[Editor Charlie sez: Bono’s strange history as a streaming booster turned Spotify investor.]
[Editor Charlie sez: Bono’s strange history as a streaming booster turned Spotify investor.]
[Recall that Spotify is not doing a traditional IPO, but something called a “direct listing.” The difference between the two is a bit down in the weeds, but is crucial. In a traditional IPO (sometimes called a “full commitment underwriting”) a group of investment banks or the equivalent form an “underwriting syndicate” that buys new shares from the company at a valuation set by the underwriters. Hence the “pricing” concept for IPOs–you will hear that right before a new company starts trading. If the path to an IPO has been managed correctly, the underwriters’ valuation is higher than the last private valuation of the company’s last sale of its preferred shares to private investors.
The underwriters want to price in a range that they can resell to retail investors, so they wouldn’t ever price at $1,000 for a stock that is to sell in the open market. Think about it–how long did it take Amazon and Google to get to $1,000 in the open market? They didn’t start there.
Another reason–which I suspect is the true reason–that Spotify is not going the underwritten IPO route is because they can’t get the valuation they want. This may have something to do with another aspect I believe to be true–Spotify is not cracked up to be a public company.
Chris O’Brien in Venture Beat has a really insightful post on Spotify’s problems with valuations:
The reality is that by taking this route Spotify is pursuing a risky strategy. And it’s likely only doing so because it was backed into a corner by its investors and by private fundraising that led to a dangerously high valuation of $19 billion.
“This is not a story of problems in the IPO market,” according to Kathleen Smith, a principal at Renaissance Capital and manager of IPO ETFs. “It’s a problem with Spotify’s valuation.”
So let’s be honest–the reason why Spotify wants to trade publicly has a lot more to do with Daniel Ek’s misplaced ego than it does with any intrinsic value of his company. And don’t forget–when the dust settles, it is his company and this was his idea. Genius or goat, he will get the credit.
But of course Spotify’s “public or bust” approach is really designed to allow existing stockholders to cash out. And here’s the twist–if you’re going to sell, someone has to buy. And if you don’t have underwriters standing behind a price point, then there is no floor to the stock price if the sellers start running for the exits.
So–Spotify is trying to look to existing private market sales–very limited and nothing like public market sales–for guidance on its stock price. (Private markets are sometimes called “secondary markets” where you can buy private company shares.) Maureen Farrell in The Wall Street Journal has some reporting on this which is both murky and enlightening coverage of who Spotify is “managing” (some might say “manipulating”) its stock price already. And if you wonder what running for the exits looks like, check out the VIX crash.]
Spotify AB is counting on its surging private-market value to bolster the music-streaming service’s appeal to investors in an unorthodox public debut that could be the biggest since SnapInc.’s $20 billion IPO last year.
The listing, expected as soon as the end of March, isn’t an initial public offering, in which underwriters set a price and place shares with chosen investors before trading. Instead, the Swedish company will simply float the shares on the New York Stock Exchange and let the market find a price, in what is known as a direct listing.
While Spotify and its advisers are still determining how exactly the process will work, the company and its banks are expected to have a role in helping guide the market to a price and connecting buyers and sellers initially, people familiar with the matter said. A suggested price range is expected to be relayed to the market before trading starts, but the price will ultimately be set by what buyers are willing to pay and the price at which sellers part with their shares.
Private trading is expected to be a key part of the company’s effort to guide the market to a price, people familiar with the matter said.
The so-called secondary markets in private technology stocks are typically an afterthought in an IPO, in part because trading tends to be thin and not always a reliable indicator of value. But Spotify and its advisers at Goldman Sachs GroupInc.,Morgan Stanley and Allen & Co. are closely watching trades among private investors and have taken steps to spur volume, the people said. The company recently informed existing investors that it waived its right to buy shares before they are offered to others.
Washington, D.C. – The Content Creators Coalition (c3) released the following statement on Spotify’s plan to go public on the New York Stock Exchange:
“Spotify’s founders had an opportunity to pioneer new models and partner with artists on ways to make the music ecosystem work for everyone – services, artists, and fans. Instead, they cashed in – enriching company owners and deep pocketed investors and doing nothing for working artists who continue to chase pennies online. This IPO chooses a short term payday over long term progress and will only weaken the streaming ecosystem, burdening the art of music with Wall Street’s bottom line first mentality and erecting new barriers between creators and their fans.
“Spotify’s algorithms and curated playlists have already failed artists and songwriters, making haphazard and emotionally stunted connections between supposedly ‘related’ acts and pushing costly advertising tools as the best way to reach new fans. The result is the worst of all worlds – at one end artists and independent rights holders have no meaningful input into how their work is presented and promoted on the service and at the other end, they are paid grossly substandard wages for the airplay they do receive. And it will get worse as Spotify’s managers focus more and more on shareholders and less and less on music.
