Spotify, Tencent And The Laws Of Unintended Consequences

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News has emerged that Spotify and Tencent Holdings could be swapping 10% holdings in each other’s companies ahead of Spotify’s public listing. There are some obvious implications for both enterprises, as well as some less immediately obvious, but even more interesting permutations:

  • Spotify gets a foothold in China: Tencent is the leading music subscription company in China with QQ Music, Kugou and Kuwo accounting for 14.7 million subscribers in 2016. Apple Music has got a strong head start over Spotify with 3.5 million Chinese music subscribers. Tencent, with its billing relationships, social reach (WeChat, QQ Messenger) and rights holders relationships (Tencent sub-licenses label rights) provides a potential China launch pad for Spotify. So, the obvious implication is that Spotify could use Tencent as an entry point into the market. But this is where things get complicated. Tencent is planning a $10 billion flotation of Tencent Music. How would this valuation be impacted by Tencent aiding the entry of a direct competitor – which is a leader in virtually every market it is currently in, into the market of? A joint venture could be the way to square the circle.
  • Spotify continues its narrative building: As I have long argued, Spotify needs to construct a compelling narrative for Wall Street. It needs to be able to show that it is making strong progress on many of its weak points. Getting better deals from the labels was one such move. Now it has ticked the ‘what about China’ box too.
  • Tencent gets a foothold in the US: Earlier this year the Chinese government put in place restrictions on Chinese companies investing in overseas companies, in order to slow the outflow of Chinese capital. (It slowed a potential investment by Alibaba in UMG). Swapping equity is a way to get round this restriction. It also builds on Tencent’s move extending its stake in Snap to 12%. Tencent is pushing the rules to the limit in order to become a key player in US digital consumer businesses (Spotify of course will become, in part at least, a US company when public). The intriguing question is whether Tencent will get any access to Spotify’s western billing relationships.
  • Valuation disparities: Tencent Music has around a 3rd of Spotify’s subscriber base, a fraction of its revenue and half of its market valuation. Yet a 10% swap deal is on the table. Which suggests that Spotify really, really feels that it needs that entry point into China….

If this deal pans out the way it has been slated, it will potentially save Spotify and Tencent from a resource-draining clash of Titans for when (not if) Spotify would enter the Chinese market. It also provides Spotify with a potential long-term insurance asset. When Yahoo acquired a stake in Alibaba it was very much the senior partner. But, as Yahoo’s business imploded its Alibaba stake became its core asset.

Spotify obviously won’t be thinking that way but history shows us to never say never.

UPDATED: This post has been updated to reflect that the 10% equity swap is with Tencent  Music, not Tencent Holdings Ltd

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Announcing MIDiA’s Streaming Services Market Shares Report

coverAs the streaming music market matures, the bar is continually raised for the quality of data required, both in terms of granularity and accuracy. At MIDiA we have worked hard to earn a reputation for high-quality, reliable datasets that go far beyond what is available elsewhere. This gives our clients a competitive edge. We are now taking this approach a major step forward with the launch of MIDiA’s Streaming Services Market Shares report. This is our most comprehensive streaming dataset yet, and there is, quite simply, nothing else like it out there. Knowing the size of streaming revenues, or the global subscriber counts of music services is useful, but it isn’t enough. Nor even, is knowing country level streaming revenue figures. So, we built a global market shares model that breaks out subscription revenues (trade and retail), subscribers, and subscription market shares for more than 30 music services at country level, across 30 countries and regions. You want to know how much subscription revenue Spotify is generating in Canada? How many subscribers Apple Music has in Germany? How much subscription revenue QQ Music is generating China? This is the report for you. Here are some highlights:

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  • At the end of 2016 there were 132.6 million music subscribers, up from 76.8 million in 2015
  • In Q4 2016 Spotify’s subscriber market share was 35% and it had $2,766 million in retail revenue
  • Apple Music was second with 21 million subscribers at the end of 2016, a 15.6% market share and it had $912 million in retail revenue
  • In 2016 Apple was the largest driver of digital music revenue across Apple Music and iTunes
  • The US is the largest music subscription market, which Spotify leads with 38% subscriber market share
  • The UK is Europe’s largest streaming market, which Spotify also leads
  • China’s subscriber base is the second largest globally, but it ranks just 13th in revenue terms
  • Japan is the world’s third largest subscription market, in which Amazon has the largest subscriber market share
  • Brazil is Latin America’s largest music subscription market

The report contains 23 pages and 13 charts with full country detail as well as audience engagement metrics. The dataset includes four worksheets and a comprehensive methodology statement.

