Acquired - Spotify’s Direct Listing

0:00Did you read the mission statement on Spotify's F1? No. So whereas last week Dropbox's mission is to unleash the world's creative energy, Spotify is to unlock the potential of human creativity. You definitely should get some tigs in on them. Then unrestrained, hippie world out there. Welcome to season two, episode six.

0:38of acquired the podcast about technology, acquisitions, and IPOs. I'm Ben Gilbert, David Rosenball, and we are your hosts. Today, we are covering a company making history the week it makes history. Spotify and their direct listing, which is not an IPO. But if it were an IPO, this would be the largest IPO listing, whatever you want to call it, from Europe ever and the seventh biggest of all time.

1:07debuting at about roughly a $30 billion market cap. Wow. And almost a billion, a billion dollars worth of shares on the first day traded. Yeah, trading hands. Big company.

1:22big shake up in the industry over the last few years with the rise of streaming. And a big change to the way that the companies go public. So, David, I'm excited to dig in and help understand myself exactly why they did a direct listing, what a direct listing is, and it probably more importantly excited to hear from you more about the history of the company itself. Oh, there's always a story, Ben.

1:50All right, if you are new to the show, you should join us in our Slack at acquired.fm. There's over 1200 people talking about acquisitions, IPOs, tech news as it comes, and helping us do research for the show. And thanks to listeners who are throwing in some interesting stuff about Spotify as David and I were researching. All right, listeners. Now is a great time to talk about a new partner of ours here on acquired, LaGoura.

2:17the agentic operating system that is redefining how the world's best legal teams work. Yup, it's sort of obvious that AI is going to completely change the legal industry. I bet most of you listening have dropped a contract into some sort of AI chatbot out there. LaGora took that insight and asked the question, what if you really built something with that power from the ground up for the legal industry? So the founders did exactly what great founders do, operate with obsessive customer focus.

2:46They embedded inside a massive law firm for months. They sat with the lawyers just watching how the work really gets done. And that's how you get features that customers love, like tabular review, where you...

2:59drop in a folder of hundreds of contracts and it pulls every key term into a grid a lawyer can actually work with. Lugora's bet here is interesting. Since it lets each lawyer handle more complexity, any given person can increase the quality of their work and do higher value work, and this means that the pie can grow even as each individual task takes less time.

3:19And they recently launched LaGora agent offering greater intelligence and performance. The agent lets lawyers set an objective. Then it can handle the planning and the execution and delivery of the final product. Legal teams get to maintain full control and transparency since they're still involved where judgment is required. And LaGora works where you already work. You can use it within Microsoft Word while redlining or drafting. The early LaGora numbers essentially speak for themselves. When they have a head-to-head pilot with their top competitor, they win 70% of the time. Legora now has over a hundred thousand lawyers on the platform from 1200 legal teams in 50 countries. And crazily, they went from one million to a hundred million in ARR in about 18 months. Truly insane numbers. And that is the real test.

4:11Plenty of things demo well, but the question is whether a busy associate actually reaches for it during crunch time or whether a partner trusts it before going into a conversation with a major client. If your legal team wants to check it out, whether you're a law firm or you're in house at a company, you can learn more at logora.com slash acquired and just tell them that Ben and David sent you. Well, David, before we dig in, I spent a bunch of time, I think, As the news started to trickle out that Spotify was doing a direct listing, not an IPO, several months ago before they priced, before they had a date, before they had an F1, not an S1, to announce. Farron company issuer. Oh, oh. I didn't realize that the F1 is because they were not a US-based company. Not because of the direct listing, but because they are a foreign issuer. That makes sense.

5:03Before we dig in some things that you need to know about what is a direct listing or a direct public offering, which is not an initial public offering. The biggest difference is the company doesn't take any dilution. So if you're thinking about, what does a company normally do in the IPO? There's two big reasons. One, they create liquidity for existing shareholders. So everybody who's got stock sometime after that has the opportunity to sell that stock and get some liquidity on that. The other is that the company actually creates new shares. So all the previous shares get diluted. But the company gets to raise money. So they sell the new shares at the

5:41they've created, they raise millions and millions of dollars to have money in their coffers. With a DPO, a company doesn't take any delusion and they don't raise any money. So Spotify doesn't have a dollar more in the bank account yesterday from selling shares that they do today. I guess don't that. Don't create any new shares. It's literally just, hey, anybody who is a current shareholder can now sell. There's no lock up.

6:11It's just it's theoretically less expensive of a process because you don't have to go do the whole road show and hire bankers and all that which we will get into also. But one thing that was interesting that I was sort of thinking through is one disadvantage is that if you are a buyer of this stock.

6:29You have to consider the fact that an insider, somebody who previously had information rights to the company or might be an employee of the company is selling. So you actually have a counterparty who's probably more informed than you on every single transaction of shares in these early days of trading. Yep, very true. On the other hand, you know.

6:51Spotify is a 12-year-old company certainly the founders and employees early investors they want liquidity and also you know we'll also talk about this but there's been a robust private market for Spotify shares for many years so trading has been happening there has well before we go into the history in fact I found one fun bit of trivia David, there's a very famous company that did a DPO in the 80s that sort of popularized this. Do you know who it is? I do not know. So in 1984, Ben Cohen and Jerry Greenfield needed funds for their ice cream business. They advertised ownership stakes through local newspapers for $10.50 per share with a minimum number of 12 shares per investor and their Vermont loyal fan-based

7:42ended up funding Ben and Jerry's ice cream in a DPO for its first way to raise capital, raising only $750,000 from 1,800 ice cream loving vermonters. Oh my goodness. Talk about an addictive product. I know. Addictive and viral as we will get into.

8:04That's right. And interesting to know, we'll come back to this later. They then did a $5.8 million IPO the following year. So they actually did issue new shares once they were their public. So took that one away and let's dig in. All right. Well, history and facts. So as probably a lot of people know, Spotify is a Swedish company or founded in Sweden.

8:29not Switzerland as the New York Stock Exchange learned this week, unfortunately. Sweden is a different country. For those who didn't see the news, there's a chance that a Swiss flag got raised at the New York Stock Exchange. Somebody was in hot water. We'll come back to that at the end of the show. But it was started in Sweden by two co-founders, Daniel Eck and Martin Lawrence.

8:57started in 2006. Daniel Eck, the CEO, who's still the CEO, was kind of like a wonder kind of the Swedish tech scene. He started his first company when he was in school at age 13, hired all his classmates, a lot of fun history, which we'll get into. But to really understand Spotify, you have to go even farther back and start with another company.

9:21that we've also discussed on this show a little bit. A interesting footnote of history called Napster. Yeah. Who would have thought that the very thing that destroyed the music industry and brought the record labels to their knees could possibly have a hand in saving them?

9:49Unfortunately, it was the record labels that brought Napster to its knees. But as we shall see, there is a very direct and straight line from Napster to Spotify to today. So Napster founded in 1999 by the Sean's, Sean Fanning and Sean Parker. Sean Parker is SEAN. Sean Fanning is as H-A-W-N.

10:13And then also a third co-founder who doesn't get talked about as much but his friend of the show, Jordan Ritter, who's based in Seattle now. And there's a really, really good internet history podcast episode with Jordan about the founding and early days of Napster all the way through the lawsuits with the record labels and shutting down and the aftermath.

10:34I highly recommend that if you want more detail than the couple minutes, we're going to spend here on Napster. Go listen to that episode on Over on IHP. Sean Fanning started Napster originally. He was a college student at Northeastern University in Boston. He and his friends, he was really into hacking computers. This was the late 90s end of 98, beating in 99.

11:03Really into hacking, he was really active on IRC and in a bunch of communities and forums, sort of trading programs on the internet. And especially on broadband. So these were the days most people at home had dial up, but colleges all had broadband. And so having, I was sort of on the tail end of this, but I remember the biggest attraction to going to college, there was the education and all that, but there was getting broadband internet.

11:32stealing files on the internet. Yeah, I remember evaluating colleges based on that. Like they thought it was the most ridiculous thing, but you know, nerdy kid going into computer science. I remember asking like on tour guides like, what's the bandwidth in the dorms? And it was the whole remember the internet too, that was like a separate backbone that only Call it universities had that was like a faster private internet linking universities. Anyway, this all plays into an appster. So Sean is, he's on active in all these online forums. He's trading files, but the including MP3s, which people are ripping from CDs, you know, this is big. This is the iMac, you know, and all this is happening. Rip Mix Burn. Rip Mix Up Wait. I mean, don't rip because that would be illegal. Yeah, don't burn. Use iTunes.

