Another insightful post by the author of Free Ride! We’re looking forward to Mr. Levine turning his attention to the racketeering at Facebook.
As Spotify begins to prepare for an IPO, which sources say the company is planning for late 2017, the relationship between the Swedish streaming giant and its trifecta of major-label frenemies (Universal Music Group, Sony Music Entertainment and Warner Music Group) is going through some drama.
Finding compromise is more important than ever for both sides. Spotify needs the majors’ vast catalogs and without long-term deals in place, it would be hard for the company to go public — which it essentially has to do in order to satisfy the terms of a financing deal.
Lads that’s not good enough, we need to fire two broadsides to her one.
Want to see a guillotine in Piccadilly?
Want to call that raggedy assed Napoleon your King?
Want your children to sing the Marseillaise?
From Master and Commander: The Far Side of the World, written by Peter Weir & John Collee, based on the novels by Patrick O’Brien
If you’ve ever had a pint on the lawn of a country pub during the English summer, if you ever experienced the audience in a cinema rising to sing God Save the Queen, had Sunday brunch at the Dorchester Hotel, or ordered the meat off the trolley, then you probably weren’t surprised by the outcome of the Brexit referendum. That outcome was the third political earthquake that the UK pollsters missed (SNP’s rise to dominance and the collapse of Labor in the last election being the other two).
So now that the relatively inevitable has finally come to pass, what impact will Brexit have on the near-term market conditions that are likely necessary to support a Spotify IPO? I’ve long held the view that a Spotify IPO in the U.S. (or anywhere else, actually) will require a bull market bubble, a crisp answer from Spotify’s management team on where they are spending the money, and now an equally crisp answer about the knock-on effects from Brexit on earnings due to currency fluctuations.
Spotify’s Convertible Debt Will Require a Bubbley Valuation: Hanging over a Spotify IPO is the $1 billion in convertible debt that the company recently borrowed from Goldman Sachs, Dragoneer Investment Group, and Texas Pacific Group (TPG is also a Pandora lender, coincidentally–if you believe in coincidences). Let’s assume that loan is in dollars.
If you take into account the loan’s 5% interest rate and the value of the warrant coverage in the deal, Spotify is essentially paying credit card interest on $1 billion (that 5% rate escalates 1% every six months until it reaches 10%, or Spotify registers an IPO).
Those lenders are not babies, see? Loans have a clause called “events of default” and when one of those events is triggered, lots of bad things happen to the company that can include the lenders taking over the company.
Remember, companies IPO for a few different reasons, but one is to raise capital for the company, reward employees and allow shareholders to get some liquidity. If at least the nominal point of a Spotify IPO is to raise money based on investor optimism about the future earnings of the company (also called the stock price), Spotify will need to raise a huge chunk of cash in order to retire even a substantial portion of that convertible debt and have any money left over to run and grow the company. That will require an equally huge valuation, probably rivaling the Facebook IPO.
Spotify may be a lot of things, but Facebook it ain’t.
Spotify’s Spending on Growth is a Critical Deflection in its Story: Why isn’t Spotify profitable? I’d give you two main reasons that are necessary factors.
[Comparing Average Revenue per User on free vs. subscription shows] a massive difference in value based on the type of user. As such, making every effort to increase Spotify’s paid subscriber conversion rates seems like the key to eventually turning the service into a profitable entity. Importantly, the cost split between these users isn’t clear. However, Apple’s, Amazon’s, and Pandora’s preference toward paid subscriptions implies something positive about the business model, even though Spotify has yet to reach profitability via its freemium business model.
—Spending on Growing Business is Why Spotify is Unprofitable: Given that Spotify has a business model devoted to free that is out of step with its slower growing but likely more profitable competition, it’s easy to see why Spotify has to borrow money at credit card rates in order to grow. And Spotify’s growth strategy is a toxic mix of high executive salaries, expensive real estate and seemingly endless collisions with artists and songwriters who make Spotify’s main product–who are increasingly impatient with free not to mention getting stiffed on the royalties that are owed.
It should not be lost on anyone that when Apple Music–Spotify’s main competition–needs money, they don’t have to borrow at credit card interest rates. And all of Spotify’s snarky tweets about Apple won’t change that.
Tech IPO Trend is Down and Brexit Won’t Help: Let’s assume for the moment that we can label a Spotify IPO as a “tech” play. I’m not so sure that’s the right way to look at Spotify’s business–Red Hat it ain’t. But then again, it’s not a traditional music play and it’s not radio (which seems to be how Pandora sees itself). Let’s call it a tech company for IPO purposes.
The trend is not good in general for tech IPOs so far in 2016, Twilio notwithstanding. That extends a bear market in tech IPOs in 2015 (28) that was the worst year for tech IPOs since 2009. Not only that, but some of the IPOs that did happen performed poorly, in some cases getting an IPO valuation that was less than their last private financing (see Box and Square), essentially making their IPO a down round. I shudder to think what a down round would mean for Spotify with the terms of that loan.
