Tuesday, February 22, 2011

$1 Billion -- The New "Magic Number" for Online Music Sub Services

Is the online music subscription business getting "frothy"? Is it deja vu all over again for investors? You be the judge.

Just a few days back, online music subscription service Pandora -- which has massive distribution but ZERO (0) profits -- filed to raise $100 million in an IPO which is expected to value the company at nearly $1 billion. And, now Spotify -- the European music subscription service that has tried (but failed) to set foot into the U.S. market for seemingly years now -- is said to be closing a $100 million round of financing that values the company at the same magic number of $1 billion. I am quite sure that Spotify is similarly profit-challenged.

So, what gives? Well, Pandora has always been a tech darling. And, the service IS everywhere. I am a fan -- and one of the few paying subscribers (at $36/year). But, ubiquity does not necessarily translate into a long-term and highly profitable business model. Similarly, Spotify has always been a Euro tech darling. But, I have never understood what makes it so special. Let's face it -- there are a lot of online music subscription services out there -- especially in the U.S. Rhapsody, Napster, Slacker ... just to name a few. What does Spotify got that they don't? Certainly not catalog. Spotify has been unable to ink the requisite label deals in the U.S., despite a steady drumbeat of announcements over the past few years saying "we are almost there!" Yeah right -- I'll believe it when I see it.

Oh yes, and there is one more slight problem. Apple just announced a major change in overall economics for subscription services distributed via Apple's App Store. Whereas subscription services used to keep it all, now Apple plans to take a major cut of all subscription revenues (30% to be exact). This move is ultra-significant for the overall business models for services like Pandora and Spotify, because so much of their distribution comes from the App Store and mobile streaming. And, add this 30% cut on top of the music labels' and related "cuts" (which can stretch beyond 70% of revenues just by themselves!) and, voila, you don't have much left to build your business. Already thin margins are now paper thin. Was this all considered when Pandora filed its IPO and when Spotify's investors were finalizing their paperwork? Doubtful -- Apple's recent body blow is still hot off the presses.

To be clear, I am a big believer in the power of music subscription services. I subscribe to both Pandora and Rhapsody.

But, would I invest in them?

Not a chance ... and certainly not at a $1 billion valuation.