Streaming Services Market Shares is available right now to MIDiA premium subscribers. If you would like to learn more about how to access MIDiA’s analysis and data, email Stephen@midiaresearch.com.

The report and data is also available as a standalone purchase on MIDiA’s report store as part of our ‘Streaming Music Metrics Bundle’. This bundle additionally includes MIDiA’s ‘State of The Streaming Nation 2.1’. This is our mid-year 2017 update to the exhaustive assessment of the streaming music market first published in May. It includes data on revenue, forecasts, consumer attitudes and behaviour, YouTube, app usage and audience trends.

Examples of country graphics (data labels removed in this preview)

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Is QQ Music Worth $10 Billion?

Western appetite for the Chinese market has long been based upon accessing the 1.4 billion consumers. This has in turn impacted valuations of Chinese companies, particularly when eager western investors are involved. However, there is a growing realisation that market potential does not always translate to [performance]. Now we have Chinese tech major Tencent seeking pre-IPO investment in its music streaming service QQ Music, against a valuation of $10 billion. That is only $3 billion less than Spotify’s valuation. So, is QQ Music worth $10 billion?

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Valuations in isolation can be misleading and therefore need context and scale. For example, Deezer had a valuation of $1.25 billion for its aborted IPO, while Spotify’s valuation is nearly 10 times higher. Moreover, Spotify’s subscriber count (60 million) is nearly 10 times higher than Deezer’s was (6.5 million), leading up to the aborted IPO. So, the best way to make meaningful comparisons between streaming music valuations is to look at the valuation divided by the number of subscribers, to give us a valuation per subscriber metric (see above). Here are a few ways to assess the value of QQ Music compared to other streaming services:

  • Valuation per subscriber: On the valuation per subscriber basis Spotify and Deezer’s valuations per subscriber are quite similar ($217 for Spotify, compared to $198 for Deezer). Tidal is significantly higher at $300 (well done that man Jay-Z for talking up the value of his service to Sprint), while QQ Music with its reported 10 million subscribers comes in at $1,000. This obviously begs the question, are QQ Music subscribers worth 5 times more than Spotify subscribers?
  • Subscriber revenue: The headline consumer retail price for Spotify is $9.99, while the headline price for QQ Music is $1.60. Spotify’s actual average revenue per user (ARPU) in 2016 was around $6.10, so if we scale QQ Music by a similar rate we get an ARPU of $0.98. If we multiply those ARPUs by the current subscriber number for each company, we end up with a monthly subscription revenue of $366 million for Spotify and $9.8 million for QQ Music. Therefore, rather than QQ Music subscribers being worth 10 times more than Spotify subscribers, they actually generate just 3% of Spotify’s subscriber revenue each month.
  • Addressable market: Valuations are of course based on potential, not just actual. China has 717 million smartphone owners (30% of the global total) and a GDP of $11.2 trillion (14% of the total). Given QQ Music’s Chinese positioning, that is its addressable market. By contrast, Spotify is a global service, though pointedly not in China, so its addressable market (excluding China) is technically 1.7 billion smartphone owners, and $67 trillion of GDP. QQ Music’s addressable market is in fact smaller, unless of course it decides to roll out to more territories. Likewise, Spotify could also roll out to China.
  • Like-for-like comparisons: We also need to be careful about the numbers behind QQ Music. 10 million QQ Music subscribers may not be the same as 10 million Spotify subscribers. Firstly, QQ Music [subscription] includes karaoke features, such as Bullet Screening, which many would not consider to be music subscribers as such. Additionally, 10 million might not actually be 10 million. Back in Q1 2016, Tencent reported to the markets that it had a little under four million QQ Music subscribers. Then in July 2016, in a Mashable piece, it claimed to have 10 million subscribers. Then nothing until January 2017, when it did another media push, announcing…10 million subscribers. If we take these reports at face value, it means QQ Music had an incredible Q2 2017 then did absolutely nothing, and I mean nothing, thereafter. Whatever the subscriber number actually is for QQ Music, the 10 million figure, at the very least, merits some scrutiny.

