Spotify (NYSE:SPOT) has finally gone public, and the first day has been a great success. While the NYSE had initially set a reference price of $132, MarketWatch reports that Spotify kicked off trade at $165.90 and hovered around $170 before falling to around $150. The unique nature of Spotify’s direct listing means that we can expect a great deal of volatility, especially in the current unstable market. CEO Daniel Ek told CNBC before the listing that “our focus isn’t on the initial splash.”
But while no one can be sure of how this stock will do in the short term, there is no doubt that Spotify is going to set a precedent in some way. Will direct listings become more accepted? Will the listing’s success or failure affect other tech companies’ decision to go public? And of course, will Spotify be successful?
The unfortunate fact is that I am skeptical of this company’s long-term future. Spotify faces threats to its growth, significant competition from larger tech companies, and it is losing money. Given how much this stock could go up or down in the next few days, investors should stay away for now and possibly avoid this company altogether.
What Truly Matters
The first thing to note about Spotify is that I am not a fan of its decision to launch a direct listing instead of a traditional IPO. Yes, a direct listing carries some advantages. It lets Spotify sell directly to investors instead of having to go through a middle man. Spotify’s shareholders can sell right away instead of having to wait for the lockup period to expire, which will let Spotify reach its true value quicker.
But with a direct listing, there is the problematic question of why current shareholders want to cash out now. Yes, some shareholders are regular early employees who want a payday, while other shareholders like European venture capital firm Lakestar are not selling as they believe Spotify can rise higher. But on the aggregate it raises questions about whether Spotify is approaching its peak.
The company does face several serious challenges. First, a look at Spotify’s SEC report shows that from 2015 to 2017, its net losses increased from €230 million to €1.2 billion. Spotify’s revenue increased in that same period from €1.9 billion to €4.1 billion, but its rate of revenue growth has been slowing down. A company going public can get away with either slowing revenue growth or rapidly increasing net losses, but both at once is a red flag.
Second is the threat of larger companies. On one end, there are larger companies like Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), and Google (NASDAQ:GOOGL) which are all developing their own streaming services which do not need to be profitable, unlike Spotify. On the other end, there is a music industry and companies like Sony and Universal which will not hesitate to squeeze Spotify for high licensing fees.
To be a good investment, Spotify has to become as profitable as the housing market, preferably by boosting its revenue growth even further, all while staying a step ahead of its larger tech competitors and keeping licensing costs down. That is a tall order.
The Netflix (NASDAQ:NFLX) of Music?
The possibility of competing with larger companies like Apple and Google is daunting especially when combined with Spotify’s financial numbers. But Spotify’s advocates say to look at Netflix (NASDQ:NFLX) as a company which can do just that. Just as Netflix has become successful through producing original content, Spotify could do the same thing by operating its own record label and finding its own unique musicians. This would attract subscribers and reduce its licensing fees.
But there are a few reasons that Spotify cannot be the next Netflix. First, video streaming back during Netflix’s rise was nowhere as developed as music streaming is today, which meant that Netflix had less competition.
Second is that customers demand different things in video and music streaming. People are more interested in watching new content in video streaming, while they want to listen to older songs and keep everything in one place. The small number of songs Spotify could get by running their own record label can never compare with the mountain of music owned by other record labels and companies, and so it is more likely customers will go to where there is the most music.
Too Much Uncertainty
Investing in Spotify right now is a terrible idea as no one can be sure how this stock will do in the immediate future. It could continue to fall in value after its initial success, and perhaps investors can give it a sniff if that happens. But there are many factors which could hurt Spotify’s long-term potential, and so I would recommend that investors stay away from this stock entirely.