“Artists stand ready to embrace streaming models that work for all. But we will always reject corporate greed and ‘too big to fail’ models that squeeze the soul out of our work and distances us from our fans.”
The Content Creators Coalition (c3) is an artist-run non-profit advocacy group representing creators in the digital landscape. C3’s work is significant to anyone who creates and makes a living from their creations. c3’s objectives are two-fold: First, economic justice for musicians and music creators in the digital domain. Second, ensuring that the current and future generations of creators retain the rights needed to create and benefit from the use of their work and efforts. C3 has grown into a national organization based on representation, advocacy, and mobilization for sustainable careers in the digital age.
As ARW readers will know, the Huffington Post censored my friend and whistleblower Blake Morgan who posted his story from a few years ago about a particularly teachable moment involving his encounter with Spotify’s tone deaf executive class. (A teachable moment that was reported at the time by Harley Brown at Billboard which makes HuffPo’s lame editorial excuse ring even hollower.)
As producer Michael Beinhorn noted:
My friend Blake Morgan wrote an article criticizing Spotify which was published yesterday on the Huffington Post website. This article began developing traction, but within 2 hours of posting, it was removed from the website and Blake received a vague email from someone at HuffPo as to why. It has since been republished by David Lowery on the Trichordist website, and now includes the email Blake received after HuffPo excised it from their site. One has to wonder why the Huffington Post- which represents itself as a hotbed of liberal thought and free speech, would publish- and then unpublish- something so important (and summarily/subsequently ban its author as a contributor to their website). Could this decision have anything to do with the fact that the current CEO of HuffPo is the former General Counsel and Global Head of Corporate Development at Spotify? Can you say “conflict of interest” or “a threat to my stock options”? Please read and judge for yourself….
Michael makes a very good point here. According to The Lawyer, the HuffPo CEO, Jared Grusd, exited Spotify in 2015 after working there for four years–2011 to 2015. While we don’t have knowledge of Mr. Grusd’s dealings with Spotify, we can infer a few likely interesting points from that situation.
First, Mr. Grusd’s tenure (2011-2015) apparently overlapped with Jonathan Prince, Spotify’s head of communications and ex-Clinton and Obama official who formally joined the company in 2014. My assessment of Mr. Prince is that part of his job would not only be placing positive news about his employer Spotify, but would also be suppressing negative stories like Blake’s post. To my knowledge, Mr. Prince is still at Spotify.
The particular years that Mr. Grusd was employed by Spotify would start around the time of the company’s U.S. launch and continue for four years, a customary stock option vesting period. We don’t know what percentage of the company Mr. Grusd owns, but we can assume for the sake of argument that it’s around 1% of the then outstanding stock and that Spotify did not repurchase his shares when he left the company. Of course, since Mr. Grusd is obviously a very important person and had two roles at Spotify, he could well own (or have the right to buy) a greater portion of the company, but probably less than 5%. He would probably have been considered something of a late-stage founder for purposes of truing up his initial stock grant and could also have been granted further stock bonuses.
A stock option is the right to purchase stock at a fixed price, usually below market and maybe way below market. Stock options “vest” over time as a way of incenting employees to stay in their jobs (and are often called “incentive stock options”). You cannot exercise stock options until they vest. It’s not uncommon for a company to grant a bunch of these incentive shares to an employee but require the employee to stay at the company for at least 12 months in order to vest at all (called a “cliff”), with monthy vesting thereafter of the remainder of the grant on a prorated basis. These “incentive stock options” may have certain tax advantages.
So if you were to get 100 stock options on a 12 month cliff with monthly vesting, after one year of employment you’d be able to exercise 25 shares, and each month thereafter you’d be able to exercise 1/36th of the remaining shares, or 25% per year. (Which can be one reason you see people leaving some startup jobs after four years.) These shares are almost invariably common stock grants.
How many shares of Spotify stock Mr. Grusd owns and his exercise price will, of course, depend on the number of shares outstanding at the time he was hired and the value of the common stock at that time (leaving aside the “cheap stock” issue), but lets assume that Mr. Grusd got 500,000 shares and that he owns all of them. But realize that he could easily own much, much more.
When a company goes public, those shares become very valuable because the exercise price of the option is almost always substantially less than the market price of shares. (Plus, there is something called a “cashless exercise” which allows holders to avoid having to pay anything at all for their stock, “collars” which allow holders to sell their position to a third party, and other tricks of the trade that allow people like Mr. Grusd to “get liquid”.)
Also remember that Spotify’s proposed stock offering according to press reports is to be a “DPO” (a “direct public offering”) not an “IPO” (an underwritten “Initial Public Offering”), an unusual choice by the company which evidently means that there are no underwriters involved. This move has been criticized by some but lauded by others (which may be evidence of Mr. Prince’s hand). One feature of the DPO is that it might be easier for someone like Mr. Grusd to sell his shares immediately or at least sooner than with an IPO. My sense is that Spotify will be under a lower transparency standard between the DPO structure and the fact that Spotify and its Chinese partner Tencent will probably be filing as a foreign issuer (on SEC Form F-1 and not the traditional S-1 for those reading along). This remains to be seen.
