Stockmarket listing may value Spotify at $31.5b

Spotify could be worth up to $31.5 billion when it goes public in the next few weeks. Picture / Getty Images

Spotify's home town of Stockholm is a long way from Silicon Valley, both in geography and character. Yet you wouldn't know it from the prospectus the music streaming company filed last week, which will proceed a stockmarket listing.

The investor letter written by Daniel Elk, Spotify's 35-year-old founder, speaks of "a cultural platform where professional creators can break free of their medium's constraints".

The company will aim to provide no less than "an immersive artistic experience that enables us to empathise with each other and to feel part of a greater whole".

It is the sort of highfalutin language one rarely hears from a European company. Perhaps more start-ups on this side of the Atlantic could do with a little more of Ek's chutzpah, however.

It seems to have worked for Spotify. Recent private share sales suggest the company will be valued at as much as US$23 billion ($31.5b) when it goes public in the next few weeks, the highest valuation a European consumer technology company has mustered in a stockmarket debut.

Ek deserves credit for forging ahead with his vision since its launch a decade ago, during which he has faced opposition from powerful voices in the music industry, as well as claims that its business model is fundamentally loss-making.

Last week's filing showed that there is still little evidence of profit.

Spotify made a pre-tax loss of €1.2b ($2b) in 2017, double the €535 million from the previous year. Even on an operating basis, which strips out one-offs such as financing costs, its losses increased from €349m to €378m.

However, Wall Street has shown itself to be perfectly comfortable with heavy losses when it comes to technology companies, as Amazon and Tesla have demonstrated.

Growth is more closely followed, and Spotify has plenty of that.

Revenues have doubled in two years, from €1.9b in 2015 to €4.1b last year. The number of subscribers that pay a monthly fee for music streaming has grown from 28 million to 71m in the same period, while monthly users, which includes those who use the service for free, is up from 91m to 159m.

And although the company is making losses, a lingering concern about the streaming business - that the royalty payments demanded by music labels made Spotify fundamentally unprofitable - appears baseless.

Spotify's gross margin, the profit it makes on each new user before costs such as marketing and product development, was 21 per cent last year, improved by new deals with record labels. Crucially, the margin on advertising supported users who access Spotify for free turned positive last year.

So there is a lot for investors to like.

An investor letter written by Spotify founder Daniel Elk speaks of "a cultural platform where professional creators can break free of their medium's constraints". Picture / Getty Images

Spotify's growth has also been good news for a music industry that had once been deeply suspicious of it. Streaming revenues in the UK grew 42 per cent last year to £577m ($1.1b), overtaking physical sales as the biggest single source of income and leading to a 9.6 per cent overall increase. Before streaming caught on, global recorded music revenues had fallen each year since 1999.

If Spotify's grip on the music industry tightens, concerns from Universal, Sony and Warner may begin to mount again, as has been seen with the defensive Hollywood response to Netflix.

At that point, we will find out who needs who more, although capitulations from the likes of Taylor Swift, who stormed off Spotify in 2014 before returning last year, are a sign of its increasing influence.

What potential Spotify investors should fear more are the bigger fish in its own industry.

Apple, Google and Amazon create existential threats to almost all businesses, but Spotify is in direct competition with all of them. It may have twice the paying users of Apple Music, its nearest competitor, but the latter is much younger and Amazon has emerged as a strong third player in recent months.

Crucially, Spotify's competitors have control of the devices through which music streaming is accessed: Apple's iPhone, Google's Android and Amazon's Echo speakers.

Spotify has been allowed to coexist peacefully, but this is far from guaranteed in future.

Apple's new smart speaker, for example, is restricted to Apple Music. Amazon has refused to sell speakers made by its rival Google. Spotify even mentions Facebook, which has only made tentative steps into music, as a potential threat in its stockmarket filing. A fear of what may come could explain recent Spotify job listings, which hint that the company is planning a foray into hardware with its own speakers.

But it still may take little to convince consumers to swing from one service to another: for the most part, they all provide access to the same enormous music library. Spotify's counter to this is that its users value not merely the music they have access to, but the wealth of personalised, algorithm-driven playlists that its app generates based on a user's listening histories.

Almost a third of listening on Spotify is through these playlists, suggesting users would miss them if they left. The company may also choose to invest in exclusive material one day, a playbook that has certainly shielded Netflix from Apple and Amazon.

We should hope that Spotify is able to hold its own, as it would provide a role model of how a European technology start-up can stand up to Silicon Valley. If it doesn't succeed, what hope do the rest have?