A venture cash infusion might do wonders for growth, but mounting losses could stifle profits.
With $250 million in venture capital raised at a valuation of $4 billion, it's good to be Spotify. Or so it seems. The Swedish start-up is closing in on the market capitalization of Pandora, which is currently valued at $5.7 billion and went public in 2011.
Last year, Spotify raised $100 million from the likes of Goldman Sachs, at the same valuation. But this time, only Technology Crossover Ventures, a firm based in Silicon Valley, was around to cut the check, in what David Pakman, a venture capitalist and the former CEO of eMusic, calls a flat round, or sign that the company's growth has stagnated.
As an unprofitable company, Spotify could certainly use the handout. To succeed, it needs to continue expanding globally--a year ago, it was in 17 countries, now it is available in 32, according to The Wall Street Journal--and losses are mounting as more users bring higher royalty costs for playing songs.
"It's a low-margin business--earning under thirty percent in revenue but likely about 23 to 24 percent in gross margins--so they need more cash to fund the operations," says Pakman. "Spotify is often lumped in with many of the other consumer Internet giants as an iconic brand with very large reach and nice growth. But what is different from them and makes it so unlike Facebook, LinkedIn, Twitter, and even Pandora, is that their margins are much lower than everyone else's, so it will always be harder for them to be profitable."
At 40 percent gross margins, Pandora isn't profitable either, though its future looks brighter than Spotify's. As Glenn Peoples wrote in an excellent Billboard feature this fall, there is still plenty of cash to go around in broadcast-radio advertising--$14.2 billion was spent in 2012. Sure, there are the radio titans like iHeartRadio and SiriusXM to condend with, but investors are coming around to Pandora because of how quickly it keeps adding users (70 million and counting) and the fact that smartphone radio is becoming ubiquitous.
With 24 million users and a model in which it pays 70 percent to rights holders for music as opposed to the 61 percent Pandora paid out last year, Spotify has fewer advantages, which are readily apparent: In 2012, its revenue stood at $576.5 million, while losses grew from $60 million in 2011 to $77 million in 2012, largely due to licensing fees.
Spotify has reportedly negotiated price breaks with record labels and hopes pushing into markets such as Signapore, China, Malaysia, and Mexico will vastly increase the number of users who pay for its service. But will that $4 billion valuation deliver on its promise? That's hardly worth holding out for.
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