12:26by your music. So he realizes there's no good front end to this stuff. So he's like, okay, I'm, well, I'm, you know, I'm a CS major, I'm going to start coding up a front end client for trading files, peer-to-peer on the internet. He decides to call it Napster. He releases the first version of it and it basically just takes off like wildfire. First at Northeastern, you know, a college in Boston, this will, we will revisit social apps on the internet.

12:55starting at colleges in Boston and taking off like wildfire. Spreads lots of other colleges all around the country. He brings on two folks. One is Jordan Ritter, who's also based in Boston. He takes over back in programing. And another friend that he has from the IRC Internet Relay Chat community, a guy named Sean Parker. And Sean joins and he's basically kind of the business head of Napster.

13:25Parker was, you know, he's kind of like a hacker hustler guy. He had a whole bunch of internet businesses that he started in high school. He decided not to go to college. Apparently he was making like 80k a year while he was in high school just from internet businesses. So they, uh, the three of them get going. They raise $50,000 from Fanning's uncle and they move out to Silicon Valley. Uh, and kind of the rest is history again. You can listen to the IHP podcast, but basically within a span of two years, from 99 to 2001, Napster goes from being like the killer app for broadband. I mean, this was the reason I pressured my parents to get broadband at my house when I was growing up. So I could use Napster or use it better than dial up. You know, they get sued by all the music labels and the company shuts down and kind of flames out in a blaze of glory all within about two year period. So 2000.

14:19Well, the ashes of Napster kind of live on. It gets resurrected as well. No, but I mean, I'm thinking about the time in my life where I was actually using like Napster Napster and I had a zip disk that I would store my music on when I would download it. And I would like, you know, those are only a hundred megs. I'd like delete the old music that I didn't want anymore so I could get the new songs off Napster. But the I can't believe that was only a two year period. I know. It was crazy. Well, because the labels sued Napster. They couldn't work out settlements. They sued Napster. They sued all of the individuals who were working at Napster, all the founders, all the investors, the LPs of all the venture funds, like they just went nuts. Oh, my God. And so quickly, and what happens, you know, I remember this, I'm sure you do too, is Napster gets shut down. But then, you know, a million flowers bloom in its place. Yeah, a lime iron.

15:12because all this stuff, because that leads to Skype, which also will influence Spotify, which we'll come back to. Anyway, Sean Parker, though, he exits Napster after all, this is happened in 2001, but he doesn't, you know, he does, he's not one to rest on his laurels. He founds a company called Plaxo, which we've also discussed on this show out in Silicon Valley. They're all out in California now. 2002 starts Plaxo.

15:40gets backed by Sequoia, raises money from Sequoia. I believe Mike Moritz is on the board. But Sean's still a kid, and he's running this now sort of enterprise email identity company. He ends up getting pushed out after the downturn in 2004, Sequoia and the other board members push him out of the company, leads to a whole lot of animosity.

16:07Ultimately leads to the infamous Facebook pajama pitch to Sequoia That is covered in the social network, which we'll get to too So Parker's done and real briefly for anyone who doesn't um, who doesn't have the time to go check that out. Basically, uh, Sean Parker swore that when he was getting involved with Facebook, they would never go and, and give Sequoia a piece of this. And finally, uh, Mark Zuckerberg, um, is, is persuaded to go and pitch Sequoia and shows up in his pajamas as a show of true respect. Yes. Two, two respect. Now infamous in Silicon Valley lore. Um, so Parker's pushed out of Plaxo, doesn't sit still for long again. He supposedly, his roommate at the time, is dating a girl who's a student at Stanford, an undergrad at Stanford. And Parker sees on her computer one day a site called thefacebook.com.

17:11And this gets dramatized in the movie, The Social Network, where Parker is played by Justin Timberlake of all people. And it's so good. A girl, he has a trist with a girl on the Stanford campus and then sees it on her computer the next morning. Supposedly it was actually his roommate's girlfriend. But anyway, next thing you know, Parker basically hustles his way into meeting with Mark Zuckerberg and then Facebook co-founder Eduardo Saverin, because Facebook is still back on the Harvard campus in Boston. He goes to New York, he arranges a meeting with the two of them. This is all documented in the social network, the company's a few months old. And he basically talks his way into joining the company as its president. And Parker has also become close with Peter Teal at this point. Founder's Fund doesn't exist yet, but PayPal has already exited eBay and Peter is now investing in the PayPal Mafia and other folks.

18:09and Peter ends up leading the first true investment in Facebook by his 10% of Facebook for $500,000, a quite pressure move. And then we all know what happens after that. But I think, yeah, I think Facebook, I think it worked. That'll be a story actually that we have already told. You can go listen to our episode on the Facebook IPO, but I think everyone knows what happened.

18:38For Parker, though, in the next year in 2005, you know, remember, he's still super young. He's got to be like, I don't know, 24 or 25 at this point. He has a party at his vacation home in California, ends up getting busted by the police. They find a bunch of drugs at the party. And as a result, he gets ousted from his role as president of Facebook. Again, all this is in the movie in the social network.

19:06So that was on Parker. Sean Parker was born in 79 so that would mean all this is going down in what 2005 so he's probably 26. Yeah. Yeah. Some more somewhere between 25 and 27. So he's like the adult supervision at Facebook. It's kind of a miracle that Facebook survived all of this because we'll get into some more stuff here. So, you know, Parker, again, doesn't sit still for very long. He joins up with Peter Teal, who had just, at this point, started Founders Fund, the VC firm that Peter started. And after the Facebook investment, Parker joins in 2006, but he still has music and Napster kind of on his mind. And if you remember, Facebook, in the original early days,

20:00Facebook was actually the Trojan horse to realize what supposedly was Mark Zuckerberg's true vision, Wirehog, which was Wirehog. Yeah, that's right. They were co-developing. I think when they were...

20:13when they were working on they were even doing this in California I think after they had moved out they were working on both Facebook the social network and wire hog the music sharing network and we're going to deploy wire hog to everyone who had signed up for Facebook to be sort of the the exactly David the Trojan horse the way that you you bring p to p to the masses yep exactly and remember Facebook was only a college is at this point in time it wasn't open to the whole public and And so Wirehog was essentially Napster 2.0. It was file sharing, but mostly primarily music and then video file sharing had become big at this point. Bit torrent and other applications were very popular. And so actually that pitch to Sequoia, the infamous pajama pitch that Mark Zuckerberg and Facebook did, supposedly they primarily pitched Wirehog, not Facebook. Wow.

21:09But Parker, you know, he's lived through all of this. He's been sued by the music industry by all the labels had Napster killed. He kind of says, like, look guys, like, now is not the time. Someday, Wirehog Napster, it'll all come back, but, you know, the industry has not changed enough. We're gonna get sued.

21:31The Facebook is working. Let's do that. Let's kill Wirehug. So supposedly Parker was the one responsible for either before or after he left. He stays really involved in the company even after he stopped being president. He's the one who kills Wirehug within Facebook. All right, listeners. Now is a great time to tell you about a longtime friend of the show, Vanta. AI has scrambled the whole security picture. It used to be that you proved that you were secure once a year on audit or a static PDF, then everyone would nod and you're done.

22:01But in an AI first world, that doesn't hold up anymore. Yep, your risk surface changes every week now. A vendor turns on an AI feature or someone writes in a new model without telling IT, and your posture is different than it was last week, let alone at your last audit. Vanta's own research found that around 70% of companies have this quote-unquote shadow AI running with no security review at all. Right.

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22:48Which is exactly why more than 16,000 companies today run on Vanta companies like ramp cursor and snowflake all stay audit ready and catch the risks that crop up between audits across every vendor every AI tool the whole environment and that's the real value.

23:07Trust has to be continuous now, which is why Vanta automates your security, your compliance, and the work to earn and prove trust. We're huge fans of Vanta over here and literally hundreds of acquired listeners have become Vanta customers at their companies over the years. So you can get a thousand dollars off Vanta at Vanta.com slash acquired. That's V-A-N-T-A dot com slash acquired for a thousand dollars off and just tell them that Ben and David sent you. All right, so chapter one.

