What Spotify's Deal Tells Us About Pandora Media and Twitter

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Stocks are essentially unchanged this morning, with the S&P 500 and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) up 0.13% and 0.05%, respectively, at 10:17 a.m. EST.

Stocks have had a banner year, no doubt about it, with the S&P 500 reaching new highs on a regular basis and racking up a 26% (price) return as of Thursday. Naturally, this has some observers wondering whether the stock market is in a bubble. It isn't; there is still far too much fear and reticence on the part of individual investors, whose portfolios were savaged by the crisis in 2008, to put us in that territory. There is none of the frenzied buying that is normally associated with speculative excess ... except with regard to IPOs or social networking/Web 2.0 companies -- as Twitter's (NYSE: TWTR  ) recent debut demonstrated.

This morning brought more evidence of the froth in that segment of the technology industry, as Spotify raised $250 million in a financing round that values the Swedish digital music service at $4 billion. A year ago, it raised $100 million from Goldman Sachs at a $3 billion valuation. Between these two rounds, Spotify has grown its number of users from 15 million to 24 million, but the number of paying subscribers is just 6 million, so the current valuation amounts to $667 per user paying $10, €10 or £10 per month for unlimited access to a catalog of more than 20 million songs.

Is that a defensible valuation? Perhaps. We'd need to know more about the expected growth in subscribers and the churn rate, etc. to make an informed judgment. However, 6.8 times 2012 revenues of €434.7 million doesn't look cheap, particularly when losses increased to €58.7 million in the same year.

Similarly, Spotify's closest public market-comparable company, Pandora Media's (NYSE: P  ) losses have been widening since 2011, to $52.6 million over the 12-month period to Oct. 31. Yet the shares trade at nearly 200 times the next 12 months' earnings-per-share estimate. You can be sure that Pandora was one of the key benchmarks the financiers used in valuing Spotify for this financing round.

In that regard, seeking financing at this juncture was a very smart move by Spotify's owners: Pandora's shares are up a stunning 236% year to date. As an owner, you want to sell equity in your business when you know you will receive at least as much value as you are giving away. That is precisely what Spotify did.

Twitter's IPO has made these sort of deals, at these sort of valuations, possible, and it has also blazed a path for a slew of potential public offerings from other social networking/Web 2.0 companies. Those shares will be valued based on the multiples of Twitter and other high-flying stocks; once they hit the public markets, they, in turn, become part of the (overvalued) reference set for the companies coming down the pipeline behind them.

All well and good for the owners, early investors, and bankers, but I would warn individual investors about participating in this process -- they are closer to being last in line than first, and these shares are hot potatoes, just waiting to burn someone.

At last -- a social networking stock with a bulletproof business model!
This incredible tech stock is growing twice as fast as Google and Facebook, and more than three times as fast as Amazon.com and Apple. Watch our jaw-dropping investor alert video today to find out why The Motley Fool's chief technology officer is putting $117,238 of his own money on the table, and why he's so confident this will be a huge winner in 2013 and beyond. Just click here to watch!


Read/Post Comments (0) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2739451, ~/Articles/ArticleHandler.aspx, 11/22/2014 5:43:39 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement