The Largest Tech IPO of 2018 Is Overhyped

I admit it… I’m one of those people who sings a little too loudly (and a little off-key) when I have my headphones in. Especially if Journey’s “Don’t Stop Believin'” comes on.

I can’t help it, music moves me… to the chagrin of anyone within listening range.

In fact, most of my iPhone’s memory is devoted to my playlists. Before upgrading my storage recently, I actually had to delete photos in order to keep all that music ready to blast at the touch of my finger.

Now, I have plenty of room… but there’s a problem.

I’ve been known to shell out upward of $20 a month to buy songs from Apple. I know, that’s completely unnecessary with today’s streaming technology. But I was stuck in my ways.

So recently, I “unstuck myself”… and I joined the popular Swedish-born direct-listening service, Spotify. And I’m never turning back.

So when Spotify – valued at about $20 billion – announced going public with a stock offering in March/April in a unique way, I perked up. I started combing through the headlines, and already analysts are calling this the largest tech initial public offering (IPO) of 2018. The anticipation is huge!

But, alas, I’m a cynic at heart. Despite my excitement, I had to ask myself… is the hype for Spotify stock really worth it? So today, let’s take a detailed look at this IPO to find out.

Talkin’ Bout a Music Revolution

In my mind, Spotify is part of the single most important innovation in music since perhaps Kurt Cobain discovered ear-splitting feedback and raw, queasy lyrics about teen angst.

The concept is simple: You stream music on the internet. For free. Or, at most, a small $9.99 monthly fee. You just need the Spotify app to access it all.

When Spotify launched in October 2008, this was a disruptive, revolutionary idea. That’s why the company helped pioneer the music streaming market, paving the way for services such as Apple Music (Apple’s streaming service, which went live much later in 2015).

Spotify is an endless, user-friendly treasure chest.

You listen to whatever you want, wherever you want, whenever you want. The app is compatible with practically every device I can think of, from computers to smartphones to tablets.

And if all that music sounds overwhelming, don’t worry – you can also use its unique music-discovery feature to find songs that fit your music tastes.

The entire platform is a grand idea.

Unfortunately, investors like us couldn’t take part in this revolutionary service because the company was privately held for the past decade. So now that we can soon take part in the stock, we need to make sure it’s worth the investment.

The Times, They Are A-Changin’ for a $1.8 Trillion Industry

The first thing to note is that, according to PwC, the global entertainment industry is expected to rise from $1.8 trillion in 2016 to $2.2 trillion by 2021. That’s nice, but it represents a compound annual growth rate of 4.2% – down from the 4.4% forecast made in 2016.

That means the old-school entertainment industry is starting to plateau. To fix that, the industry needs to focus on building sustainable relationships with customers.

After all, consumers are king. When it comes to recordings – film, television, music – we get to dictate what we want to see, hear and experience. We vote with our time, our attention and a small subscription fee (think Netflix, Amazon Video and Hulu).

Just as industries and products like health care, cars, refrigerators, thermostats and so on were in need of a revolution – see precision medicine and the Internet of Things – so was entertainment.

And that revolution is here. Spotify is just one of the big players.

That’s why Spotify has about 140 million active listeners, and 70 million of those are paying premium fees for advanced features. Better yet, the service boasts 30 million songs and adds over 20,000 per day.

It also features over 2 billion playlists, generated by the company’s growing user base (a great idea that engages the customer much more directly), and 5 million more playlists get created or edited daily.

This is obviously an enormous reach. However, there’s one problem…

The Problem: Money, Money, Money

Despite all of this, Spotify hasn’t found a way to be profitable.

Yes, sales jumped 52% to $3.09 billion in 2016. But the net loss more than doubled, coming in at $568 million. (Although the net-adjusted loss is more like $310 million.)

For example, roughly $2.62 billion of that revenue evaporated with the cost of goods sold. Another $440 million disappeared to sales and marketing expenses, etc.

At least earnings before interest, taxes, depreciation and amortization came in at negative $169.2 million in 2016, versus the $180 million loss the prior year, Billboard calculated.

But we need to see the company generating positive income.

Spotify isn’t. So the numbers made me raise an eyebrow. With that in mind, I turned to Paul Mampilly to get his thoughts on Spotify’s public listing.

Paul Mampilly Talks Spotify Stock

Paul is our go-to guy for all things disruptive tech, so I knew he had to have some interesting thoughts on this. Here’s what he told me:

Spotify’s public listing is interesting from two angles: First, it’s a nontraditional IPO because it cut Wall Street out of price setting. Instead of making shares available to the general public, Spotify will list itself directly on the stock exchange. That means only institutional investors have access – eliminating the need for banks to set an initial price, link sellers and buyers, etc. This is something that makes the initial trading a wild card because Wall Street’s participation offers price stabilization for IPOs.

Second, Spotify is still losing money, though it has a huge subscriber base. However, it’s also a subscription business, which means repeating revenue – and that’s a great model. Plus, like Netflix, it’s a global business, so it can continue growing.

So, the biggest worry for Spotify is this: Are enough people going to buy the IPO for you to want to be in it from Day 1? Because most times you get a chance to buy it lower. That’s because most people play IPOs for a quick pop in the first day or week, and then dump it.

I say that people who want to buy the stock as an investment should bide their time, wait to see how the stock trades – and see how Spotify’s business performs over a few quarters. Then you can build your position over time, if things look good.

All in all, Spotify is an amazing product with a great model. That may ultimately lead to profitability down the road. But this is a “wait and see” one. Don’t get caught up in all the hype just yet!

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