For investors who have been wanting to buy into one of the world's largest music streaming services, the wait may soon be over. News recently broke that online music company Spotify has filed for an initial public offering with U.S. regulators. That would result in shares trading on a public stock exchange. Speculation that the company was planning an IPO has circulated for years, but some caution is in order for those thinking about adding shares to their portfolio.
Spotify's lucrative-looking business
Spotify is looking to go public on the New York Stock Exchange sometime during the first half of 2018, using a public offering method called a direct listing. Unlike a typical IPO, a direct listing cuts out any investment banks and doesn't raise new cash by issuing new shares to the public. Instead, a direct listing is a way for existing investors in a private company to cash out, selling their stake on a stock exchange to the general public as they see fit.
Spotify would become the highest-profile company to utilize this method of public offering if it gets approval from regulators and goes ahead with the plan. Perhaps one reason the company is opting out of raising new capital is that it recently announced an equity agreement with Tencent Holdings (NASDAQOTH:TCEHY), the owner of China's largest music streaming service. Spotify said it would be receiving cash for the deal, as well as a small stake in Tencent, strengthening its relationship with its Chinese counterpart.
Spotify has said it has 140 million total monthly active users, 70 million of which are paying subscribers. The company touts having 30 million songs available, and has been valued as high as $19 billion.
Reasons for skepticism
Spotify's user counts put it at the top of the online music streaming industry -- excluding Tencent, which operates almost exclusively in China. Its number of paying users is more than twice the number paying for Apple's (NASDAQ: AAPL) service. By comparison, Pandora Media (NYSE:P) has over 70 million monthly users and only 1 million premium paying users, and Amazon (NASDAQ: AMZN) has over 16 million users for its streaming music services.
Although it's currently in the lead among the heavyweights in the music business, that's a lot of competition stacked up against Spotify. And that's before including similar offerings like satellite radio provider Sirius XM (NASDAQ:SIRI) and a slew of smaller players like Tidal and Napster. That could be another reason Spotify created closer ties with its Chinese peer.
Besides competition, Spotify has also had legal struggles as of late. Multiple lawsuits have been brought against the company, alleging improper licensing. The latest, served up by music manager Wixen Music Publishing, is suing for $1.6 billion to compensate artists who were allegedly affected.
Perhaps the most concerning issue, though, is the fact that Spotify is still an unprofitable enterprise. Despite strong revenue that topped 1.9 billion euros in the first half of 2017, the company lost between 100 million and 200 million euros. Revenue has been growing along with new subscriber additions and the operating loss is apparently narrowing, but those figures are a good reason to curb enthusiasm about the IPO.
While it may be exciting that the streaming music industry's leader is making its debut on the public market, exercise caution. Pairing its financial issues with legal question marks and stacked competition make for a potentially hazardous investment for new buyers when Spotify stock becomes available.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Nicholas Rossolillo owns shares of Apple. The Motley Fool owns shares of and recommends Amazon, Apple, Pandora Media, and Tencent Holdings. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.