23:36Sean Parker starts Napster and that gets brutally murdered by the Music industry chapter two Facebook in its own success Becomes the dominant thing and there's there's no reason to focus on wirehog there Yep with their chapter three So for chapter three we come back to Sweden now and to Danielek the CEO of Spotify so Daniel As we said, he started his first company in 1996 at the age of 13. He was in school. It was a website web developer for clients, sort of like Tony Shae and the Zappos guys when they moved out to California. Yeah, man. That was the thing to do in high school.

24:29You could make way more money than anybody else because it was this highly valued skill It was the work didn't have to be good like there was no good I mean, there's no like modern frameworks for doing any web development then so you just throw something together and and adults are amazed that their businesses on the internet There's no square space at this point in time now So after a couple years Daniel's making like $50,000 a month and has 25 employees. He's still a early teenager. He does go to college briefly. He goes to the KTH Royal Institute of Technology, which is the top engineering school in Sweden. But he drops out. He wants to focus on startups. He joins one startup called Tridera and ends up getting acquired by eBay. Then he becomes the CTO of a virtual world game called Star Doll. Remember when virtual worlds were a big thing.

25:25Yeah, I don't know about you, but I still spend most of my time in Second Life, David. Yeah, you might be just about the only person left who does that. Then after that, he starts an online ad company called Ed Vertigo, gets acquired by a company called Trade Doubler, which is also a Swedish company.

25:48that is sort of like the PayPal Mafia, or I would, we at Wave would say the Airbnb Mafia of Sweden. And then after that, finally, trade-double or we'll come back in a second. But after that, finally, Daniel becomes the CEO of a company called U-Torrent. And U-Torrent is a bit torrent.

26:08client. So now BitTorrent is basically it's a it's a PewDiePie file sharing protocol that is the spiritual successor to to Napster to Kizah to Limewire to sort of the first generation of file sharing companies. And BitTorrent is I don't know fully the technical details, but essentially it shards files, makes it a lot easier to transfer very large files between users. So people are using it for music, but now people are also using it for video movies, television shows and the like. Yeah, it has the major benefit of you being able to concurrently download multiple pieces of a file from different sources. So rather than David me taking up the

26:52hogging the entire way to download that one file that you have, I can split it into 100 pieces and grab 100 pieces concurrently from different people. So the more people that are hosting the file, the more people that can share to the network. Yep. The faster it all moves. And so this is UTorn's based in Sweden. Later that year, this is 2006, after Daniel becomes the CEO, it ends up getting acquired by BitTorn. And this is like, piracy, you know, which started with Napster has now reached like a fever pitch. There's actually, I had forgotten about this. There's a political party in Sweden that is formed, a legitimate political party called the pirate party. And they're all, I do remember that. Their platform is like eliminating intellectual property rights from the law, period.

27:44globally and and like there are a lot of people that support this apparently in in the you know national elections at the time they get about seven percent of all votes in the country it's crazy and so like you know everybody this is the music industry has been decimated at this point um you know people are worried that Netflix has transitioned into is starting the transition into video streaming uh people are worried you know bit torrents out there people are pirating movies you know what's next Basically, there's no, there's no hope in sight for intellectual property on the internet. So, so has Apple ridden in on their, their white night horse yet? Oh, yeah, totally. 99 cent downloads. 99 cent downloads. So iTunes, you know, it's hailed as the saver of the music industry. But easy beats free, the classic Steve Jobs is them. Yep. But

28:36iTunes is still and until the beats acquisition which we covered it's still in the purchasing music paradigm where you're paying money per file and then you can play that file anywhere but it's only one song or one album it's not like the best experience and this is where Daniel actually can't play it anywhere it's like I mean, until they switched to the DRM free for the $1.29 instead of the $0.99 stuff, it was still restricted to five devices that had to be authorized in kind of a clued-view way. You literally had to transfer the MP3 around because the cloud hadn't really blossomed yet and certainly not streaming. So if you think about sort of step functions to the user experience, I'd say iTunes was like 20% better because I didn't have to

29:28go into shady parts of the internet to try and find this music that fell off the back of a truck. It was like right in my music player, which is great. And you knew it was the right song, you know, the true. Right, right. All the crappy files you'd get from Napster and, you know, because it's like, it's like somebody like playing, like, playing something out of their computer speakers and then re-recording it onto a separate thing. So this weird like hiss in the background. It was great. But it really wasn't, you know, it wasn't a whole step function better. It was, you know, easy, sure it beat free, but it wasn't a paradigm shift. It was still like the same way that I'm all the same downsides of transferring an MP3 around, but with the new downsides where it also costs money. Remember organizing your iTunes file library?

30:15I want my life back. I want all those hours back. I meticulously cared about this. For a while, I'll try to get some of those software, some of the programs, I think something about a brain, like brain, sound brains or something that would go through and help you by recognizing the audio signature and filling it in. But even that was wrong. And I'm so obnoxious and meticulous about keeping that stuff accurate that I have spent weeks.

30:45cumulative weeks of my life. I think this was probably like the biggest, you know, wound inflicted on our generation was that like, you know, all this product, potentially productive time that we could have been spending playing video games, you know, which we were doing the rest of the time. We were organizing our iTunes file.

31:04I thought I was gonna have that with me for life. Like, I remember, you know, you look at your dad's record collection or, you know, my, my parents also had this, like, rich CD collection. And I'm like, this is the way, like, this is my music collection that I'm gonna carry with me forever. And I remember, I mean, we're, I'm jumping a little bit ahead, but I remember this moment a few years ago where like, I got a new computer and I didn't transfer my iTunes library over. I just like, have it on an external hardware. It was around my house. And it was like this painful, incredible illustration of sunk cost fallacy.

31:33where I just, I like, I'm like mourning the fact that there's these hundreds and hundreds of gigabytes that I'm just not, not bringing with me into the next chapter of my life. And, and, and did anything bad happen from it? Like, no, I have access to basically, I think all of that music, except for sort of some, you know, live stuff here and there and some covers and all that. But like, you know, I hadn't, I hadn't opened.

32:01iTunes and listened to any of that in years. Yep. Yep. So this is really the insight that Daniel Eck has, which is, which is too prompt. It's that the user experience for music is not just that the industry is broken, but the user experience is broken. And iTunes is not great for all the reasons we talked about. But piracy.

32:24isn't great either, you know, bit torn and all the spiritual successors of Napster. You still have the same problem, you gotta manage the files, you don't know what you're getting. It's really, it feels like, you know, all of this feels like technology that's not like product-ized. And so he has the vision that there's a better way and there's actually a better way to consume music.

32:49that is better than pirating better than iTunes and that is what becomes Spotify. So he decides, yeah, the music industry is hard, but I'm just gonna go for it. He teams up with Martin Lawrence and his co-founder, who was one of the trade doubler co-founders. Remember, trade doubler had acquired Daniel's last company before he joined U-Torrent. They fund the company themselves, they figure they can raise venture capital and they'll do some deals with record labels, get launched, they have this new paradigm for consuming music, of course everybody's gonna see how much better it is, and it turns out it's quite a slog to get the record labels on board. So this was shocking. Yeah, shocking. So this was 2006 when they started the company. Apparently the name Spotify comes from their in Daniel's apartment, their brainstorming names for the company, they're sitting in different rooms and they're shouting back and forth,

33:46with suggestions, Martin shouts something, and Daniel mishears it as Spotify. And immediately Googles it, realizes that the domain name is available and thus Spotify. I love these stories. I do. Like of how these things kind of be. They later, they later try and justify it as like, well, it's a mashup of spot and identify. But No, that's, that's not what happened. It's like, it's like, uh, Pyramiddy are when asked in all hands meeting after the eBay IPO. What does eBay stand for? He was like, well, I was kind of, I've been trying to tell people that it's like electronic bay, but I just thought eBay sounded cool. Totally. Um, so they build, uh, they build the product. Uh, they're working with the labels, um, but it takes, as I said, forever. Um,

34:37to get any deals done and the labels in particular don't want to go anywhere near giving the rights to streaming to the US. So it's actually really fortunate that the company starts in Sweden because eventually after basically two years, they're able to convince the record labels to let them experiment with this new paradigm of streaming. Remember Netflix is already around at this point, like the model is proven, but only in Sweden. They won't let them do it in any other companies. So finally, Finally, in October 2008, so almost two years after they start the company, they launch in Sweden with free accounts available by invitation to everyone. So they use the invitation, you know, growth hacking method for free accounts. But if you want to pay to subscribe, anybody can come in and pay to subscribe. So it's like, you got to be part of the club to get in for free, but you can bypass the line if you pay 10 euros a month to subscribe. That's a great

35:38That's so interesting because it does, I mean, it hits that critical mass where if you're using a viral invite system like that, it's not hard to find someone with 50 invites to Gmail anymore. But at the beginning, it's so coveted if you care about being on it and that social. I mean, that's, it's so clearly not gonna be a long-term revenue strategy, but it's like, hey, if people will pay for this now, we may as well do it. Great way to start. Great way to start.

