Spotify sounds out the street

Contact: Scott Denne

Despite Wall Street’s demonstrated distaste for pricey consumer tech offerings, Spotify intends to go public in the riskiest possible way. The streaming music service has unveiled its registration documents to begin trading its shares directly on the NYSE, bypassing an initial public offering. Spotify posts growth that makes it the envy of many consumer internet businesses, yet its low-margin business model limits its ability to staunch its losses.

The Sweden-based company’s top line jumped 39% last year to €4.1bn ($5bn), although its net loss more than doubled to €1.2bn. Renegotiating of its licensing agreements improved Spotify’s gross margin in 2017, but it still sits at just 21%. Given that it’s facing off against deep-pocketed tech vendors, including Apple and Amazon, it will be challenging for Spotify to negotiate lower rates and as it stands, the company has already had to lower the price of its service to bolster user growth.

Matching its private market valuation will be tough. New consumer tech debuts haven’t received a warm welcome on Wall Street. Snap trades just ahead of its IPO price a year after its debut, while Blue Apron has been decimated amid customer declines. Eschewing a traditional IPO to set a price could make its stock more volatile than it has been in the private markets – in private trades this year, Spotify’s market cap has swung between $15.9bn and $23.5bn.

It’s tough to find a perfect comp that aligns with Spotify. In some ways, it looks like Netflix. Both provide streaming entertainment and post enviable growth. Netflix, however, offers exclusive content to its subscribers, whereas Spotify has largely the same music that its competitors do. Moreover, Netflix, which is twice the size, has a higher gross margin and generated more than $500m in profit last year. Those differences will make it difficult for Spotify to fetch anything close to the 11x trailing revenue where Netflix trades. Still, its growth rate and low churn will likely keep it well above the 0.8x where Pandora trades. When Spotify enters the NYSE, we anticipate that it will be priced on the low end of its private market valuation, around 3x trailing revenue.

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