The richest man will be the last one streaming

More firms are jumping on the music streaming bandwagon, even though serious flaws have emerged in the industry's business model. Only the most cashed-up ventures will survive the competition.

It is increasingly looking like the on-demand streaming music war will be a winner-takes-all battle.

There’s Spotify, with its reported $US250 million ($A273.1 million) in fresh funding and $4 billion-plus market capitalisation. Despite never turning a profit, the Swedish-based service has investors salivating, with over $US538 million in funding poured into the service since its inception.

Then there’s its competitor rdio, from the founders of Skype, which was reported by Techcrunch to have laid off 35 employees last week and has been searching for a new CEO since July this year.

The differences between the fortunes of these two companies are striking considering the differences in their product are minor.

With Spotify, you have a well-funded, high-profile business that has been deemed by many as a likely multi-billion dollar IPO prospect, which continues to spend money in overseas expansion and pile up losses. With rdio, you have a company with a comparatively miniscule $US17.5 million in total funding (just 3 per cent of Spotify’s figure), looking to the never-nice tactic of headcount reduction as a way of reducing cash burn.

There is also French competitor Deezer, which is claiming a paid subscriber number of over five million, placing it just behind Spotify’s claimed paid number of seven million. There are reports that its launch into the US market has caught the eye of Microsoft, who are seriously considering making a play to buy the service.

It’s an area that is moving quickly. But it also places incredible demands on capital. Ultimately, these services rely almost solely on the music of the artists it features. Without the catalogue, the services are empty utilities – and the labels know it. The labels are driving unsustainable royalty agreements with these services, which pretty much ensure that their costs will rise in line with their revenue, creating an unsustainable business.

Although right now, they can. Spotify, Deezer and rdio are engaged in a landgrab that they hope will result in one ultimate winner. As competition dissolves, the winner will seek to renegotiate their deals down with the content owners – the labels – and look to create a model where both label and service generate profits.

This competition is good for the labels so long as investors continue to plough funds into these services, despite no immediate profit upside.

How long this will continue is unclear. Despite strong consumer uptake, music streaming is a business that has so far failed to generate a return to investors in the form of profit. Most investors placing funds into these businesses are looking for an exit-based return. They are hoping that these services can scale into businesses that either make them appealing as an acquisition target for a larger media concern, or seek to float and effectively transfer the investment and return risk to the public markets.

Pandora is an example of a listed music service. It is not a streaming service like Spotify or rdio; it is effectively a radio station tailored to its individual users. It is listed on the NASDAQ and has a current market cap of $US5.37 billion. In the past 12 months, its shares are up 256 per cent, despite generating a net loss during that time of $US47 million on $US569 million of revenue. Investors appear more enthused with increased revenue and user numbers than they are scared by stubborn losses.

Is there room in the streaming space for three businesses with the same content, same advertising model and same end-consumer revenue model? Probably not. The likely outcome is that three will become two, with the premium and free users of the unlucky loser most likely gobbled up in a financial deal by one of the remaining two. The capital requirements of these businesses – in particular, the capital required to launch in new markets (not necessarily in headcount, but in music royalties) – will favour the well-resourced. The most resourced is most likely going to be the winner in the music streaming battle.

InvestSMART FORUM: Come and meet the team

We're loading up the van and going on tour from April to June, with events on the NSW central & north coast, the QLD mid-north coast and in Perth, Adelaide, Melbourne, Sydney and Canberra. Come and meet the team and take home simple strategies that you can use to build an investment portfolio to weather any storm. Book your spot here.

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free

Related Articles