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Spotify Shares Still Under IPO Price: The Honest Broker

This is not an investment advice column, but perhaps it should be. After my recent bleak — but accurate — forecast on Netflix, someone asked me if I’d shorted the stock. No, I haven’t, but that would have been a smart trade. But I hate making money off other people’s misfortunes.

Which brings me to the topic of Spotify, a business that has caused musicians a great deal of pain and suffering. And recently also to its shareholders.

I want to make some predictions about Spotify’s future, but first let me go back to what I said four years ago when the company decided to go public. Here are the key points as I saw them in early 2018.

Not only was the prediction correct, but so was the schedule. I suggested Spotify could thrive for another 24 to 36 months, but the problems would be apparent by that point.

With that in mind, let’s take a look at what’s happened since Spotify went public. As you can see, shares peaked exactly 24 to 36 months after going public — but since then they’ve plummeted a staggering 70%. The shares are now trading below the original offer price. By comparison, U.S. stocks as a whole are up almost 40% over the same period.

Spotify stock price chart since the IPO

This might come as a surprise to some people, but many major shareholders clearly had an inkling that this drop was coming. At the time of the IPO, several major record labels were shareholders in Spotify — but (surprise!) Sony and Warner Music soon divested most of their stakes. Universal Music remains a shareholder and still owns around 4% of Spotify, but clearly should have sold before the 70% collapse.

I don’t expect Spotify to go bankrupt. Despite my bleak prognosis, I never predicted that this company would go away. In a way, that’s a shame. The music ecosystem would probably be better off without Spotify and other predatory streamers.

The problem from the start wasn’t that Spotify couldn’t make money. Instead, the real problem is that streaming is never generated enough Cash to make everyone involved happy.

The stock market’s negative reaction to the company’s latest earnings report reflects this painful truth. It’s hard to find new subscribers these days, but investors’ real concern is Spotify’s lousy profit margin. Gross profit margin was 25.5% — maybe acceptable for a run-of-the-mill company, but disappointing for a dominant tech platform. Worse, Spotify told investors it doesn’t expect margin improvement in the current quarter.

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For comparison, Microsoft’s gross profit margin is around 70%. This also applies to Pfizer. It’s even higher at Facebook — despite all of Mark Zuckerberg’s strategic mistakes, its gross profit margin is 80%. Spotify shareholders were less ambitious, but even they were hoping for a margin in the mid-’30s. But with more than 400 million active users, Spotify still can’t make it.

The reality is that in order for streaming platforms to meet their financial goals, someone needs to be squeezed — and those cries of agony you hear from musicians reading their latest royalty statements are what that squeeze sounds like.

The blunt truth is that streaming music isn’t very profitable. And possibly never under the current business model.

After all, Spotify has to pay publishers, composers, record labels and all of its thousands of executives and employees. Then there are all the other operating costs – rent, computers, bandwidth etc. Oh, don’t forget the musicians – they should get a few crumbs off the table.

But it’s just crumbs. The decision to set a low monthly price for streaming should speed up adoption, but the money generated just isn’t enough. And it’s a business law that the most powerful interests end up getting the lion’s share.

It was clear from the start that musicians would suffer the most because they have the least amount of power – and mostly don’t even know what deals were made between streaming platforms and labels. Of all interest groups, they are the most fragmented group, unable for various reasons to take real collective action. And although their creativity is the original source Everyone the money generated by the company, they are almost never at the negotiating table when deals are made.

So I don’t expect their prospects to improve under the current regime.

Here’s the bottom line on Spotify:

This original pricing strategy (under $10 a month for unlimited access) was designed to shift the market from owning music to streaming it. This was an attractive deal and inevitably convinced most fans to give up their physical albums. From a business perspective, however, this approach only works if you have the most optimistic — and unrealistic — estimates for subscription numbers. What investors are beginning to realize is that projections of this nature are unrelated to the current reality in which Even the most successful platforms could face declining user numbers.