So, to answer the opening question, is QQ Music worth $10 billion? That depends. Compared to other streaming music services, the metrics suggest that it isn’t. But, to Tencent’s local investor market, maybe so. 80% of Chinese stock market transactions are from small retail investors, i.e. not institutional investors. So, while a $10 billion valuation might look high to institutional investors, to enthusiastic local retail investors who know QQ Music and have read all the stories about the booming streaming music market, this will appear to be a golden opportunity to get in on the great streaming boom.

Is QQ Music worth $10 billion? It depends on who you are!

Four Companies That Could Buy Spotify

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For much of 2016 it looked nailed on that Spotify would IPO in 2017 and that the recorded music industry would move onto its next chapter, for better or for worse. The terms of Spotify’s $1 billion debt raise (which mean that Spotify pays an extra 1% on its 5% annual interest payments every six months beyond its previously agreed IPO date) suggest that Spotify was thinking the same way too. But now, word emerges that Spotify is looking to renegotiate terms with its lenders and there are whispers that Spotify might not even IPO. It would be a major strategic pivot if Spotify was to abort its IPO efforts and it begs the question: what next?

The World Has Changed

When Daniel Ek and Martin Lorentzon were drawing up the Spotify business plan in the 2000’s, the music and tech worlds were dramatically different from what they are now. The ‘Potential Exits’ powerpoint slide in Ek’s investor pitch deck would have listed companies such as Nokia, Microsoft, Sony and HTC. Over the subsequent decade, those companies have fallen on harder times (though Microsoft is now experiencing a turnaround) and all of them have moved away from digital music, which is why an IPO seemed like a much better option for being able to get a large enough return on investment for Spotify’s investors.

The only problem is that the IPO market has changed too. IPOs were once the best way for tech companies to raise capital but with the current VC bubble (and its recycled cash in the form of exited-founders reinvesting as Angels) equity and debt investment is much easier to come by. In 1997, there were 9,113 public companies in the U.S. At the end of 2016, there were fewer than 6,000. 2016 was the slowest year for IPOs since 2009. And of course, Deezer aborted its IPO in 2015. Snapchat’s forthcoming IPO will be a Spotify bellwether. If it does well it will set up Spotify, but if Facebook’s continued aggressive feature-cloning on Instagram continues, it could underperform, which could change the entire environment for tech IPOs in 2017. The fact that only 15.4% of Snapchat’s stock is being listed may also push its price down. No fault of Spotify of course, but it is Spotify that could pay the price.

$8 Billion Valuation Narrows Options

Because Spotify has had to load itself with so much debt and equity investment it has needed to hike its valuation to ensure investors and founders still have meaningful enough equity for an exit. Spotify’s revenues will be near $3 billion for 2016 but its $8 billion valuation is half the value of the entire recorded music market in 2015 and more than double the value of the entire streaming music market that year. However, benchmarked against comparable companies, the valuation has clearer reference points. For example, Supercell had revenues of $2.1 billion and was bought by Tencent for $8.6 billion in 2016. King had revenues of $2.6 billion and was bought for $5.9 billion by Activision Blizzard, also in 2016.

The complication is that both of those companies own the rights to their content, while Spotify merely rents its content. Which means that in a worst case scenario Spotify could find itself as an empty vessel if it had a catastrophic fall out with its rights holder partners. King and Supercell would both still have their games catalogue whatever happened with their partners.