However–Dr. Beinhorn has correctly put his finger on Mr. Grusd’s problem. If Mr. Grusd has Spotify shares that he holds personally (and not through a blind trust) and as a former Spotify “insider” (for securities law purposes) he appears to have every incentive to keep the murky Spotify story as postitive as he can. In his current role at HuffPo Mr. Grusd is uniquely positioned to suppress bad Spotify news for his personal enrichment even if Spotify hasn’t offered him anything to do so specifically.
Whether any of this happened, we can’t be sure. But it sure looks funky.
Another thing that’s funky? Mr. Grusd was evidently General Counsel of Spotify during the time (2011-2014) that many if not all of the licensing failures occurred that lead directly to all of Spotify’s current litigation problems. It would be typical for a General Counsel to sign off on something as legal and as critical to the company as its licensing practices (or failures). Whether that’s leverage for Mr. Prince to extract compliance from Mr. Grusd is something you’d have to ask them–or Spotify’s D&O insurance carrier.
Either way, potential Spotify stockholders buying shares in the public market should be able to hear the good and the bad about the company’s management or mismanagement which Blake was trying to tell them. I don’t know if a former insider has a legal fiduciary duty to the public (or even to existing stockholders) in this regard, but at a minimum it would certainly be a better look not to suppress stories that could inform the investing public if your CEO really does have a conflict of interest.
So on balance, I think Michael Beinhorn has put his finger on something of extraordinary importance to public policy and the well-being of the investing public in general about which the HuffPo’s readership and potential investors in Spotify ought to educate themselves.
All indications are that Spotify wants to list in Q1, and timing of the confidential F-1 filing would support such a calendar. But yesterday came news that the company has been sued [yet again, this time] for $1.6 billion for copyright infringement. It’s unclear how the suit will affect Spotify’s direct listing plans, outside of needing to add a new risk factor to the confidential docs.
[Editor Charlie sez: This day has been coming since we first ran this spoof picture of Daniel Ek–but not everyone was laughing after they got their Spotify royalty statement. Mark Mulligan has parsed Spotify’s recently release financial statements and has some interesting admissions by Spotify–starting with a more accurate total of paid subscribers.
This tweet was widely reported as “50 million paid subscribers” by Spotify’s boosters in the press:
But Mark Mulligan points out–as did many privately–that the correct number was much less than 50 million, although Mulligan’s analysis results in an even more generous number than the whisper number (assuming “paid user” means the same as “paid subscriber” which it might not given Spotify’s premium deals like its partnership with the New York Times):
That would be the New York Times that did not cover Spotify’s $44.3 million class action settlement with Melissa Ferrick. Here’s an excerpt from Mr. Mulligan’s excellent post]
As Spotify nears a public listing or an acquisition by Alibaba or Tencent, it remains the benchmark for the health of the streaming economy. With the underlying fundamentals remaining largely unchanged in 2016 despite stellar growth, here are a few thoughts on how the economics of streaming might change:
An often repeated argument from record labels is that streaming services will hit profitability when they reach scale. So, when does that happen? 48 million subscribers can lay a good claim to being ‘scale’, but it isn’t driving profit. While the market establishes itself, streaming services have to overspend on product innovation and marketing (and then, later, on user retention). So, these costs will likely rise in relative terms. Meanwhile, rights are always going to remain largely in line with revenue (though the UMG and Merlin deals reward growth with some discounting, which is a welcome innovation). But even these deals will not change the fact that rights will be large enough to challenge margins and will largely scale with growth. Which means no truly meaningful scale benefits. So here are a few alternative ways in which streaming margins might be improved….
Stuart Dredge over at Music Ally is reporting Spotify’s losses widened to $600 million last year. Read his article here.
I just wanted to point out that some significant portion of these widening losses are due to currency swings. March 29th 2016 Spotify announced a $1 billion US denominated convertible debt deal with TPG and others. Since that time the US dollar has risen considerably against most currencies. A disproportionate share of Spotify’s income is NOT in US Dollars. Therefore the vig on that convertible debt is now headed towards payday loan rates. Ouch!
This is good news and bad news for artists.
The good news is this may force Spotify to limit the free tier and convert more US subscribers to premium. They need more US dollar income to stop the hemorrhaging from the US debt! Remember artists’ royalties from premium subscribers are 8-10 times higher than free listeners. More premium subscribers is a good thing for artists.
The bad news is Spotify has already indicated they want to pay lower royalties to artists because they are losing so much money. This is completely fucked up. It’s not our fault the company is so poorly managed.