Business Matters: A $3 Billion Valuation Brings Spotify Expectations Back to Earth
Business Matters: A $3 Billion Valuation Brings Spotify Expectations Back to Earth

Spotify Looking For Billions In Funding
Spotify is reported to be seeking funding of $3.5 billion, according to Business Insider, or $4 billion, according to the Financial Times.

The company has over 10 million active users, well over 3 million subscribers globally, and is growing rapidly. It's easy to argue that Spotify is groundbreaking, innovative, popular and absolutely full of potential. But you'd have a lot more difficult time successfully arguing the company is currently worth upwards of $4 billion.

Let's put a $4 billion valuation of Spotify in perspective. That's more than the $3.3 billion Access Industries paid for Warner Music Group last year. And it's equal to what Google reportedly offered for online video service Hulu. But there are big differences. Warner owns recorded music and publishing assets, and Hulu has exclusive rights to some of its content. Spotify, on the other hand, has few assets and licenses all its content.

One could compare Spotify to iTunes. Business Insider calculated a hypothetical market capitalization for iTunes as if it were a standalone business, but it used the wrong assumptions. Rather than figure out what iTunes would be worth based on a multiple of earnings or free cash flow, Business Insider took Apple's market capitalization and assigned a portion to iTunes based on its percent of Apple's overall revenue. But that approach will grossly overvalue iTunes because it fails to recognize that some segments of Apple's business are more profitable than others.

Simply put, iTunes' operating income and gross margin are exceed by those of Apple as a whole. iTunes pays out 70% of revenue to rights holders, giving it a 30% gross margin. Apple as a whole had a 44.7% gross margin in the quarter ended December 31. A lower gross margin means lower earnings and less free cash flow relative to the company as a whole. If, as Business Insider says, iTunes accounts for 1.6% of Apple's revenue, it accounts for less than 1.6% of its market value, or $8.9 billion. In addition, taking iTunes away from Apple would remove the incredible value iTunes derives from being a part of Apple's overall product strategy.

Comparing Spotify to current Internet darlings is filled with problems. Fast-growing Internet companies often have very high price/earnings ratio. LinkedIn, for example, currently has a P/E ratio of 851, a market capitalization of $10.2 billion and earnings of just $11.9 million in its last 12-month period. What it lacks in earnings it makes up for in earnings potential because its business model scales incredibly well.

But Spotify is quite unlike user-generated Internet companies because it licenses content and pays a percent of revenue to rights holders. It may very well pay a lower percent of revenue for royalties in the future, but Spotify will always pay for content. Its business model scales, but not nearly to the extent of a company like LinkedIn, Google or Facebook. In contrast, user-generated content scales very well because a company need not pay royalties for the content created and uploaded by its users.

If Spotify were worth $4 billion, potential investors must surely realize there would be few exit opportunities. There are a handful of large, global companies that could afford such a price tag. Apple and Google are the two that make the most sense. Both have vast consumer relationships and use digital entertainment to further their core businesses. Apple in particular would give Spotify all the advantages that currently make iTunes so successful. But for $4 billion or more, Apple may be more likely to build than buy.

Short of potential suitors, the other option is an IPO. It's not an unlikely scenario. Napster and Pandora are among the digital music companies to tap the public markets. Spotify could follow in their footsteps if it continues to grow at a torrid pace and keeps its expenses in check. And the market, always in search of the next great Internet stock, could very well big Spotify up to a market capitalization in excess of $4 billion.

eMusic Set To Launch Video Marketing Campaign
eMusic is launching a new marketing campaign and has hired music writer Jason Diamond (New York Times, NPR, Vice, others) to be its lead blogger at its 17dots blog. The company continues to target the "culturally independent" consumers that have been its focus since it started doing market research to help hone its product and message. The campaign will feature rich media, display, TV ads and social media promotions on Facebook, Twitter and YouTube, according to a company spokesperson.

In addition, eMusic is launching its latest round of "eMusic Explorations" with a short film about "Ghostory," the latest album by the band School of Seven Bells. The film followrs "eMusic Researchers" to Muscle Shoals Sound Studio in Muscle Shoals, Alabama to see if the album "can do more than stimulate curious musical minds, but also awaken spirits." ( eMusic's 17 dots blog)

Is Spotify Set To Launch in Australia and New Zealand?
Spotify is thought to be nearing a launch in Australia this week, and it looks like New Zealand is on the way, too. The company alerted the media it will have an announcement this week. It has advertised job openings in the country and currently has an opening for a PR manager and sales manager for Australia and New Zealand.

The company has slowly expanded over the years. It hit the U.S. in July. Germany, a notoriously difficult country for licensed digital services, got Spotify on March 13. ( Gizmodo)

Mog Debuts iPad App To Positive Response
Mog, reported to have been sold to Beats Audio, debuted its iPad app Saturday. Time called the app "excellent" while PadGadget noted its "high definition graphics and a clean, easy to use layout." At the same time, Mog has rolled out a new Windows app so PC users have the option of listening to Mog on a web browser or the native app. Both the iPad app and the Windows app have built-in support for Apple's AirPlay. ( Mog blog)