Rumor has now circulated that Spotify is seeking funding of between $3.5 Billion (according to Business Insider) and $4 billion (according to Financial Times). I can already see the instant reaction of Sirius XM (NASDAQ:SIRI) and Pandora (NYSE:P) investors:
- What! Spotify isn't worth that much
- Spotify does not have near the content that Sirius XM does, how could they be worth $4 billion?
- Spotify does not even have a viable business model!
- Spotify is just a jukebox in the sky!
- Spotify will be killed by data charges that consumers have to pay to cell phone companies!
Already there are likely some readers saying, "Yea! That's right" to each of those points. The REAL situation is that Sirius XM and Pandora investors ought to hope and pray that Spotify gets that type of valuation! In fact, they should celebrate the mere fact that Spotify is even throwing around numbers like this!
There is an old saying that "every ship rises in a high tide". If you are invested in either of these audio entertainment providers, seeing Spotify garner this type of attention is great news, so long as the company you are invested in is operating a decent business of their own. Spotify valued at even 42 billion is cause for celebration.
I oft get heavy criticism for covering and writing about other audio entertainment companies. As a long term Sirius XM investor with a website dedicated to satellite radio, people seem to expect that I will always carry pom-poms for satellite radio. I do cheer for Sirius XM, but as the company has progressed to profits, I raise my expectations. However, news like what we have here with Spotify is VERY relevant to what Sirius XM and Pandora are doing. Think about that for a minute.
IF SPOTIFY IS WORTH $4 BILLION WHAT DOES THAT MEAN FOR SIRIUS XM?
Spotify garnering a valuation like that could mean wonders to Sirius XM. Consider that Liberty Media (NASDAQ:LMCA) owns a 40% stake in the satellite radio provider and is rumored to want to get at least a controlling interest in the company. The goal of Liberty media would be to obtain the additional 11% as cheaply as possible. Liberty's Greg Maffei has stated in the past that he felt Sirius XM was over valued. That statement came with the company trading around $2! Well if Spotify gets a great valuation, it could be argued that Sirius XM, a company operating at a profit, should enjoy a much more substantial valuation. Of course this sets aside traditional valuation methods and relies on a direct comparison to another company, but the reality is that this is exactly what people will do.
The reality is that a Spotify valuation of $4 billion gives Sirius XM CEO Mel Karmazin and the Board of Directors some ammunition that they did not previously have when they sit down at the negotiating table with Liberty. Sirius XM can say something like, "Your tender offer for 700,000,000 shares (the number needed by Liberty to get a majority stake) at $2.50 per share is simply not high enough Mr. Malone...Come on...Spotify just raised $4 billion and they do not have the revenue stream that we have built."
While the initial reaction of many Sirius XM investors may be to laugh off this type of valuation for Spotify, they should actually in fact be clamoring for it to happen. Remember, "Every Ship Rises In A High Tide". In fact, rather than bashing away at the likes of Pandora, Sirius XM investors should be wishing success upon the company. Why? Because the crossover and demographics of the two companies differ enough that they do not really step on each other toes too much. Each can do well, and the success of each can actually help the other. Think about that. A successful Pandora begins to garner more influence with record labels, and these are the same labels that Sirius XM needs to negotiate with. This can be a Coke and Pepsi story. More than one company can enjoy success.
IF SPOTIFY IS WORTH $4 BILLION WHAT DOES THAT MEAN FOR PANDORA?
For Pandora, a valuation of $4 billion for Spotify may be even more important. Pandora is trading at a deep discount to their IPO price of $16 per share, and the company is in the stage of their existence that they are still trying to prove themselves. Spotify has some similar challenges. A high valuation of Spotify could help build investor confidence that this new fangled Internet radio thing may actually have some legs. Pandora, with a massive audience could turn that bullishness into some stock appreciation in their own right.
Pandora and Spotify are much more head to head in competition that Sirius XM and either company, but again, there is enough difference that they can all coexist and enjoy success. Going head to head with Spotify is no easy task, but if Spotify can help prove that Internet streaming is viable and exciting enough to raise $4 billion, then people will take notice across the entire audio sector. Pandora investors have every reason in the world to have an undying desire for Spotify to be able to raise billions.
Now we should journey down "Royalty Road". Spotify has enjoyed successes in negotiating with record labels, and in many ways has even gotten those labels to partner up with them by introducing apps on the Spotify platform. Pandora pays out a ton of money in royalties. In fact, it is the biggest expense the company has! If Spotify can successfully negotiate workable deals with record labels, companies like Pandora may be able to do the same. The labels will never be cut out of the business, but Spotify has found ways to work with them that are intriguing. Pandora could learn from this, and if the street backs Spotify with a substantial cash infusion, the labels even have to take that news seriously. The next time royalties come up, companies like Pandora may be able to get themselves more manageable deals.
Now that the initial excitement is out of the way, let's not forget that Spotify's desires and what they are able to raise may differ substantially. However, even if Spotify is able to raise $1 billion, that news would be significant.
There is also the flip side of this coin. If Spotify can not raise significant funding after these rumors have surfaced, it may mean that the street simply does not see the viability in the audio entertainment sector. New saying..."All Ships go lower in a receding tide".
It is the flip side of this coin that represents the exact reason why following the sector as a whole, and events like this is so important. Cheering and wanting a company you are invested in to do well is fine, but in the end, there are outside influences that can impact anything. Better to know these things than not know them. I am certain that Sirius XM and Pandora investors were all pretty happy until this summary. Now I took the wind out of the sails. I can see it now. People are saying, "Darn it Spencer, I was finally thinking you were coming around and then you said that."
Investing is not about hope. It is about reality. This Spotify news, good or bad is not reality yet. The rumor is real, but the actual events have not yet played out. What I try to do is present the things people should watch for so that they are armed with information before hand rather than reacting to it later. Savvy investors understand the value here. Pom Poms are for cheerleaders. Winning teams are on the field of play with a good offense and a good defense.