Why Are The Major Labels Dumping Spotify Stock?

Given that the future of music consumption seems to lie largely in streaming, why are so many major record companies choosing to offload their stock in Spotify now, one of streaming's biggest and most well established players?

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Guest post by Stephen Carlisle of NOVA Southeastern University

Streaming is the future of the music business. Everybody knows this.

Except, it appears, the record companies.

On Tuesday, August 7, 2018, in an earnings call with stock analysts, Warner Music Groups revealed that it had now sold all of its holdings of stock in Spotify, realizing $504 million. ¹

This is the culmination of a trend. Within one month after Spotify’s shares first traded publically in the United States (April 3, 2018), the labels immediately started dumping their shares.

• Sony Music sold 50% of its shares. ²
• Warner Music Group sold 75% of its shares. ³
• Independent Record Label Global Digital Rights Agency sold 100% of its shares. ⁴

And now, less than three months after the initial stock dump, Warner Music Group has joined Merlin in the “total divestment club.”

When asked for a reason for the sell-off, WMG CEO, Steve Cooper, was all standard issue Silicon Valley unicorns and rainbows. As reported by Variety:

“’Just so there won’t be any misinterpretation about the rationale for our decision to sell, let me be clear:  We’re a music company, and not, by our nature, long-term holders of publicly traded equity,’ he said. ‘This sale has nothing to do with our view of Spotify’s future. We’re hugely optimistic about the growth of subscription streaming, we know it has only just begun to fulfill its potential for global scale. We fully expect Spotify to continue to play a major role in that growth.’” ⁵

Except that WMG is not a stand-alone music company. It is wholly owned by the investment firm Access Industries. ⁶ Which is very much in the business of holding long term equity stakes. ⁷

One would assume that companies such as WMG and Sony know a thing or two about the music business. One would also assume that as direct shareholders of Spotify, they would be privy to day to day operational information about Spotify that the general public would not necessarily know. Please note that I am not suggesting anything resembling insider trading. Spotify’s management style, as discussed below, seems to involve burning large amounts of cash without regard to the bottom line. Something like this would be very apparent to a shareholder of a not yet publically traded company.

Yet, if the prospects for Spotify are as rosy as the internet would have you assume, why, in a least two cases, dump the stock and run for the hills? (As of the writing of this post, only Universal Music Group still retains its full share out of the major labels.)

As they like to say in politics, “the optics of this are not good.”

Most of this is likely because the business model of Spotify does not work, and does not have prospects for working anytime soon, as previously posted on this blog. ⁸

But don’t take my word for it. Forbes Magazine published this article the day after Spotify shares were first publically traded, titled “3 Reasons Not to Buy Spotify Stock.” ⁹ The reasons boil down to the simple fact that Spotify has never turned a profit, loses hundreds of millions of dollars every year, and it’s getting worse. As reported by Forbes:

“Spotify is growing fast, losing money, and burning through a common measure of cash flow. According to its prospectus, between 2015 and 2017, revenues grew at a 45% annual rate to €4,090 million. In 2017, Spotify reported a net loss of €1,235 million, nearly six times more than it lost in 2015, and its Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) was negative €324 million.” ¹⁰

Further, Forbes quotes Spotify’s own prospectus on this point:

“Since our inception in April 2006, we have incurred significant operating losses and as of December 31, 2017, had an accumulated deficit of €(2,427) million. For the years ended December 31, 2015, 2016, and 2017, our operating losses were €(235) million, €(349) million, and €(378) million, respectively.” ¹¹

So if you hold shares in a company that is running a deficit of over 2 Billion Euros, with annual losses approaching 400 million Euros, you might come to the conclusion that Spotify is not going to make any real profits for quite some time, and thus no dividend to you, the shareholder. It might also point towards the conclusion that Spotify’s continuing losses will not have an upward effect on the stock price, making it more prudent to sell now.

Could Spotify turn a profit by reducing its costs? Of course, and Spotify is always ready to point the finger at greedy copyright owners.

“We have incurred significant costs to license content and continue to pay royalties to music labels, publishers, and other copyright owners for such content. If we cannot successfully earn revenue at a rate that exceeds the operational costs, including royalty expenses, associated with our Service, we will not be able to achieve or sustain profitability.” ¹²

Boo! Hiss! Greedy copyright owners!

Except there’s this. In February of 2017, despite losing truckloads of money for years, Spotify found it necessary to open offices in New York City. And not just in any old office building. It rented space in the newly rebuilt World Trade Center. ¹³ According to Digital Music News, this is 478,000 square feet of office space spread over a total of 14 floors. This was not enough. Spotify later signed an option to take on 100,000 more square feet. ¹⁴ I suggest that you click on the link provided in the endnote and take a look at the pictures.

Nice pool table, guys.

The cost of this? Again according to Digital Music News:

• $2.77 million a month, or $33.29 million a year
• Over the 17 years lease, more than $566 million in rent
• $31 million in upfront payments

To this we can add the fact that:

• In 2015, executive and board member pay was $16.9 million, an increase of 300% over the previous year. ¹⁵
• In 2015, the average Spotify employee made $150,000. ¹⁶
• During 2015, Spotify lost $253.8 million (235 million Euros). ¹⁷

It does not seem from these numbers that Spotify is interested in reducing its costs, if it has to come by way of reducing their prestigious digs and creature comforts. If you are a record company, and you know this from close up observation, it might make sense to sell your shares.

Also mystifying is that if the Music Modernization Act is passed, Spotify is about to get a huge gift from Congress. This is by way of the provision for complete immunity from lawsuits from copyright owners that will be retroactive to January 1, 2018. ¹⁸

I have my doubts that this provision is constitutional, but we shall see, when and if the MMA is passed by Congress.

But the record companies would know this as well. So why are they selling?

Possibly because of the totality of what they know, they are afraid the stock price of Spotify is going to collapse.

And it just might.

When public trading of Spotify commenced, the share price translated to a market value of $25.6 billion. This is for a company that has a deficit of over $2 billion and loses hundreds of millions of dollars every year, and every year it gets worse.

I obviously am not a securities specialist, but these numbers fairly boggle the imagination. How is it that a company that loses hundreds of millions of dollars every year, and always has, is worth $26.5 billion?

Yet, for the most part, all we have been reading about is how streaming is going to “save the music business,” and glowing reviews about Spotify in particular. These reports inevitably highlight the amount of revenue being realized, without ever qualifying this with the fact that overall revenue in the music business is far below what it was. And almost never questioned is whether streaming, as Spotify performs it, is in fact a sustainable business model.

It appears that we largely have our answer. One 50% cash-out. Two 100% cash outs. Sony and Warner’s gross revenues from the sale totaled $1.264 billion. The prospect of increasing that amount was either not lucrative enough, or not very likely enough, to get them to stay.

As they say, “the optics of this are not good.”