Should Spotify Go Public?

Spotify made a few waves recently when it hit a new high in valuation. The digital music giant is now worth approximately $4 billion, after raising $250 million through Technology Crossover Ventures. Last year, the music service snagged $100 million through Goldman Sachs, and since then its user base has grown by 60%.

Though Spotify has made no suggestion of having an IPO anytime soon, that doesn't mean the possibility is wholly out of the picture. How does this company size up against current public digital music services? Should investors await Spotify's arrival to the public markets with baited breath, or is there a better available option out there right now?

Sizing up the numbers
Spotify's growth from $3 billion to $4 billion in just one year is impressive and not too far from public rival Pandora's (NYSE: P  ) market cap of $5.4 billion. Spotify has also reported 24 million active users, while Pandora checks in at 72.4 million. The company trounces Pandora on revenue, with total annual sales coming in at a reported $585 million last year, compared to Pandora's $427.1 million.

Revenue might grow even larger before long -- Spotify recently reported having 6 million subscribers who pay $10 a month for premium services. That presumably adds up to $60 million a month, or $720 million annually (should all those users stay on board). Pandora, by comparison, has 3 million paying users.

According to the International Federation of the Phonographic Industry (IFPI), digital music brought in $5.6 billion in revenue last year. Spotify's sales of $585 million in 2012 took up 10.4% of that market share, while Pandora only held 7.6%.

Digital music sings the blues
In the realm of digital music, there always seems to be a new upstart on the horizon, ready to snatch the spotlight and shrink the market share. Spotify already has to watch out for new entries into the field like Deezer, a popular service that is not yet available in the U.S. but may hit these shores before too long. Besides upstarts, many companies with previously established reputations are making strides into the streaming music terrain, from Apple to Google to Sirius XM Radio. Each of these companies is using the online music market to buffer already strong overall sales, which makes the market share for pure-play companies like Pandora and Spotify suffer.

Even if Spotify can combat the constant arrival of sleeker, younger models (along with the growing interest of larger companies doing the same thing), there's still the recording industry, and the royalties therein. Last year, Pandora paid 60% of its revenue -- $258.7 million -- in royalties to artists. Those expenses have sent both its operating and net profit margins spiraling into the red since at least 2009.

Spotify might be even worse off when it comes to royalties. The company vows to continue paying 70% of its monthly revenue to artists ($500 million since the service launched). Taking that kind of chunk out of Spotify's sales might be good for the artist, but it leaves little left for the actual company, and thus its would-be investors.

Should music be the food of your portfolio?
Investing in a pure-play digital music service might not be the best idea, since so much of their funds go toward paying royalties. If you absolutely must have something musical in your portfolio, stick with one of the companies that have already achieved success from selling something else first.


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