Western Companies Are Not Likely Buyers

So, in the event that Spotify does not IPO, it either needs to raise more capital until it can get to profitability (which could be 3+ years away) or it needs someone to meet its $8 billion asking price. Of the current crop of tech majors, Apple, Google and Amazon are all deeply vested in their own streaming plays (Apple Music, YouTube and Prime) so the odds of one of those becoming a buyer is, while not impossible, unlikely and for what it’s worth, ill advised. Though there could be a case for Apple buying Spotify for accounting purposes as buying a European company would be a way to use some of its offshore domiciled $231.5 billion cash reserves. Reserves that the Trump administration is, at some stage, likely to make efforts to repatriate to the US in one way or another. Facebook is the wild card, but it’s unlikely to want to saddle itself with such a cost-inefficient way of engaging users with music. A distribution partnership with Vevo or launching its own music video offering are much better fits.

Go East: Four Potential Suitors For Spotify

So much for Western companies. Cast your gaze eastwards though and suddenly a whole crop of potential suitors comes into focus:

imgres-2Tencent: With a market cap of more than $200 billion and a bulging roster of consumer propositions (including WeChat) and 3 music services, Tencent is arguably the most viable eastern suitor for Spotify. The fact that the company recently reported inflated subscriber numbers for QQ Music (which were in fact a repetition of the same inflated numbers given to Mashable in July last year) hints at Tencent’s eagerness to court the western media and to be judged on similar terms. A Spotify acquisition, especially an expensive one, would be both a major statement of intent and an immediate entry point into the west. It would also transform Spotify into a truly global player.

imgres-4Alibaba:
Another Chinese giant with a market cap north of $200 billion (although it has lost value in recent years), Alibaba has a strong retail focus but has been diversifying in recent years. Acquisitions include the South China Morning Post, Guangzhou Football Club and the Roewe RX5 ‘internet car’. Spotify would be a less obvious fit for Alibaba but could be a platform for building reach and presence in the west.

imgres-1Dalian Wanda: With assets of over $90 billion, revenue of more than $40 billion, a heavy focus on media and an insatiable appetite for acquisitions, Dalian Wanda is a strong contender. The company has built a global cinema empire in its AMC Theatres division, most recently picking up a Scandinavian cinema chain for a little under a billion dollars late January. Dalian Wanda’s strong US presence and long experience in that market, along with its bold global vision make its fit at least as good as Tencent’s. The fact that it is currently mulling a €6 billion acquisition of the German bank Postbank indicates it can buy big.

imgresBaidu: Baidu’s $10 billion revenues make it a markedly smaller player than Dalian Wanda but its $66 billion market cap and strong music focus (e.g. Baidu Music) make Spotify a good strategic fit. Spotify could help Baidu to both counter the domestic threat of Apple Music and to build out to the west, which could act as a platform for building out Baidu’s other brands.

imgres-3Other runners: A host of telcos could be contenders, including the $78 billion SoftBank and India’s Reliance Communications. However, most telcos will surely realise that emerging markets will soon hit the same music bundle speed bumps that are cropping up in western markets. One other outsider is the $29 billion 21st Century Fox. Perhaps less of a wildcard than it might at first appear, considering that News Corp was a major shareholder in the now defunct Beyond Oblivion. And of course, don’t rule out Liberty Global.

An IPO, albeit a delayed one, still remains the most likely outcome for Spotify, but if it proves unfeasible there is a healthy collection of potential buyers or at the very least, companies that could buy into Spotify to give it enough runway to get towards profitability.

Have Spotify and Apple Music Just Won The Streaming Wars?

Spotify has just delivered 2 landmark data points: 40 million subscribers and $5 billion paid to rights holders to date. Although the 3 million added in Q3 was down on the 7 million added in Q2 (boosted by a summer pricing promo) there is no escaping the fact that Spotify’s momentum has accelerated rather than declined since the emergence of Apple Music. 2016 is proving to be Spotify’s year. The question is how well the rest of the market is performing beyond the 2 market leaders?