36:01Shortly thereafter in February 2009 They launched in the UK and then they slowly kind of roll out in Europe after that But it's it's really working and it's growing As a personal aside here, I did a summer internship with exact targets UK subsidiary in summer of 2009 and I remember reading all this articles in TechCrunch and 08.09 about Spotify and what a disruptive innovative thing this was and sitting in my dorm room in Ohio State being like, I feel so disconnected.

36:36Like, you know, I'm here manually curating my iTunes library, and like I keep hearing about this streaming music thing. And it was like the most awesome experience to go and do that internship in London and get to use Spotify. But then when I came back in September of 2009 to get plunged into the dark ages back into the US again, it was this really weird experience. Yeah, totally. Well, so summer 2009, this is when Sean Parker comes back into the story rises from the dead yet again a rides back in from the sunset on his horse so spotifies growing across Europe their labels are slowly letting them go into more and more countries and towards the end of the summer they end up raising $50 million in what was their series B at that point from Wellington partners the hedge fund and Lee caching the

37:31the wealthy Hong Kong-based billionaire, but Sean Parker, so at some point, at some point Daniel comes to Silicon Valley, comes to the US, and he meets with Mark Zuckerberg and Facebook, and apparently Sean Parker's there too, and he's like, this is it. This is Napster 2.0, this is the way to do it.

37:59But they just closed this round, this $50 million round. Sean at this time had joined up with Peter Teal as a partner at Founders Fund. And so Sean writes Daniel this email. And we'll link to it. I believe he hadn't met him because in this email, he says, I look forward to meeting you in person. I really liked this, but I look forward to meeting you. I see all these anyway. So maybe it was that Daniel met with Zuck and Zuck told Sean Parker about it or Whatever Sean Parker went crazy. Sean Parker goes crazy. I fell in love with this thing. Totally falls in love with it. And so he writes this email which is online on the internet published for posterity. We'll link to it. It's amazing. And so I'm just gonna, I'm just gonna quote liberally from this email here. It starts off with, you know, I've been playing around with Spotify. You've built an amazing experience. As you saw, Zach really likes it too. I've been trying to get him to understand your model for a while now.

38:57but I think he just needed to see it for himself. Facebook has been in partnership discussions with various companies to fully integrate music download with the Facebook profile. Most of these deals would have resulted in the wrong user experience, and I've done my best to stop them where they didn't make sense. Remember, Parker has no formal involvement with Facebook at this point in time. In particular, there's no way that iTunes could enable the right experience on Facebook.

39:23and he continues, he says, ever since Napster, I've dreamt of building a product similar to Spotify. What's clear, go for it. What's clear is that the labels never quite understood the way people really consume share, consume share and experience digital music and they couldn't admit to themselves that this behavior pattern wasn't changing any time soon. Rather, they'd have to change their the way they did business essentially to make it work.

39:50and these are so clearly two kindred spirits like the way that Sean Parker thinks about music and the way that Daniel like thinks about music like it is you are when you read this thing you're sort of reading the future product roadmap for Spotify as laid out by Sean Parker which I'm sure Spotify had already thought through and if you if you find if you find the content of this episode interesting you'll just like like love every word of reading this so go check it out in the show notes well this is what's interesting so I don't know it It's probably impossible to know whether Spotify had already had on their roadmap all the things that I'm about to say that Parker lays out. But essentially this is the first key to Spotify was what we talked about earlier, which is really getting the product experience right. It's a better product experience than either iTunes or piracy because you don't have to worry about organizing in files and all this just right there at your fingertips wherever you are on any device. That's great.

40:47But that's only the first thing. The second key to Spotify is Facebook and Distribution. So Sean and his email to Daniel says, my goal for the second generation Napster, once we'd gotten around to cleaning up the messy interface, which he actually rails on as an aside. He rails on Napster's interface for most of this letter. He so clearly holds himself as like a product designer and is just massively ashamed that they weren't able to sort of clean it up. Anyway, which is funny because he was I mean, he was technical, but he was basically the business team at Napster. He was not the product designer. Yeah. So my goal for the second generation Napster was to implement social and sharing features. This would have dramatically increased the volume of sharing happening through the system. Based on the comment you made to Zuck, I suspect you're moving in this direction. You should build this capability directly into the client using Facebook to connect to authenticate and then leveraging the viral communication channels to spread Spotify rapidly around the world.

41:46He says you guys are likely going to be the first major success story with Facebook connect which Facebook had just launched which was their login platform and he says if you need some on its own has been has been quite the topic of discussion well Cambridge Analytica and all that and he says if you need some help navigating Facebook platform in particular the viral channels I'm happy to lend a hand and This is really how Spotify becomes a 30 billion dollar company So, also, this email is a master piece of, you know, if you're a VC and you're trying to get yourself into a deal, an investment or when a deal, like, this is how you do it. Take notes. Because shortly thereafter, Founder's Fund comes in and John adds another 15 million to the round that was already closed. Daniel says, of course, you know, I need to have you involved and then Founder's Fund and John end up investing. But this is it.

42:45At this point in time, this is the end of 2009. The company Spotify believes they're about six weeks away from being able to launch in the US. They've been working on deals with the record labels forever. Sean knows dealing with the record labels takes longer than you think. He thinks it's about 12 weeks away. In the next quarter, they'll get out in the US. Turns out to take another two years until they're finally able to launch in the US. It's not until 2011.

43:12But that also is very fortuitous for the company because they basically take those two years and they do two things They foster their relationship with Facebook through brokered through Sean Parker and they essentially re-architect the entire product to rely on Facebook connect and social login and then distribute every action that every user takes and we'll get into this within Spotify gets distributed out to their Facebook account to the newsfeed. And this is really what drives Spotify's viral growth. This is, you know, it's the Farmville for Music. Like you really are just seeing every update that every one of your friends takes in Spotify in your newsfeed.

43:59Ben listen to Wake Me Up before you go. I mean, I seriously, I remember turning publishing on and off specifically when I was listening to certain songs. I hope this doesn't go out on my Facebook. And I was one of those people, David, did you ever use audio scrubber or last? Yes. Last and last or move with, yeah, merge with last FM. I was like, I had that hooked into iTunes so I was always scrambling to my last.fm account and then when I realized so that I enabled the switch for that to get published to Facebook but like no one else.

44:32It was very much a homebrew computer club type thing to be sharing all your music data on Facebook before Spotify. And then I remember when Spotify lit up in the US it was like holy god every single person's listening habits are showing up here in real time. You know it's either like you farm a root vegetable or you listen to what was popular music at this point in time.

45:00So hard to remember. Justin Timberlake. Here's the thing that's actually not hard to remember is I'm pretty sure I I heard a great quote once that was your your music taste for the rest of your life is whenever you're listening to senior year of college So I would bet if we go look at what you and I actually listen like I was listening to a ton of radio head and when I listened to today a lot of radio head. No, I think It's so it works colleges. That's why it's important. It sets your habits for life So 2011 basically Spotify's now had time to build this relationship with Facebook and in July of 2011 they launched in the US but September 2011 is the biggest moment in Spotify's history and that is 2011 Facebook F8 their big annual conference during the keynote Zuckerberg invites Danielek up on stage and announces a major partnership between Facebook and Spotify

45:59And it's two things. One, at that FE, Facebook had announced a launched Open Graph and the platform, the year, well, the platform launched many years before, but Open Graph launched the year before, that basically allowed lots of people to now insert activities that people were doing in non-Facebook apps like Spotify, Lake Zinga into the newsfeed. They launched the ticker.

46:23in 2011, which is basically like a real-time fire host stream. I think this was kind of in reaction to Twitter of everything, literally everything, all your friends and just streaming by you. It was like that little, you had your regular newsfeed, but then up in the top right corner, you also had the real-time ticker. Yep, and it was basically just garbage that got overwhelmed with marketing that all these companies were hacking into Facebook.

