Spotify: From listing tracks to listing shares

A decade after it started serving songs to the public, Spotify AB is far more than a one-hit wonder.

The world's most popular on-demand music-streaming service has amassed more than 140 million users, nearly half of whom happily hand over cash to access the Stockholm-born company's vast library of songs and albums. As it has grown, it has also attracted its share of powerful detractors, from a frustrated Taylor Swift pulling her catalogue three years ago to a music publisher that handles songs by Neil Young and Tom Petty suing for at least $1.6-billion (U.S.) in damages just last week.

Spotify is now on the verge of inviting a new kind of scrutiny as it moves to open its books to the public for the first time. On Wednesday morning, reports emerged that the company had filed documents for a public listing with the U.S. Securities and Exchange Commission.

It has been a remarkable 10-year run from listing tracks to listing shares. The company is positioned at the forefront of the biggest shift in music consumption since the invention of recording: from owning music to accessing it. The phenomenon is driving the first worldwide revenue growth in recorded music in nearly two decades.

And as consumers and creators navigate that shift, Spotify is now trying to work through the next winding turn in its own journey – sustaining itself as a multinational company with roving leadership while using its data to put more money in the hands of artists.

Now it has signalled it wants to join the public markets in an equally disruptive way – by reportedly skipping a traditional share sale and listing its stock directly on the New York Stock Exchange this year. Doing so would save Spotify the costly process of initial-public-offer underwriting and prevent share dilution, a significant change in how companies approach selling shares to the public.

It would also accelerate the reshaping of the music industry. Going public would pop open the hood of the technology that's changing paid music consumption – while giving investors the chance to pump money into recorded music in a direct, meaningful way. Asked about filing paperwork for a direct listing, first reported by Axios, both Spotify and SEC spokespersons declined to comment.

An October, 2017, paper from Spotify investor GP Bullhound suggested the service could have a $20-billion-plus introductory valuation on the stock market, and, by 2020, could be valued as high as $55-billion. "There's an excess in demand from corporate and financial institutions to get into the music business, and a deficit of available places for them to put their money," says digital-music analyst Mark Mulligan, who's long anticipated a public listing for Spotify.

Things have changed a lot for the Stockholm startup.

Starting in Stockholm

Spotify was launched by Martin Lorentzon and Daniel Ek – both serial entrepreneurs – in Sweden and other European countries in 2008, after a few years spent coding and brokering licensing deals with record labels.

Musicians and their works make up much of Spotify's corporate vocabulary; After The Globe and Mail toured its old corporate headquarters last September, Jenny Hermanson, managing director for its Nordic home base, sat down for an interview in the Lady Gaga room. In the mid-2000s, she says, Sweden's best-known contribution to the music industry was The Pirate Bay, the torrenting service that helped supplant peer-to-peer piracy services that sprung up in Napster's wake; even Mr. Ek spent a brief time as a torrenting-company executive. "We were the best at being the worst," Ms. Hermanson says, laughing.

Licensing music is expensive and requires dealing with country-specific copyright law – and the model of subscribing to a pool of music rather than buying individual songs or albums was, back then, a new one for consumers to wrap their heads around. So the company's first goal was to prove it worked at home, in Europe. "Instead of focusing on the world, focus on doing it here, prove the point and then expand it," Ms. Hermanson says.

It took some time. Spotify launched in the United States in 2011, and in 2014 in Canada. Today, Spotify has 60 million paid global subscribers streaming all the songs they want, usually paying about $10 a month. Adding in its free, ad-supported service, Spotify now has 140 million users. Over the years, according to Crunchbase, its investors have ranged from Goldman Sachs to Coca-Cola Co. to Hong Kong venture-capital firm Horizons Ventures.

Its road here was not an easy one. The company had plenty of PR wins, including getting Metallica drummer Lars Ulrich – the face of music's war on piracy a decade and a half ago – to hug Sean Parker, a Napster co-founder and Spotify board member, live on stage at a company event. But much of streaming music's early story was driven by artists denouncing the fractions-of-pennies they got for each time a user streams a song, versus what they got if the user straight-up bought the music.

That criticism quieted – slightly – as streaming services began driving a turnaround in the record industry, pushing revenues up from historical lows. In 2016, global streaming revenue grew 60 per cent year-over-year, with total recorded-music revenues up 5.9 per cent to $15.7-billion. It marked the industry's highest revenue growth in two decades. Part of this comes from downloaded-music king Apple's entry into streaming in 2015; while competitors including Jay-Z's Tidal and now-shuttered Rdio have long jostled for market share, Apple Music now has more than 30 million subscribers. Soon after Apple Music's launch, Spotify chief executive Mr. Ek said it helped "validate" the business model and actually boosted his own company's growth.