Here’s what the New York Times recently wrote on this subject:

“Is there such a thing as too many streaming options? How many people are really willing to pay for it? And could this business be less profitable and far less reliable than what the industry has been doing for years?”

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In my opinion, the predictions were wrong from the start. The most bizarre fact here is that record labels — historically slow to embrace new technology — jumped on the streaming bandwagon before they’d proven they could foot all the bills and still make decent profits.

The music industry acted out of desperation, not wisdom. They had ignored the internet for years, perhaps hoping it would just go away. But when they learned, to their shock and disappointment, that their usual techniques of litigation, lobbying, and legislation weren’t killing digital music, they began operating out of fear. They got into streaming without realizing where it was going or how much money it would generate.

That was a mistake.

Here are Spotify’s actual quarterly “free cash flow” numbers. You will find that the numbers go in the wrong direction. That shouldn’t come as a surprise. If you’re giving people unlimited streaming for less than $10 a month, you’re operating on a razor-thin margin, and unpleasant surprises are likely.

Spotify Quarterly Free Cash Flow

2022-06-30 64.92
2022-03-31 30.30
2021-12-31 326.54
2021-09-30 204.00
2021-06-30 90.37
2021-03-31 49.43
2020-12-31 206.76
2020-09-30 127.42
2020-06-30 4.40
2020-03-31 -23.17
2019-12-31 490.56
2019-09-30 296.90
2019-06-30 249.53
2019-03-31 195.36
2018-12-31 258.64
Source: Macro Trends

I note that these cash flow numbers are in place millions, not billions. In other words, Spotify, despite its size and dominance, generates less money than a single hit movie or video game.

I’m not surprised that Spotify has worked so hard to find other sources of growth outside of music. The irony here is that the streaming platforms are the single biggest reason why recorded music is such an ugly area of ​​investment right now. For this reason, back in 2018, one could have predicted that Spotify would invest in podcasts and other non-music categories. This also explains why streaming platforms might be so eager to feature so-called “fake artists” — especially when the musicians are willing to give up most or all of their royalties on commissioned arrangements.

But no matter what Spotify streams, the company needs subscribers. And the very actions Spotify has taken are contributing to consumers’ waning interest in new music. A crappy interface with mediocre audio quality that provides almost no information about musicians inevitably leads to declining fan loyalty – so it’s not surprising that people cancel music subscriptions when the economy is tight.

Spotify’s attempts to steer listeners into music that’s more profitable to them (e.g., hire work from unknown artists) yield the same end result. This is like the famous table of new books at the front of the Barnes & Noble store – where the company has the choice of displaying the books that people like the most, or instead showcasing offerings from publishers who are ready for to pay for the placement. Every time a company decides to deliberately steer consumers toward inferior products through behind-the-scenes financial incentives, it undermines its own business model. There may be a short-term boost, but sooner or later it will lead to falling customer loyalty.

What do we do now?

It may be too late to fix Spotify’s problems. When the company started out, it could have pursued a strategy of charging more per month and offering a higher quality platform — with all the bells and whistles that would get consumers excited about music. This approach would have resulted in a smaller company, but likely a more profitable one — with more money for musicians and other stakeholders. But they went a different route, with a cheap option at a great price. The inevitable result is that a decade later, most consumers think music isn’t worth much.

A better solution — which could still happen — is for smart, visionary people who care about music to offer a superior alternative to Spotify. This alternative would win the loyalty of people who are true music lovers. And there are millions of such people, maybe even hundreds of millions.

Spotify can be bypassed. A new player could learn from the obvious flaws in their offering and offer us something better. Or more music-focused smaller companies in the current landscape (Bandcamp, Qobuz, Tidal, even Discogs or CD Baby, or a blockchain company) could find a way to take on the big players. The current disillusionment in the financial world with streaming could make this even more likely.

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So don’t give up hope. We could always get something better than the current streaming chaos. If and when that happens I will be an early adopter.


Ted Gioia is a leading music writer and the author of eleven books, including The History of Jazz and Music: A Subversive Story. This article originally appeared in his Substack column and newsletter The Honest Broker.

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