46:49But so in this partnership, not only is Spotify a launch partner for the ticker, so what all your friends are listening to, playlists, they're making everything, is getting pumped into the ticker and the newsfeed. They also, if you have Spotify installed on your computer and you're on Facebook, there are play buttons on all of these things. In the ticker and in the newsfeed, you just click the play button on the song. Right within Facebook, it starts playing the the music. And so if you don't have Spotify installed, this is a big incentive to now install Spotify. And you know what, we sort of, what's the right way to say this? We sort of criticize and poke fun at the, wow, they really hijacked Facebook for this purpose. But this is like the exact perfect product usage fit match where

47:47It was an amazing, amazing experience as a Facebook user to suddenly have, like, real-time music available as a play button from that little thing. Like, at the very least, it was super valuable to see, to have social music recommendations. And this is a thing that, like, we, it's sort of assumed today that's, like, Oh well Spotify's cool playlist will show me what my friends are listening to or based on my listening habits or You know a friend will tweet out what they're listening to but this was like so crazy breakthrough that I It basically takes the way that people used to word of mouth recommend new albums to their friends or old things They had found that were cool and and bring them into the primary way that you were interacting online and I just think like

48:37It was a brilliant move on Spotify's part to be able to get this distribution and You know partner with Facebook in this way, but Talk about a perfect a perfect reason for Facebook to have a platform Yeah, like Facebook was never gonna do this. They can't wire hog they had a million other things to do and and this made their service so much better at least in, you know, maybe not as crazy as they went with the implementation, but this notion of being able to experience my music based on what my friends are listening to. Actually, I think you're right. Like it is unfair to lump Spotify into this whole group of companies. Zingha being, you know, primary offender number one of just hijacking the newsfeed. Like it actually was a pretty good product experience. Now do I care that like Ben is listening to wake me up before you go or somebody I went to middle school with is like,

49:28No, so they overdid it, but like this, and I think you see this now, like of all these companies and there was a whole wave of them, you know, Zinga, there were a bunch of social newsreader apps, there were social shopping sites, like all this stuff. All of these companies are dead because they weren't actually like useful products that people wanted. But Spotify is still around and there's a $30 billion company now. It's like the only, what, I mean, Zinga's still around, but...

49:52That's mostly because of their real estate holdings. One other point on Spotify is, while it's significantly ratcheted back on Facebook, you don't really see this in people's news feeds anymore, Spotify themselves gained enough of a critical mass where most people, or let's throw out most millennials in the US who are going to be on Spotify, are on Spotify?

50:18I don't know if that's a totally fair assumption, but let's just take that at face value for the moment. They have that experience in the sidebar on Spotify where you can see what your friends are listening to that is snagged from the Facebook friend graph. And so, you know, they're not using it as it necessarily as a growth vehicle anymore, but I would say maybe once every other week or so, I will listen to a song because it's in that sidebar on Spotify and it's still Um, you know, harkening back to that, it added to the Facebook experience. It adds to the Spotify experience to have a current view of what your social network is listening to. Yep. Yep. Well, regardless, it certainly works for Spotify. So basically overnight, like, I mean, literally in 24 hours, they get a million signups from this, because it's all over everyone's new speed. Wow.

51:11And then within the month, they've doubled their user base. They were almost doubled. They were just over 3 million users. Primarily across Europe at this point in time, they just launched in the US. And by the end of September there, I believe over 6 million users. And over 2 million of those are paying. So. The US is a heck of a market to enter. Yeah. Well, especially on the back of Facebook and Mark Zuckerberg, bringing you on stage on the keynote.

51:40Right. So two million of the six million from the US were premium. That was worldwide. So six million worldwide, two million paying premium. And that's a lot of money. That's also, that's not so different from today. I mean, today it's in the high 40%. But I mean, it's really interesting. From the earliest days, they had an incredibly well converting freemium model.

52:06incredibly well converting and they tweak it over time so originally it was free to listen on desktop and then you had to pay to go mobile they tweaked that so that it was free on mobile as well but only shuffle mode so you couldn't you still can't pick specific songs you can only shuffle playlist yeah it converts really well so basically you know on the back of that like that's the rocket fuel that that Spotify needs to reach escape velocity and take off into the large company it is today. So they finished 2012 the next year with 20 million active listeners, so huge growth, like over three X from 2011, five million paying subs, so almost three X growth on paid, one million paying subs in the US at the end of 2012. And then they just start raising a ton of money to keep pumping it into marketing.

53:03And product development, too. 2012, there is 100 million from Goldman Sachs at a $3 billion valuation. 2013, there is 250 million at a $5 billion valuation. They also...

53:14funny aside, kind of just like Dropbox. This is the era when everyone wants to be a platform. So Spotify also gets caught up in this, builds the Spotify platform, allow app developers to build apps based on music. It's like, wait, really? Yeah, of course, this is all buried in history now, but. Completely missed that. Lots of hype. They launch it late 2011. They kill it in 2014, but it's like, this is the future, you know, you can build apps with music. And it's like, what? Anyway.

53:44Fortunately, it's so funny to watch these companies try and launch these broad-based platforms that don't make sense, and then you kill it, and then yours down the line, launch another platform that is highly targeted, something that really makes sense. Spotify Connect today is freaking awesome. The ability to play Spotify out to various partners, Sonos, and everyone that can hook a speaker or a playback device into Spotify, it works so well.

54:09Turns out that was the killer way to integrate with Spotify for things coming out of Spotify. Yeah. Yeah. Totally. But they get there. And they just keep raising more and more money. They ultimately end up raising, I believe, about two and a half billion dollars in the private markets. They also in late 2015 and then into 2016, as, you know, Facebook is now no longer Facebook is vastly locked down its platform. You're not getting all this crazy distribution. They really catch the next wave really well too and time it well with machine learning and recommendations. They launched the Discover Weekly playlist, machine learning generated algorithmically generated playlist unique to each user with new songs that they think you like or songs that you don't know well that they think you like. They launched that at the end of 2015.

55:01radar, which is new music from artists you like, launches in 2016, along with the daily mix. And this drives kind of the next wave of growth in the company and engagement. And so by the end of 2016, they have 40 million paying subscribers, which like, that's a huge growth. And just to take a pause on sort of...

55:24internal innovation it's worth pointing out that the Discover Weekly playlist was a like very much an experiment within the company before they launched daily mixes before they came out with release radar before that got promoted to like a first-class thing on the home screen it was just one of the playlist available to you like 70s 80s 90s Discover Weekly and They had this framework which were playlists on which they could sort of test this new concept of can we algorithmically generate Stuff that people will want to listen to and be accurate in that and improve in that and it's really interesting I mean the innovation that the company had that they have sort of a few innovations over their lifetime But that ultimately made them a $30 billion company It was streaming should be the way that this that this world works and we're gonna persevere with the music labels to make that happen Facebook is this amazing distribution vehicle so we're gonna you know that that's

56:17that's our sort of innovation number two. And we're in the wave of number three right now. And they really had a nice framework internally to be able to not only test something, but then like now we're seeing really double down on it as it was working and promoting it to like a first class piece of the platform. Yeah. And I think it also, it's a good point. We didn't really cover earlier. This has always been a thread through Spotify's product history.

56:42is best expressed in these playlists and discover weekly in radar and daily mix, is this idea of the playlist? Playlists had been around since recording cassette tapes in the 80s, and then certainly iTunes had playlists, but what was great about Spotify is they really made playlists the first classes, and this was part of what they...

57:04got the labels back on board with is, whereas iTunes is a singles focus, like you are buying individual songs. You can buy albums, but like people buy songs. With Spotify, the focus is on playlists, and that kept people engaged, engaged with artists, and listening a lot more. And when the labels were getting paid, labels and artists are getting paid based on number of streams, keeping people streaming more, listening more, aligns and send them is a lot better.

57:34Absolutely. So end of 2016, 40 million paying subscribers. Now, some of those are family plans, some of those are student plans. We talked about this in the Beats episode. You know, it's not quite fair to say that you just multiply that by 10 and that's how much they're $10 per month or euros per month is the cost and that's how much they're making per month. But even if you multiply it by five, be really conservative. That's $200 million or euros in subscription revenue per month. That's a lot of revenue. I mean, that is a serious business. Wouldn't it be great if they could keep a ton of it instead of just like 10% of it? Wouldn't that be great? Well, they keep 30%. Yeah. Well, ultimately, so I guess where I was going with this is ultimately there during that year and in 2016, they're

58:29gross margins on the premium stuff is 16%. The ad consolidated stuff, they actually lose, sorry, the ad supported stuff, they actually lose 12%, so it's a negative 12%, gross margin, and their consolidated is 14%, which jumped up the next year due to sort of a deal negotiation, but the thread as we get into sort of narratives around the IPO, which we'll go to in a few minutes, I'm sorry, the the direct listing, not the IPO, is certainly that it's incredibly low margin business relative to a lot of these other technology behemoths that have really become huge in the last few years. Well, to get us there quickly, companies growing.

