Is Spotify really worth $20bn?

Music service will soon have its IPO and investors think it can be as big as Netflix. Are they right?

When Spotify lists on the New York Stock Exchange in the coming weeks the loss-making music streaming service is likely to be valued at more than $20bn (£15bn): such is the faith of investors in its charismatic Swedish founder, Daniel Ek.

Ek, they believe, can build Europe’s answer to Netflix – a global cultural behemoth that can take on industry incumbents and the big four technology companies at the same time, and come out on top. If Netflix can overturn Hollywood, then Spotify can transform the music industry. At least that is the hope among US fund managers.

Only 10 years after it was founded, Spotify is a force to be reckoned with. It has 159 million active users, with 71 million paying monthly subscriptions. The rest are part of Spotify’s “freemium” service and have to listen to ads to get their music free. Annual revenue last year was nearly $5bn. Apple Music, by contrast, has 36 million subscribers.

In a letter posted alongside Spotify’s pre-float filings on Wednesday, Ek said the company hoped to “democratise” the music industry. Spotify, he wrote, could “connect all of us, across the world, in a shared culture that expands our horizons”.

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Lofty aims, couched in the aspirational terms that those in Silicon Valley like to espouse. But there are reasons to doubt Spotify can pull off the same level of success as Netflix. Music is a very different industry to film and television, and the competitive landscape it finds itself in brings challenges that Netflix has never had to face. The industry has never regained the profitability it enjoyed before the likes of Napster ripped up its business model.

Spotify lost $1.5bn last year, up from losses of $650m the year before. Its relationship with the music industry incumbents– that is, the companies that produce the records – is one major obstacle. The company has to license its library through the same bottleneck of major labels as any other player in the streaming world, and for the time being the labels still hold all the cards. Its losses are down to it paying more in licensing than it can afford – even as the amount that trickles down to many artists is less than they can survive on.

The company has paid out some $10bn in royalties to artists, music labels, and publishers so far, according to the financial services company Hargreaves Lansdown, and it is obliged to pay at least $2bn in further royalty payments over the next three years.

“Just four music companies control the rights to 87% of the music streamed on Spotify,” says the Hargreaves analyst Laith Khalaf, “which gives them a healthy bargaining position when it comes to getting their pound of flesh from Spotify’s revenues.”

Spotify’s Daniel Ek
Spotify’s Daniel Ek. Photograph: Shannon Stapleton/Reuters

But Pär-Jörgen Pärson, an early investor in Spotify, reckons the power dynamic is shifting, and there is reason to believe the terms of contracts will become less onerous. Pärson, a partner at the Swedish venture capital company Northzone, argues that the licensing agreements signed to date “were very much slanted to the owners, and the cost of growth fell to Spotify to finance”.

Now, he says, “it’s the streaming services that hold the key to making or breaking artists, and also to the kind of underlying support an artist needs in order to build their careers and their creative work. That was historically the role of the labels but they have increasingly failed at delivering.”

Even if Spotify can negotiate down its royalties, however, it will still face a hard time divorcing itself from the major labels – in sharp contrast to Netflix, which has reduced its reliance on Hollywood content by producing its own hits.

Netflix has been focusing on in-house productions, promising more than 800 new shows over the coming year as part of an $8bn spending spree. But music fans value a complete library that spans every label and genre.

Then there is the competition. Three of the big four technology companies, Apple, Google and Amazon, have their own direct competitors to Spotify. Of those, Apple Music is by far the most successful, offering an equivalent service for an equivalent price – but one built directly into its bestselling smartphones, tablets and smartwatches.

Apple Music still has fewer subscribers but it has one other major advantage: Apple does not need to turn a profit from its streaming music service, while Spotify does. Apple can leverage an operating loss on Apple Music indefinitely, to sell more iPhones and make an overall profit; Google can extend its domination of the overall market with Google Play Music All Access; and Amazon can use Amazon Music to sell more of, well, everything.

“Apple are a formidable threat,” agrees Pärson, but goes on: “I think that they have a product that is inferior – shown time and again whether you look at customer reviews – and their key value is that they are embedded into the phones. But we shouldn’t forget that they only have a 20% market share, and Spotify is everywhere.”

Ed Sheeran – Spotify’s lucky charm

Ed Sheeran
Ed Sheeran performs at the Z100’s iHeartRadio Jingle Ball 2017 at Madison Square Garden in New York. Photograph: Angela Weiss/AFP/Getty Images

With 46m monthly listeners, and more than 1.5bn streams of his single Shape of You, Ed Sheeran is the archetypal artist of the Spotify generation. Easily the most-streamed artist of 2017, both in the UK and globally, Sheeran’s brand of affable acoustic folk-hop has been inescapable, both online or off.

For Spotify itself, the launch of Sheeran’s latest album, Divide, was a chance to demonstrate just how powerful the company can be. Warner Music, Sheeran’s label, spurned offers from streaming services like Spotify, Tidal and Apple Music for a period of exclusivity or a marketing partnership.

The idea behind such exclusivity deals – called “windowing” – is two-fold: Artists such as Drake and Taylor Swift get cash direct from the streaming service, and at the same time boost physical sales and digital downloads fromfans who can’t bear to be without the album, even for a couple of weeks.

Sheeran’s album was launched on every streaming service at once, but the artist was plastered over the front of the Spotify app and inserted into almost every one of its hugely influential pop playlists, resulting in every single one of the 16 tracks on Divide hitting the UK top 20 – and nine of them making it in to the top 10.

But where Spotify’s enormous influence can help pop giants, smaller artists bemoan an unparalleled concentration of power. DJ Gareth Emery has more than 1.1 million monthly listeners on the app, but bemoans the fact that “artists get crumbs from the table.

“The whole system is cloaked in secrecy, nobody knows how much they’re going to get paid or when,” he said. “It can take over a year to get paid for a stream, and up to two years. Even with over a million listeners, and tens of millions of streams, I couldn’t rely on Spotify for an income – so it blows my mind how smaller artists are supposed to manage.”


Alex Hern

The GuardianTramp

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