The streaming music market as a whole is experiencing unprecedented growth, with the major labels collectively reporting a 52% increase in streaming revenue in Q2 2016 compared to the same period 12 months ago. Given that total streaming revenues (including YouTube etc. but not Pandora) grew by 44% in 2015 (according to the IFPI) the picture that is emerging is one of, at worst, sustained growth, at best, accelerating growth.

Although the major label numbers have to be interpreted with caution due to factors such as Minimum Revenue Guarantees (MRGs) – see my previous post for much more detail on this – the headline trend is growth. However, headline growth is not necessarily a reflection of how most of the market is actually performing. In fact, a forensic examination of these numbers cross referenced against reported Apple Music and Spotify numbers reveals that the outlook for the rest of the pack is very different indeed.

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At the end of 2015 there were 67.5 million subscribers, by the end of June 2016 that had increased to 83.2 million – a 23% increase from the end of 2015 and a 63% increase on Q2 2015. Spotify’s subscriber count for Q2 2016 was 37 million (including super trialists) while Apple Music was just under 16 million. This gives them a combined market share of 56%, which in itself is not particularly surprising. However, when we look at what has happened to the rest of the pack that things start to get really interesting…

The Rest Of The Pack Is Getting Left Behind

By end Q2 2015 Spotify had 20 million subscribers and Apple Music none. This meant that the rest had 31 million between them. By Q2 2016 this ‘remainder’ had shrunk to 30.5 million. Among this chasing pack there is a diverse mix of stories, with some services showing solid growth, some losing lots of paid subscribers and some disappearing all together. Meanwhile Spotify and Apple Music added 32.7 million to the global subscriber base. Thus over the same 12 month period these two players combined, became bigger then the entire rest of the market in subscriber terms with a 63% combined market share. An interesting side note: Tidal’s reported revenues of $47 million in 2015 mean that it can’t have had more than around 800,000 commercially active subscribers by year end, which means that the reported and ‘implied’ 4.2 million current subscriber count is probably closer to half that.

Streaming revenue followed a similar trend with Apple and Spotify dominating and the rest falling slightly (by 1 percentage point year on year). Spotify paid around $1.6 billion in royalties in 2015 and a cumulative $6 billion by September 2016, implying about $1.1 billion in 2016 already. The amount that Spotify paid to record labels in Q2 was somewhere between $479 million and $622 million, depending on when and how Spotify paid for those 7 million new super trialists it acquired that quarter. Towards the lower end of that range is probably the safer bet. Apple by comparison paid around $220 million. And as with subscriber numbers, the rest of the pack lost revenue.

It’s A 2 Horse Race

When Apple launched Apple Music some less informed observers suggested that it was too late to the party and that there was only room for one big player. The numbers from Q2 2016 show that Apple was far from too late (fashionably late perhaps) and that the rather than being a winner takes all scenario, the streaming market is a 2 horse race. Unfortunately for the rest of the pack it does look like there is only space for 2 leading global players, with Apple clearly having played a key role in knocking Deezer out of 2nd place and racing on ahead.

Still A Place For Regional Leaders

This does not mean that there is not space for other players, there is. Especially regional leaders like QQ Music, KKBox, Anghami and MelOn. But the consumer marketplace only has so much appetite for global scale $9.99 AYCE services. Which is why pricing and product innovation are so crucial if the recorded music business wants a vibrant streaming sector. Compare and contrast with the streaming video market where there is immense innovation with niche services and a diverse range of price points. Music streaming needs the same approach. Tidal may have (very successfully) differentiated on brand and content but it remains fundamentally an also-ran, $9.99 AYCE service. As things stand, the only really serious attempt to play by different rules is Amazon’s steadily emerging streaming strategy. Expect that dark horse to make up ground by playing by different rules. Perhaps even Pandora may be able to break the mould too.

But it is only through differentiated strategies that serious inroads can be made and unless pricing and product innovation occurs (and the labels and publishers need to enable it) expect the streaming race to continue to be a tale of 2 horses.