59:18As we mentioned earlier, there's always been a robust secondary trading market for the stock. They've raised all of this money. They don't need to raise any more money. We'll get into the business model in a minute in narratives, but at the very least, they have a very nice cash flow dynamic where their subscribers pay them up front every month, the $10 or $10 a month subscription fee. They don't pay the revenue share.

59:44Spotify doesn't pay the revenue share out to the labels until after the end of the month. So just like Amazon in this regard, they have a positive or a negative working cash flow cycle that allows them to be cash flow positive even if they're not net income positive. And in the meantime, they had hired a guy named Barry McCarthy as their CFO who is their CFO. He had been the former CFO of Netflix also took a short detour after that. You see how O of clinical sad, we're not going to talk about that one here. That would be it for the full episode was to get to yell clinical. Oh my goodness. One of my friends in business school did his summer internship at clinical. That's for another episode. Anyway, fortunately for Barry, he moves on quickly from clinical and becomes the CFO Spotify. And Barry's the one who really leads the charge saying,

1:00:41Why would we do an IPO and give 7% of the offering? A, raise money when we don't need it. Take delusion in the company. Give 7% of the offering to banks. Let's just do this direct listing. So they do. They set a reference point. So there's no, there's no.

1:00:55pre-sales, like in an IPO, they set a reference point for trading of $132 share, or which equates to a market cap of about $23.5 billion. That's where shares have been trading on the private market. They announce that they're going to do the first trade publicly on Tuesday, April 3, which they do. It opens the first trade happens at $165 a share in 90 cents, right around the 30.

1:01:22Totally way higher like the reference prices 132 writers reported that it would be between 145 and 155 You know that it just just kept climbing up to the day Yep, and so that's about a 30 billion dollar market cap It ends the day at 149 dollars a share or 26 and a half billion dollar market cap still up As we alluded to, the folks at the New York Stock Exchange mistakenly raised the Swiss flag outside the Exchange. They're going to start with S. Instead of this, we just flag. It's OK. That's quickly rectified. But this morning here, we're Thursday morning, two days later, still trading about $150 to share. So right around just below $27 billion, we're going to cap.

1:02:06Yeah, and the really important thing here sort of for the future of direct listings is you know will it will it sort of settle here because the thing that everyone was really worried about is there's gonna be all this incredible volatility. They didn't hire bankers to stabilize You know that that if it ends up falling below $132 a share that's below the last Last place it was trading in the private markets But you know all indicators are positive right now and Spotify did a few really intelligent things to sort of mitigate some of the possible risks of doing this direct listing and having all the volatility. The first of which being, they actually did hire investment banks. And as you sort of read a lot of these articles, it becomes clear that it wasn't one, it wasn't two. They paid gold in the SACs, Morgan Stanley, Allen in company.

1:03:00Morgan Stanley is technically serving as financial advisor, but ultimately, they're going to pay $44 to $50 million in banker fees. It's quite comparable to what they would have paid if they had actually IPO'd.

1:03:17sort of shy of recently if you look around Snapchat paid over 60 million, but but if you look, you know, Dropbox was only around 30 million, Mongo was it like 17 million, StitchFix was at 7 million, like they're actually despite the fact that that they are doing a direct listing and there's lots of other reasons why that's awesome. They are paying a hefty fee out to banks to help, I think to help stabilize or help craft the messaging or something. Yeah, I'm not sure exactly what the banks are doing. I think it's probably their institutional sales forces that are marketing the stock to large institutional investor, clients, hedge funds, mutual funds and the like, I think that's probably what they're

1:04:02paying them for, which is really what a bank would do in an IPO process. It's just that they're doing it on an advisory basis instead of literally buying the shares from the company and then reselling them to those investors. One other thing, the other really smart thing that Spotify did leading up to this is they encourage second market trading for their employees.

1:04:31you know, the more volume gets out there to be traded, the more certainty they have around what it's going to be in the public markets. And so, I don't know exactly what they did. I think they waived, they waived basically their right to be the ones purchasing when employees are selling their shares to encourage this. So, all right, listeners.

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1:07:00So that's almost 40% among the two co-founders. That's like a drop box level of ownership. It's more than drop box. Yeah, they took on so much capital. Yeah. I mean, they've raised $2.5 billion and it's been 12 years. Yeah. Well, they raised it such high valuations along the way. And again, you know, this is narratives here. They raised it such high valuations. Their revenue numbers were so impressive.

1:07:29But the question is, how much of that is going to flow down to the bottom line after the labels take their 70% cut? Well, it's so funny to be doing this right after Dropbox because if you look at them, these ownership percentages are so high and you say, why are they so high? Growth is an amazing leverage point.

1:07:50profitability or close to profitability or at least running a lean operation and generating a lot of cash is also a really high leverage point. Both of these companies grew wildfire, monetized from an early day, and that just gives them a lot of ability to raise it really high valuations and bring a lot of cash into the business with a lot of certainty in the future.

1:08:15the difference between Dropbox and Spotify as I'm sure you'll get into. I actually didn't look up. Do you know offhand what Spotify's overall gross margin is? I do. I do. So it actually went up last year because of a renegotiation with the labels where Spotify said, look, we want to hire take rate.

1:08:35But if we don't grow and hit our numbers, you get to take more money. And so it went from, if you look at their consolidated gross margin from 2015, 16, and 17, it was 12%, then 14%, and then a huge jump last year to 21%. So they're definitely betting the farm on future growth here right now, and being nicely compensated for it from the labels. Yep, so it's 21%.

1:08:59And for folks that haven't stared at gross margins all day, what you would want from a technology company is really high fixed costs and really low variable costs. So that would be a really high gross margin because your actual cost of revenue is very low. So if you look at something like a Facebook, they tend to hover around an 85% gross margin. Google, I think it's high 80s, low 90s. But Dropbox, getting back to that comparison, is just under 70, so 67% gross margins currently at Dropbox. So all of this is significantly higher. And Ben, just like you were saying, the reason this is important is tech companies require a huge amount of fixed costs in the engineering, in the servers, all the stuff that you need, the employees that you need to build the companies. But then the business models tend to be so

1:09:56scalable on a marginal cost basis like it doesn't cost Facebook anything to sell another ad or Google anything to sell another ad word Dropbox it does cost them in storage To bring on new customers, but yeah, especially as after they've moved off AWS It doesn't cost them that much, you know, they're still making 70% gross margins right not the case with Spotify That's right That's right. Getting into the narratives, a quick snapshot of their business today, they're unprofitable. In 2017, they did $5 billion in revenue, which is awesome, but they took a $1.46 billion loss. You would hope to see that change soon where they're actually generating a profit rather than generating a billion and a half dollar loss when they have $5 billion in revenue, but they're not there yet.

1:10:49on their balance sheet, they have $582 million of cash available, so about half a billion bucks of cash. Now, if one thing that's interesting to note, so they didn't raise any money because this wasn't an IPO, they've got half a million dollars of cash available on their balance sheet, but they're losing a billion and a half.

1:11:10every year, or at least at their current run rate. So unless they get profitable fast, they will actually need more money to continue funding the business. Now, yeah, I think there's a yes but here. Yes, but If you look at it because of some of the dynamics we were talking about earlier with the negative working cash cycle they actually are cash flow positive operating cash flow positive so in 2017 they generated 179 million euros in operating cash flow now they still lost money on a cash basis for the year right because they're having to pay off interest on on the debt that they have the convertible debt that they have

1:11:55So, you know, yes, they will eventually need to turn that income positive. That's the bet here. But they are cash flow positive on a, they are cash flow positive. But it's not anywhere near the levels that Dropbox is at. I believe, well, I can look it up quickly. I believe Dropbox is generating right around half a billion in operating cash flow right now and growing quickly. Spotify growing too, but like they're kind of hamstringed by these margins.