"When I joined Spotify eight years ago, the argument was 'I invested so much in my CD collection – how can I trust that you will be here next year?'" Ms. Hermanson says. "We don't hear that any more here."

Expanding global outposts

Spotify's winding growth story is eerily mirrored by the physical growth of its Stockholm offices. Moving into a mid-rise building in 2012, the streaming-music company only needed the top two of 11 floors. Bit by bit, as staff expanded, it slowly nabbed more and more floors, eventually taking over all but one – resulting in another company becoming fully wedged between Spotify's offices.

It was a peaceful co-existence with the once-quiet upstairs neighbours ruling the building where they were first a minor player. But Spotify finally outgrew the building itself, moving its 1,200 Stockholm employees into a whole new office and leaving behind pieces of its recent history – including a top-floor stage once graced by Nickelback and a low-key studio once briefly commandeered by Kanye West.

Mr. Ek isn't around when The Globe visits in September, which hints at another part of the company's new reality. Sure, Stockholm is its home, but the company now operates with ever-expanding global outposts and sizable operations in London and New York. Senior executives spend a lot of time between offices.

The company is keenly aware of the consequences of growth, Ms. Hermanson says, and has redoubled its efforts to maintain Spotify's inclusive, Swedish-style culture. It flies new hires to Stockholm for orientations and runs what it considers to be a conversational approach to idea-gathering and management .

Paid streaming's influence keeps finding new ways to ripple across the music industry. Even music itself is changing in response to streaming's business model: Albums are returning to longer, CD-era lengths, as artists such as Drake take advantage of a piece of Billboard chart math, for which 1,500 on-demand streams of any song from an album are counted as the equivalent of an album sale.

The charts themselves are reacting, too, to a frustrated music industry: Starting in 2018, streams on paid subscription services will have more weight on Billboard charts than free streams, such as on YouTube, or Spotify's free tier.

Spotify last year fell upon new kinds of controversy, too, including allegations – which the company has vehemently denied – that it was commissioning artists to write songs specifically for the service that wouldn't require the company to pay traditional royalties. Some music critics, meanwhile, have become concerned with streaming services blurring lines with record labels, as well as the highly concentrated power the services now wield in ordaining new hit-makers through their massively influential playlists.

One narrative that hasn't changed for streaming services, including Spotify, is the struggle to turn a profit. Its revenues continue to rise, hitting nearly €3-billion ($3.6-billion U.S.) in 2016 – nearly triple that of 2014 – but so do its net losses, reaching €539-million in 2016, according to the most recent annual report of parent company Spotify Technology SA in Luxembourg. The costs, of course, all come down to licensing music. And according to the annual report, music rights and associated costs ate up nearly 85 per cent of the company's revenue in 2016.

While the company has reportedly renegotiated its payout rates with record labels this year, it's yet to see if that will directly impact the bottom line. It still won't appease artists who already worry about making less money through streaming than through sales. That, too, is only when the songs are properly licensed; just last week, Wixen Music Publishing filed a lawsuit against Spotify for at least $1.6-billion in damages, arguing that thousands of its songs by the likes of Neil Young, Tom Petty and the Doors were not properly licensed or compensated for. Spotify declined to comment on the suit.

Promise of emerging markets

Rumours have flown for years about Spotify going public, and Wednesday's report bolsters suggestions the company would attempt a direct listing on the New York Stock Exchange in early 2018. Going public without raising cash, says Mr. Mulligan, the digital-music analyst, would still allow institutional investors to get their hands on an in-demand music company, giving Spotify a strong share price and, in turn, allow its early-stage investors to exit with good returns.

While subscriber growth may soon plateau in developed markets, a public Spotify could appease investors by focusing on emerging markets such as Mexico and Brazil, as well as China, whose tech conglomerate Tencent Holdings Ltd. just announced a minority-stake equity swap with the Swedish company.

Mr. Mulligan also suggests that, to appease public investors, Spotify will likely have to put special emphasis on metrics that can tell a growth story, such as the conversion rate from free to paid users, when numbers such as profit or user growth in developed markets cannot. It would also need ancillary revenue streams, and could use its market cap to acquire less-streaming-focused music companies – things such as production startups or artificial-intelligence firms.

Ms. Hermanson shakes her head when queried about a potential public listing back in September, but, when asked what the company theoretically might do with extra cash flow, she talks about a crucial byproduct of Spotify's ecosystem: remarkably sophisticated listening data. One of the service's most popular features is "Discover Weekly," which curates music for each user based on their listening habits. And it recently released the Spotify for Artists app to give musicians more data to make decisions with – such as, say, plotting tours to where their most diehard listeners are.

"It's quite a playful time, because no one knows what the format is going to look like in the future," she says. "But one thing I know, being here for a long time, is we won't do anything that people have done before. Because then we're not happy."