Would Spotify Make a Good Stock?

Streaming music businesses like Spotify, Pandora need more revenue, report says.

A Spotify logo is seen as founder and CEO Daniel Ek addresses a press conference in New York, Dec. 11, 2013.

Spotify's IPO could happen in 2015 and could value the music streaming service at $8 billion, Reuters reports.

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Spotify may soon be traded on the stock market, but a streaming music company might not be the best long-term investment due to the costs of song licensing sapping revenue and the expectation of free music staving off a paid subscription model.

Spotify has a free service with ads, as well as a premium subscriber tier for $9.99 per month without ads. The company, based in London and founded in 2006 in Sweden, is recruiting a U.S. financial reporting specialist, Reuters reports, adding to speculation it will register for an initial public offering of stock with the Securities and Exchange Commission. The IPO could happen in 2015 and could value Spotify at $8 billion, Reuters reports.

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There are fears among some analysts of an Internet bubble leading the market to overprice tech deals and stocks, which could lead Spotify or investors to overvalue an IPO.

Streaming music service Pandora Media has done well for itself on Wall Street since going public in 2011 at $16 per share. On Friday it traded at around $37 per share. Pandora is free with ads, or users can pay $36 per year or $3.99 per month for a subscription without ads. Spotify has more than 24 million active users compared with Pandora's 73.4 million.

The stock market remains favorable to Internet companies, and others – including mobile payment company Square and cloud computing company Box – may be planning to go public during 2014. Unlike those kinds of services, the streaming music business has more difficulty profiting from its users, many of whom have come to expect music to be allowed for free as long as they tolerate the occasional ad. Approximately 18 million of Spotify’s 24 million users were listening to music for free as of March 2013.

This demand for free music and the high costs of paying royalties to music companies for the rights to stream songs is a big challenge for companies like Pandora and Spotify, so they need to find a better way to sell ads and monetize their users, says Paul Verna, senior analyst with information technology researcher eMarketer. Streaming music services are growing in popularity worldwide, but expanding to new countries is expensive because of licensing laws and the cost of planning online ads that are relevant to customers in those areas, Verna says.

“The music licensing frameworks are different for every country and they also need to have a local advertising sales force,” Verna says. “There is a growth opportunity, but every new territory they go into is a calculated risk.”

[ALSO: Google Takes on Spotify in the Streaming Business]

The global user base of streaming music companies may grow to 1.7 billion by 2017, increasing from 767 million in 2013, according to a new report from Generator Research, cited in a link here by Digital Music News because the report is only available to subscribers. Paid subscribers for streaming music services may spike to 125 million from the current 36 million, but record labels are taking approximately 70 percent of royalties from those services, the report said.

“The streaming business has to slowly move from a free economy to a paid economy as the sustainability of an ad-supported revenue model is a big question mark,” the Generator report said. “Pandora has never made a profit and we think that the company will never make a profit, unless there is a major change in strategy.”

There are challenges facing streaming music services but Verna says he does not buy Generator’s bleak prediction, given that Pandora has been savvy expanding its user base and reaching out to car companies that are expanding the use of mobile applications in vehicle computers.

“Given the challenges, Pandora is doing a good job,” Verna says.