1:12:25Yeah, yeah, and thanks for that correction. That's a that's a great point and not to be overlooked And the last thing I'll say is growth is spectacular Like if you look at revenue growth from 2016 to 2017 they went from 3.6 billion up to that that 5 billion number You know when you're generating that much revenue to be growing like that is is really I mean, they're in a they clearly hit a high pressure valve when they were looking around for what market to enter. This doesn't look like it's going to stop flowing anytime soon. They have 159 million monthly active users. 71 million of those, which is almost half, are paying premium subscribers, which means they've switched off the ad tier and into the paying tier, which is they have doubled the number of Apple music subscribers.

1:13:16I actually don't know if that's subscribers or monthly active users, but they sort of brag that they're double Apple music. So, you know, I think it's huge growth business. I think it's subscribers, I think it's paying. Yeah, I think that's true, too. So real quick, I looked up Dropbox. So Dropbox 2017, $330 million in cash flow from operating activities, Spotify, $179 million. So roughly, Little less than twice as much for Dropbox. Cool, thank you. So if you look at what Spotify says in their F1, they're advertising that streaming is the title wave on here and it's very early days and it's growing globally. That smartphone growth is a huge driver that spotifies the market leader in a huge way and even this behemoth Apple can't catch them.

1:14:11They use data in a huge way to provide this personalized experience. They're running as an operationally lean business and that they really saved music. Like they are not shy about this story. The way that they opened their F1 is really by talking about the incredible decline that the music industry was in and how streaming sort of pulled them out of it and saved the music industry. And so the way they talk about themselves, the skeptics would argue that you know, they are really at the mercy of these labels and they have no bargaining power and they have no pricing power. And what Spotify says is look like the music labels love us because we save the industry and there's all these ways for both artists and labels for everyone to do better because the way that we enable people to listen to music actually creates growth for music. Yep. And I think all that is true. You know, it's

1:15:11Sean Parker and Napster 2.0 working with the music industry. Yeah, so what would the skeptics say? You know, it's I haven't heard as much about this in the last call it six months, but for the few years before that, it was like Spotify was a trope like it's a terrible freaking business They're always the suppliers have all the leverage the the music labels take a huge cut Not only do they have take a huge cut, but there's a most favored nations clause in the in their Agreements where basically for Spotify to get a better rate they have to go and a group and get all of the major labels, the sort of four or five major labels that make up 85% of the music's listened to on Spotify to agree to this new lower rate. It's a total cartel.

1:16:02And unlike the technology business of, let's look at Netflix, for example, where they actually license the shows and pay an upfront cost of, you look at House of Cards, $100 million to create House of Cards internally, or a license that Netflix creates the shows.

1:16:21that Netflix creates the show or pays a license fee sorry I conflated those two existing back catalogs from from other existing produce shows they pay a one time fee up front and they own that for a certain number of years whereas and and so they can generate as much revenue as they want for it. They get to keep the revenue and it's just a sort of a one-time cost. But if you look at what Spotify is doing in compare and contrast, every single stream has a percentage that's paid out to the music labels and therefore, Spotify cannot outrun their costs. It's this difference between variable and fixed costs. Netflix has an even greater amount of fixed costs versus Spotify, both because they're paying upfront a fixed price to license.

1:17:05the shows and movies that they didn't make. And then a lot of money to actually make their own content. But then when they, all their revenue, they just keep all the revenue. They don't have to pay a percentage of their subscription fees to the movie studios. It's the opposite what you're saying with Spotify where...

1:17:26A percentage, a large percentage of their subscription revenue is getting handed right back to the labels. So as the subscription revenue grows, so does the amount that they have to pay. Yep. It's a good, good succinct explanation.

1:17:42Skeptics also argue they have catalog parody with Apple music whereas if you look at something like a Netflix I have all this great stuff available on Netflix. Oh gosh, there's this entirely non-overlapping subset of stuff available on HBO go Maybe I'll pay for both. I'm sorry HBO now Maybe I'll pay for both and there's actual people actually do subscribe to multiple of these things and if you look at a music subscription service basically no one subscribes to multiple because they have the same back catalogs and skeptics would say that Congratulations, you have algorithmically generated playlists. I don't think that's differentiating enough to make people switch or make artists want to launch with any sort of exclusivity or anything like that because it's still only ever going to be this subset of the market of listeners they could release to by releasing on both. And lastly, that music is something that's just going to be owned by the platform owners.

1:18:38Sure, you've done well Spotify, but you had a 10 year or nine year head start on Apple music and God, they're growing so much faster than you are. They will catch you soon. I think when we did the, when we did the beats episode, was it 36 million subscribers? I believe that Apple music is at now. So roughly half of Spotify is paying subscribers and that's in two years, two and a half years since it launched.

1:19:03Yeah, I mean it's a bit of a farce for Spotify to say we have twice as many subscribers as Apple Music. Like you are almost a decade older than Apple Music. Yeah, they're they're coming up fast. And for all of Spotify is really brilliant as we talked about distribution tactics. You can't beat being the default player on the device. But then also, you know, there's another. There is another. I don't know. So that was what the skeptics would say. I mean.

1:19:30I use Spotify. I don't pay for Apple Music. I'm highly ingrained in the Apple ecosystem like maybe they're the ones who can do it. Well, I was going to say there is another player, you know, looking in the shadows here, which is what do I do? I use Amazon Music. And that's Jeff Bezos. Your margin is my opportunity, even if your margin is very small. David, that's because you don't like music.

1:19:57I do like, I actually converted, I now pay for Amazon Music. But it's cheaper. I think it's $7 a month, I just said $6 or $7 a month. But because it's baked into Prime, either. So when you pay for it. You're 12% gross margin as my opportunity. Welcome to Bezos Land. Yeah. Because it's all bundled, it's all part of Prime. Amazon can have a totally different business model.

1:20:24So Amazon Music Unlimited, which is what you pay for is cheaper than Apple and Spotify, just as good. I mean, maybe there's some small things on the margin that like Spotify does better with algorithmic recommendations and Apple being baked into the device, but like ultimately, especially within an Alexa world now, being the default on Alexa, that's very powerful. Apologies to all the speakers of our listeners who we just activated, Lady A.

1:20:53and prices is meaningful to a lot of people and then there's the free tier for Amazon which is you have complete control it's a limited catalog but it's most of the stuff that you care about if you're a casual music listener and then it's just completely free with prime and you can play directly you're not limited to shuffle mode you can play on any devices you know it's it's a big disruptive force yeah yeah I'm not going to bet on it but Good case. I think it's, why wouldn't you bet on it? I don't think Amazon gets music. I mean, we've seen them try with Amazon MP3. They've taken multiple steps at music. I think it's an animal that you have to have the right DNA to create. I think that could be. We talked about that a lot on the Beats episode. I do think there's an element of segments of the market.

1:21:53There are a lot of like how big is Spotify's tam really of people who are gonna pay 10 bucks a month in the world for music like they already have 70 million people doing it How many more people will do it especially when there's an alternative out there of like I could get something that's like 60% is good for free Yeah, I mean for free that yeah, so I think Amazon will take share on the from Spotify's free tier or better yet, since it's a growing market, will take the share that would have gone to Spotify's free tier. I wouldn't bet on them for the subscriber revenue. Yep. Well, I think there you have the narratives on Spotify. Yep. All right. And what would have happened otherwise? Well, let's do it. Well, they could have, they could have IPO'd. They could have IPO'd. Yeah. Now they are

1:22:56generating cash from operations so they don't need the capital. They already raised a lot of capital. Here's a crazy thing that could happen. I was foreshadowing this a little bit earlier with the Ben and Jerry's thing, but they could IPO. Like now that they're publicly traded, I mean, six months or a year or two years, like if they need to raise cash, I mean, it's like doing, you know, dilutive secondary offering that a public company would do.

1:23:27Yeah, yeah, and they could just do that as their IPO And as I was thinking through this David like I want to make sure I'm thinking about this right so Let's hypothetically say they do this they did this direct listing and started trading at what 165 and it's up to 150 right, it fell to 150, but it's at 150 right now, let's say it goes up to 180 or 200 in the next year or so. And then they go and do an IPO at 200. They basically get to raise cash later and take less dilution. Yep, yep, yep. And so like if there were these liquidity reasons why they wanted to be public, but they thought about it like, huh, I don't.

