Spotify's Unusual Market Debut

In this segment from the Motley Fool Money podcast, host Chris Hill is joined by Jason Moser of Million Dollar Portfolio, David Kretzmann of Hidden Gems Canada, and Aaron Bush of Motley Fool Rule Breakers to discuss the unusual market debut of Spotify Technology (SPOT -1.49%). Instead of using an initial public offering to raise cash, the company went public via a direct listing. Compared to other music streaming specialists like Pandora, Spotify is at least free-cash-flow positive, but the team wonders about its pricing power.

A full transcript follows the video.

This video was recorded on April 6, 2018.

Chris Hill: One of the most anticipated public offerings for 2018 happened this week. Spotify, the streaming music company, used a direct public offering instead of an initial public offering. Aaron, they bypassed the big banks on Wall Street, didn't raise any money. I'm not entirely sure why they did this. Usually, if a company is going public, we like to see, "Here's how much money we're looking to raise, and here's what we plan to do with the money."

Aaron Bush: They don't need to raise money, so they didn't. But, going public is really just a way for insiders and early investors to sell out. It's also a milestone --

Hill: That's not selling me as a potential investor.

Bush: No. But, in all honesty, that is a huge factor here. I do think you have to give Spotify credit where credit is due. They've built a $26 billion company in a really difficult industry. They have something like 160 million active users, and they actually just turned free cash flow positive. So, I feel like the timing is actually pretty decent for them to go public, but the battle is still ramping up.

Jason Moser: Yeah. I think they have a lot to prove just in the way of pricing power and customer retention. It doesn't strike me as they have all that much of a differentiated model. I think, going public, honestly, this was kind of a neat way to do it. They don't need the money now, but one of the benefits of being a public company is, this will open them up to the public market, so, later on, when -- not if, when -- they need more money, they'll have a little bit easier access to it.

David Kretzmann: I mean, it is impressive. It's a night-and-day difference, looking at the financials of Spotify vs. Pandora, which has just consistently flubbed its way as a public company over the past several of years. I think, longer-term, for me, the biggest question with Spotify is that they're going up against Apple, Amazon, Google, who all have their own music offerings, and those offerings are really a feature within their larger subset of services on their platforms. So, I question, how much pricing power will Spotify have? Can they raise their prices by $1-2 down the road without losing customers to these lower-price alternatives that really have almost identical offerings?

Bush: Yeah. Pricing power is probably going to come from having exclusives, and that's pretty difficult to get when it comes to music. A bit easier to get for launching new programming for other things, but that's less impactful. Yeah, if they could get exclusives for music, that actually would be a pretty big differentiator, and actually might be a sign that things are moving in the right direction, because that could accelerate, maybe, switching from other platforms to them. If they get more users, then they have more power. The industry could shift to where power is, from those who own the music to those who own the listeners, in which case they could increase their gross margins through lower royalty rates as well as higher prices. And it could be interesting. But, a lot has to go right for them before that happens.