Spotify Technology (NYSE:SPOT), the music streaming service is set to go public on April 3 through a direct listing. This listing method is slightly different to what investors are used to, but that doesn’t mean that we expect any less of a splash when trading kicks off.
A direct listing means that Spotify will not be issuing new shares and will not be looking to raise funds. In essence, Spotify is turning its back on the traditional initial public offering (IPO). Instead the current shareholders will sell their shares directly to the public.
The big advantage of going direct, is that costs are kept down. This is no bad thing for a firm which just laid bare the extent of its steepening losses for the first time at the beginning of the month.
On the downside, a direct listing is considered riskier because the price is not underwritten by an investment bank. Without the same safeguards as a traditional listing, the price could experience high levels of volatility. The share price is open to bigger declines when shareholders sell their shares if there is not enough demand from new buyers.
Yet given the shortage of big tech IPO’s, and the markets love affair with tech stocks over the past few years, there is a very good chance that investors will be keen to get their hands-on Spotify, regardless of the risks involved in the direct listing and regardless of its deep losses.
The Numbers
Spotify generated €4.09 billion revenue last year growth of 39% from the previous year’s €2.95 billion. Yet despite soaring revenue, the firm’s losses more than doubled to a staggering €1.24 billion in 2017 against just €539 million the previous year. In a cautionary note in the filling Spotify highlighted that “We have incurred significant operating losses in the past, and we may not be able to generate sufficient revenue to be profitable, or to generate positive cash flow on a sustained basis…In addition, our revenue growth rate may decline.” A rather stark warning, but again one that investors may well choose to ignore in order to be in on the action.
What Spotify does have in its favor is a huge, rapidly growing user base. Spotify had 71 million paying users at the end of 2017, up 48% from 2016. Paying and free monthly active users hit 159 million last year, compared to 123 million in 2016. Meanwhile the number of users leaving the service fell to just 5.5%.
The low churn rate and strong customer loyalty suggests that Spotify could still increase prices and still hang on to its client base, potentially providing a more positive outlook. However, its also worth noting that one of Spotify’s biggest costs is royalty payments to artists. In the filing Spotify identified “ material weaknesses in our internal controls relating to our royalty payments”. In other words Spotify could easily over of under pay artists, neither which is desirable for the largest cost of a business.
The Outlook
Forward guidance for 2018 is however more encouraging. Spotify believes revenue growth will slow but remain impressive, to between 20% - 30%, however it more importantly also says operating losses will fall over 12%. Paying subscribers is set to hit around 92-96 million.
DropBox Test Run
If Dropbox's (NASDAQ:DBX) IPO is considered a litmus test for Spotify, then the music streaming firm could be in for a spectacular day. Spotify is expected to run for a valuation of $20 billion and given the oversubscribed nature of the DropBox listing then Spotify could find this an achievable target.