to hear about the IPO details, they’ll be kept waiting for the foreseeable future before any news breaks about a Spotify price per share or other information of that nature. And there’s plenty of good reasons for those delays.

First, you have Spotify’s current revenue model, which leaves much to be desired, according to those in the music industry. Just ask Taylor Swift, who pulled her entire music catalog from the Spotify web site in November 2014, citing the free, advertisement-based service as the motivation for her departure. (Source: “A Spotify IPO this year is looking less likely—which is good news for Spotify,” Quartz, January 30, 2015.)

Beyond the philosophical qualms that artists have raised, Spotify’s revenue model also has different pay-out rates based on how many hits a song receives, regardless of whether the listener is a paid subscriber. The model also has other metrics, which has proved frustrating for some in the music industry. There are signs that the company is moving toward a flat-rate approach in order to settle these headaches, but nothing is yet set in stone.

Another issue weighing on Spotify revenue is the current payout to the music industry itself. The current payout model has about 70%-72% going back to a number of parties, including 55% going to record labels and artists, while 15% is distributed to publishers and songwriters.

While the 55% is lower than the 58% that one of Spotify’s top rivals—Apple Inc.’s (NASDAQ:AAPL) “Apple Music”—pays, it is still higher than what the company would like, especially if looking toward profitability in the near term. Part of the reason that the Spotify IPO may wait until 2018 is that management will try to renegotiate a more favorable agreement with the music industry.

Speaking of renegotiating, Spotify has a lot to do on that front if it doesn’t want to incur a near $500.0-million loss for waiting until 2018 to launch its IPO. As a result of two fundraising deals, the company has several mandates in place that actually lose the company equity the longer it takes to go public.

The first deal came in January 2016, when the company raised $500.0 million in convertible notes from Swedish investors. In that arrangement, the notes were specifically pegged to an IPO plan. If the Spotify IPO were to take place within a year following the investment, the investors would get a 17.5% discount on shares. After that year time frame, however, the discount will increase 2.5% for every six months.

The second plan had Spotify make a $1.0-billion deal with even stronger terms. Investors TPG and Dragoneer Investment Group can convert their debt to equity at a 20% discount of the eventual Spotify share price following an IPO. Again, if there’s no IPO within a year of that deal (March 2016), then the discount rises by 2.5% every six months. (Source: Tech Crunch, op cit.)

All of this on top of the five percent annual interest that Spotify pays on the debt, and one percent more every six months, up to to a total of 10%.

One of the inside sources said that those deals are being examined for renegotiation, with the intention of compromising on the kickers in order to give the debt and note holders a higher ultimate price, which could save the company money in the long term.

But if you do the math, Spotify could be on the hook for $449.0 million after interest costs and agreed discounts if the Spotify IPO comes in the spring of 2018. (Source: “If Spotify Delays Its IPO Into 2018, It Faces Some Serious Financial Pain,” Music Business Worldwide, February 5, 2017.)

And, to top it all off, there’s some more bad news for the Spotify IPO, and its name is Pandora Media Inc (NYSE:P).

A competitor of Spotify’s, Pandora has not had a good run of it since going public in 2011. P stock has lost nearly four percent since its IPO, and only had about a year’s worth of steady gains, taking the stock to near the $40.00 range before plunging down to its current value of roughly $13.00.

While not a direct comparison for Spotify, some investors may look to Pandora’s poor performance as an indicator that Spotify will have to make some serious changes in order to avoid ending up like its rival streaming-service.

However, it’s not all doom and gloom for Spotify, especially when compared to Pandora. Sales for the music streaming company doubled to $2.2 billion in 2015, versus Pandora sales of $1.2 billion. All this while boasting more than 30 million paid subscribers shelling out $10.00 a month for the service. User numbers rate past the 100-million mark when accounting for free visitors as well. (Source: “Will a Spotify IPO Live Up to Its $8 Billion Valuation?,” Bloomberg, July 20, 2016.) 

A final reason we may be seeing this delay is Spotify’s inability to ink new licensing deals with the big record labels. While talks have been taking place for more than a year, there’s been no word yet of a final deal.

The contracts are with Vivendi SA’s (EPA:VIV) Universal Music Group, Warner Music Group Corp., and Sony Corp (NYSE:SNE), which in sum control 80% of recorded music. (Source: “Spotify Needs to Face the Music,” Bloomberg, February 8, 2017.)

A loss of any of these providers would severely damage Spotify’s catalog, and therefore its brand, not to mention potentially cost it listeners. Sorting out these deals is critical to a successful Spotify IPO.

Spotify Stock 

So where does that leave us with Spotify stock?

As seen above, there are a lot of question marks surrounding the business and, for a cautious investor or a Spotify bear, there are certainly reasons to be skeptical.

However, a Spotify IPO is not doomed from the start. On the contrary, there are a number of reasons to believe that Spotify still can be a hot IPO in 2018, or even 2017 if the company shifts direction once more.

While competition from Apple Music and from Amazon.com, Inc.’s (NASDAQ:AMZN) “Prime Music” and “YouTube” continue to challenge Spotify’s dominance, the music industry at large is moving in the right direction.

Spotify accounts for more than 10% of the music industry labels’ revenue, meaning the service is absolutely integral to the companies’ bottom lines. Not to mention that music industry association the International Federation of the Phonographic Industry (IFPI), registered in 2015 (its most recent figures) $6.7 billion in digital music sales, or 45% of all global revenues, while physical music sales accounted for 39%. (Source: “IFPI Global Music Report 2016,” International Federation of the Phonographic Industry, April 12, 2016.)

The music industry as a whole is moving into the online space more and more, with Spotify the current top dog in the sector. With that in mind, there are still plenty of reasons to be bullish on a Spotify IPO, despite some of the potential misgivings.

What’s Next for a Spotify IPO? 

As much as it pains me to say, we will more than likely not see a Spotify IPO in 2017. Having said that, there is still a chance that the company could file this year, but most signs are pointing toward a 2018 IPO date.

But that doesn’t mean to sit on your hands and wait around. There are a few key signs to watch out for that will signal that a Spotify IPO could be on the horizon.

The first is the renegotiation of the aforementioned deals.

If the company is able to reduce the kickers it promised when it took on debt, or sign new contracts with the major record producers, then you have a couple of loose ends whose tying-up will help push toward making a Spotify IPO a reality.

And, like many of the current tech IPOs that may or may not be filed in 2017, eyes are transfixed on the Snap Inc. IPO anticipated in March. If that social media giant goes public with shining results, you may see more and more private tech companies begin to eye an IPO.

For now, though, it’s looking like a Spotify IPO happening in 2018 is your best bet.