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Spotify: The Future of Music Streaming?

By Tyler Lacoma – Mar 31, 2014 at 3:00PM

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Spotify's potential IPO and Pandora's success continue to challenge Apple and the old guard.

Image by Flickr user Johan Larsson

Spotify is looking more prepared than ever for an IPO that could change the landscape of the music streaming industry. According to rumors from Quartz, the company is already in talks with investment banks and may be planning on a late 2014 IPO date.

While the rumors have not been confirmed, the theory makes sense. Last year, the company was valued at $3 billion, with revenue that had grown by 128% from 2011. Although Spotify is still operating at a loss, its subscription model could receive healthy attention from investors since it promises more stable income than advertising revenue.

The company is also advancing its music tech services. In early March, Spotify made headlines by acquiring The Echo Nest, a start-up music intelligence company that designs recommendations for streaming radio listeners. 

Pandora gets competition
When it comes to publicly traded music streaming companies, Pandora(P) has held a lonely spot in recent years. If a Spotify IPO does come along in 2014, it will provide some long-awaited competition for investors.

Pandora's history shows strong growth in 2013. In the past year, the company has grown by almost 200%, and registered users have grown beyond 200 million. The streaming giant had a profitable 2013 and nearly $9 million in revenue for the fourth quarter alone. With a share price that grew from around $7 in late 2012 to nearly $40 in February 2014, Pandora has also won plenty of investor interest. However, cracks started to show in March 2014; between the 5th and the 25th, Pandora's share price fell 22% as investors noted the high cost of royalty fees and the company's plans to raise premium subscription fees by 25%.

Those royalty fees are worth a closer look. Pandora depends on advertisements to generate revenue and pays a small royalty fee per song that it streams. The more customers Pandora has, the higher its royalty fees rise, which directly affects profit. Pandora's solution (raising premium subscriptions) could push customers toward other services like iTunes Radio or Spotify, which use more traditional label contracts to pay for music.

Battle of the band streamers
While it's tempting to focus on a Pandora vs. Spotify setup, there are some other big players in the industry, notably Sirius XM (SIRI 4.43%), which offers satellite and streaming channels, and Apple, creator of iTunes Radio. Currently, Sirius XM is on decline in Wall Street; its share price fell nearly 10% in March and a total of 7% from this time last year. Interestingly, this is in contrast to recent upgrades from Evercore Partners and Barclays PLC, which both gave Sirius an overweight rating in March.

It remains to be seen if Sirius will meet expectations after this rough patch. Apple is now offering more direct competition by incorporating news stations like NPR into iTunes Radio, and is rumored to be talking to radio execs about further expanding Radio to create a more competitive service. This could help Apple win customers from Sirius and Pandora.

Final thoughts
If Spotify announces an IPO, Sirius and Apple would be pressed to respond (perhaps this is another reason behind the iTunes Radio expansion). Pandora may also find reasons to change its fee model toward a more profitable strategy. The market may not be big enough for all four services, so competition is likely to be fierce.

Tyler Lacoma has no position in any stocks mentioned. The Motley Fool recommends Pandora Media. The Motley Fool owns shares of Pandora Media and Sirius XM Radio. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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