And then we have to consider that U.S. tech companies arguably have greater European exposure than any other U.S. business sector. Ahem. And Spotify’s principal banker, Goldman Sachs, gets about 25% of its revenues from Europe. Any significant post-Brexit slowdown in trading or M&A, not to mention revenues, will also hit Goldman. That may make Goldman more interested in less risky syndications that a Spotify deal.
If Spotify’s IPO will be syndicated with at least some European banks as one would expect, one would want to keep a close eye on how those banks perform in the coming weeks post Brexit. If you’re like me and expect weeks on weeks of the world markets testing lower lows with oil trading in the $45-$50 range (that will likely go a bit lower due to a stronger dollar), I’ll be keeping an eye on Barclay’s, Credit Suisse, Deutche Bank, Lloyds and RBS. All of which got the stuffing knocked out on Friday. One thing about crashes, it’s usually not the first day that gets you, it’s the mutual fund redemptions and capitulation of retail traders especially when they have the weekend to think about it like they do right now.
Not to mention next Tuesday’s speech by European Central Bank President Mario Draghi at the European Central Bank Forum on Central Banking and Wednesday’s expected speech by the Fed’s Janet Yellen at the same forum.
I can’t imagine these central bankers will say nothing to see here, move along. If you’re like me and believe there is a very real possibility of a European recession, all these banks will have their hands full. In my view, too many balls to juggle to add a flyer on a Spotify IPO. They’ll be more worried about keeping their respective economies afloat rather than a Spotify floatation.
Right now I see no reason to think there is any likelihood that those trend lines will change direction for the frothy bubble in the markets that I think is a necessary condition for a Spotify IPO (or even a real unicorn like Uber). How long? Weeks and weeks for sure and probably months and months, well into 2017.
And that makes an event of default under Spotify’s convertible debt all the more likely. A fact that is not lost on the lenders who probably have a much more sophisticated political risk analysis than a free music service has available.
Brexit is Likely to Change Spotify’s Earnings to the Downside: And then there’s earnings. Remember earnings? That’s the “E” in “Price/Earnings ratio”. Even a “get big fast” Internet company like Spotify has to eventually come to grips with earnings.
Bob Pisano of CNBC (who is a guy I have a lot of time for) had this to say about the Brexit knock-on effects on earnings for companies in general:
One thing we do know: the companies with the largest exposure overseas have already been reducing their earnings and revenue projections by a greater degree than companies with a more U.S.-based focus….
Companies that generate less than 50 percent of their sales outside the U.S. are seeing earnings drop 2.8 percent; those with more than 50 percent of their sales outside the U.S. are expecting an earnings decline of 9.9 percent.
This is due to a combination of 1) the stronger dollar, and 2) weaker economic activity.
There has been a growing trend in recent years of companies, like Uber and Airbnb, raising huge amounts of money, at major valuations, without seemingly any plan to go public. Couple that with the terrible market we’ve been seeing for the past few quarters, and the IPO roadmap for this year looks bleak.
A survey from The NASDAQ Private Market, taken at the South by Southwest (SXSW) Interactive Festival in Austin, Texas, found that the problem may be even worse than originally thought.
In all, out of 126 responses, over 40 percent said that there was “no way” their companies will go public in the future. Another 34 percent said “maybe,” and only 24 percent said “definitely.” Most startling is that the number of “no way” responses went up by a whopping 62 percent from the year before.
As for what their top priority is for the year, that was tied between marketing and advertising, and hiring new talent, each of which had 26 percent. Only 10 percent said raising funding, behind both maintaining talent, and research and development.
And if they do a good job with tasks like paying talent the money they owe and respecting their rights, then maybe the marketing and advertising–actually building something meaningful–might pay off.
We think that a Spotify IPO will require very frothy market conditions. Indicators will be higher oil prices (currently low), steady interest rates (currently under upward pressure in the US), high levels of “deals” (collapsing), and higher valuation for tech stocks (currently crashing led by Apple).
The Spotify IPO Watch Signal for May 2015 is RED–no IPO in the next six months and increased risk of Spotify defaulting on its $1 billion of convertible debt.
Of the $5 trillion in transactions that were announced in 2015, almost 10 percent — $504 billion — have since been terminated. Wednesday was especially bad for bankers as two mergers valued at a combined $21 billion collapsed.
The latest cancelled deals mean 2015 has been stripped of its title as the biggest year for dealmaking, dropping to $4.06 trillion compared with 2007’s $4.09 trillion.
The companies and their bankers can blame themselves for some of the failures, said Ira Gorsky, an analyst with Jersey City, New Jersey-based Elevation LLC. Deals have grown so large, and in already consolidated industries, as to provoke the wrath of aggressive antitrust enforcers.
The Bank of England warned Thursday of big risks to Britain’s economy should voters opt in a June referendum to leave the European Union — a stark assessment from an institution known for being independent of political campaigns.
Members of the Monetary Policy committee said in a statement after deciding to keep interest rates on hold that a vote to leave the EU could prompt households and firms to delay spending, lowering demand for labor and causing unemployment to rise.