What Is Spotify Worth?

Goldman Sachs says $3 billion.

Goldman Sachs says $3 billion. 


Spotify hasn't turned a profit, but give the company credit. It somehow seems to have convinced Goldman Sachs to bet on that battered wreck otherwise known as the music business.

The digital streaming service is reportedly in the process of closing out a deal that would raise $100 million from a group of investors including Goldman and peg its value at around $3 billion total, according to the Wall Street Journal. That's a big vote of confidence from Wall Street in yet another hot web upstart with millions of devoted users and millions in annual losses to show for it.

So what, exactly, are the money men putting their faith in?

For those not familiar, Spotify is an online jukebox that works on a "freemium" model, like LinkedIn or Pandora. Users can sign up for the free basic plan and play 10 hours of music per month on their computer from the company's massive searchable library, in which case they'll occasionally have their playlists interrupted by piercingly irritating advertisements. Or, they can pay up to $10 per month for an unlimited, ad-free subscription with mobile access.

Spotify makes little to nothing on the ads, so their whole business model hinges on convincing people to pay to listen to music -- something that's obviously been a bit of a challenge ever since most of us got cable modems. The most vivid description of their strategy may well have come from Sean Parker, the billionaire Napster founder, Facebook investor, and Spotify board member, who phrased it in terms Tony Soprano would have appreciated.

"You get addicted to it," he said at a panel hosted by The Daily Beast in 2010. "You get the songs stuck in your head. You see all your friends' playlists. You end up building a music library that's 100 times bigger than anything you've ever had. And at that point you've got no choice: we've got you by the balls. If you want that content on your iPod, you're going to have to pay for it. If you want that content on your iPhone, you're going to have to become a subscriber."

This is a fairly apt description of the entire freemium model -- get you so hopelessly hooked that you can't help but pay -- and Spotify has done better with it than most. According to the company, about four million of its 15 million active users are subscribers, a roughly 27 percent signup rate that, as Pascal-Emmaneul Gobry pointed out on Business Insider last year, is far, far superior to other companies that have tried the free-at-first route. It's grabbed a fair number of fans by their junk.

Still, Spotify has some daunting challenges. First among them: profits. According to TechCrunch, Spotify is on pace to earn about $500 million in revenue by the end of this year, doubling its take from 2011. And yet, it's still likely to lose about $40 million, thanks to the massive royalty payments it makes to record labels. TechCrunch reports that the company is required to either hand over a flat $200 million yearly fee to copyright owners, or 75 percent of its revenues, whichever one is higher. Some dispute those details, but CEO Daniel Ek has confirmed that royalties have historically eaten up about 70 percent of its income. After accounting for salaries and other operating costs, its finances will likely end this year in the red. Since hiking up subscription fees probably isn't an option with finicky music fans, Spotify needs to add many more paying customers, which will take time.

What the company lacks in cash flow, however, it might make up for with friends. Spotify has already teamed up with Facebook to let users share their playlists, which has given the service extraordinary exposure while giving the world's top social network a much needed foothold in music. More importantly, it seems to have a functional working relationship with the major labels, which early on wrote off some of their royalty payments in exchange an equity stake in the company. As it's become increasingly clear that no number of lawsuits will ever stamp out music piracy, unlimited streaming services with their convenience and variety may be the industry's only long term hope for convincing many fans to pay at least something for their tunes. Given that the labels actually own a piece of Spotify, they should have a fairly great incentive to make sure it survives to profitability, even if that means driving a softer bargain on royalties.

Maybe Wall Street's not investing in the music business, but in the music business' desperation. That's a bull market if there ever was one.