1:24:17I think we actually need the cash right now. So let's not take the dilution. Let's take some dilution later if we do need to raise capital. Like you could see that this is maybe only chapter one and that the dilutive offering happens later. Yeah. I mean, I think the question though is, will they need capital? I think they don't in their current business model. They will need capital potentially if they try and move to the Netflix playbook of we are gonna develop our own artists and make our own content now that's been bandied about in music and you know there was the famous Taylor Swift you know exclusive with Apple and that didn't work out Ben Thompson's written a lot about this doesn't make sense in music to have exclusive content in the way it does with video unclear yeah because here's the thing is in in

1:25:15video since people are used to paying for multiple or switching between. If somebody launches something like Stranger Things, then you're gonna switch to that provider or you're gonna add provider if you want to watch that. If you're an Apple Music subscriber and Taylor Swift drops her new music video only on Spotify, you're not switching, like you're highly, highly ingrained with all these playlists and configuration and friends that you've made in one service of the other. You're probably not gonna do it for new album.

1:25:44I mean, maybe for like two or three artists that are all like if Jay-Z and Beyonce, here's the thing they actually do with title. Like if you look at like, it hasn't worked for anyone yet. Well, I think it doesn't work because it doesn't make sense for the artists. Like, especially in today's industry, as an artist, you make your money from shows and from branding and merchandising. Yeah, so you need maximum exposure. Maximum reach. You wouldn't want to artificially limit you know, your audience. Whereas in video, it's a lot different, like you have a lot more niche content and people are used to, you know, oh, this will be, this is an HBO exclusive or whatever, like, you know, they're the paying directly for content is a lot more ingrained in in people's psyche. Yeah. Plus, you also have the actors who actors act in

1:26:41content across creators and publishers essentially. Just because Will Smith did that exclusive movie, I forget what it's called with Netflix, that doesn't mean Will Smith can't go do his next movie with Disney or Fox or Fox's part of Disney now or Universal or whoever. Whereas in music, Taylor Swift becoming Apple exclusive or Spotify exclusive, that means...

1:27:08She's not gonna ever release content on the competitors, like that doesn't make sense. Yeah. Yeah. Something would have to change in the ecosystem where people would have to actually subscribe to multiple, multiple providers, which I don't think is going to happen. Or people, artists would actually start generating more of their revenue from streams rather than from streams being their top of funnel and then monetizing fans more through shows and all that. Yeah.

1:27:40So yeah, I don't think they need the cash Yeah, well then it makes sense that they didn't do an IPO Yeah, which I think was the whole argument of Barry McCarthy the CFO Right right and it's super the thing they touted which I don't think is the main driver But it's super employee friendly because they they don't have this six month lockup period in fact the only group I think actually I think Tencent is restricted from selling shares for some amount of time, but that was a one-off thing in their agreement, and all employees were free to trade on day one. Yeah, so Tencent is a, I think, 7.5% shareholder of Spotify. They did a deal with Tencent at the end of last year and 2017, where they essentially swapped equity stakes in Spotify and with Tencent.

1:28:32music entertainment, which is their Spotify competitor in China. And this is Spotify was never going to be able to watch in China, just like Facebook and Google haven't. This is a way to get access, you know, to likewise, Tencent TME, Tencent Music Entertainment was not ever going to be dominant in the USA, Europe, or the like. This is a way to go global, essentially, for both companies. So it makes sense that there'd be a lock up for for those. Well, should we get into tech themes? Well, let's do it. Let's do it.

1:29:03Well, mine, so in these IPO ones, I want to broaden to tech and investing theme. The big one for me that I think is the, I'm going to use your phrase, the thing that's been bandied about in the press a lot recently, has been, are we going to see more direct listings? Because if this can be a shift away from the sort of, walled garden of Wall Street and paying the banker fees and You know having to ingratiate yourself to that world which people have just railed on for you know Particularly in Silicon Valley how dumb the process is I mean there's Dick Costello has done a lot of great interviews about How silly it felt to go do the exact same presentation 80 times on the road show and Have to really be a dog and pony show

1:29:52And so to the extent where Spotify can put up one stage presentation on that the video recorded and then everybody can just look at that and then they don't fly to New York and bring half the company and ring the gong and throw the parties and give the interviews. Maybe this is the way of the future. Well, there are a bunch of problems too. The Dropbox IPO last week. There's a big day as we said in Silicon Valley here. Lots of Dropbox employees and investors.

1:30:19But it wasn't, too, because they're all subject to the lock-up. And then the lock-up comes off, but maybe that depresses the stock. A lot of people are selling. Sometimes companies will re-lock up their employees' investors to prevent the stock being depressed. Traders build the lock-up into their models. It sucks. Plus, having to create new shares to sell to the public if you don't need the cash and you always have to do basically a minimum of 7% of the company. Why would you do that? In these later rounds that Spotify was raising, they were selling 1% or less of the company. Why would you now sell a huge amount of the company? Yeah, the criteria that I basically came up with was fourfold.

1:31:12for will we see this in the future. One is I think you have to be a household brand name like Spotify. Like one of the things the bankers do on the road show is like really familiarize the institution and large blocks of potential shareholders with the company. Lots of people were already very familiar with the company. You have to not need the cash. So, you know, that already limits lots of companies. You have to have this very cash efficient business model.

1:31:38And we need this Spotify price to hold steady. And if it doesn't, I think it'll scare off people from doing this for a long time. And it's not that volatile right now. It's done a nice job of staying around where it should be, but it's bounced around a little bit. So I think the next few days are going to be telling. Great telling. Yeah. Well, I think there's one new onsite ad to your first point, which I totally agree with.

1:32:02is you have to be a known name. I don't think you have to be like a consumer household name. You have to be known amongst the institutional investor community. But that's also happening because those mutual funds, those hedge funds have been investing in private companies over the last five years. So they know these names, these stocks.

1:32:26whether it's T-Row price, or Tiger, or Wellington, or all these. I don't know about T-Row, but all those other firms were already shareholders in Spotify. These are the biggest owners of public stocks in the market. A lot of that education and marketing is already happening while companies are private.

1:32:55I have one self-serving tech theme that I thought was just fun to read in their F1. So they list podcasts. And they have a services section and they list new content offerings in one of those video and one of those podcasts. And I have been noticing, as much as I have held the belief that Spotify and SoundCloud and anyone else that's starting to work in podcasts, just doesn't do it well relative to dedicated podcast apps. You know, it's now the... I don't know if it's on like this on everyone's app, but at the top of the home screen, on my little homepage for Spotify, it's listened to these podcasts, and they say in their F1,

1:33:39This is a big market stat about podcasts. There were 348 million podcasts listeners across all platforms worldwide at the end of 2016, going up to 484 million in 2017, which is a growth of 39% year over year. And their quote on that is, this engagement presents a significant opportunity for Spotify as we believe we have the ability to enhance the podcast user experience with a better product that is focused on discovery.

1:34:06Seriously, notoriously, the problem in podcasts. Think about the dynamics are very different. The problems are very different. But think about the issues with the music industry when Spotify came along and just fixed them from a product perspective, just like Dropbox, just fixed, you know, file sharing, a different type of file sharing. The podcast, and this is where the podcast industry is today. Like, the market is there. It's growing like there's huge, but like the industry and from a product perspective is completely broken like somebody somebody needs to come along and just fix it. I still don't know if it's going to be them. I like the bet on the industry right now and I just think it's kind of fun that they had in their F1. Yeah, yeah. I don't think it's going to be Spotify either like it's it's hard for big companies to do this. Anyway.

1:35:02It's kind of hard for me to believe that Spotify is worth $30 billion. I mean, maybe I'm getting into grade the, grade the DPO right now, but like, I mean, think about like Uber just had the share tender for like 50-ish billion, and like you look at Airbnb's most recent private valuation, like, is Spotify really a $30 billion company? Yeah, I mean, the thing is like we're just so divorced from fundamentals at this point you know like Spotify is definitely a thirty billion dollar company if you if you value it on a revenue multiple hundred percent but but their margins their gross margins are structurally very different from you know other tech and software companies so if you value it on a you know well you can't do a p p basis because they don't have

1:36:00earnings, but if you value it on a cash flow, multiples of cash flow basis, it's still nutty. Even, so let's say they do 300 million of operating cash flow in 2018. I don't know if that's what they're projecting, but let's just assume. Then that's a 100 times operating cash flow that they're trading at. You're telling me that if you buy Spotify today, you are assuming So much growth that you're willing to pay 100 times the cash flow, because cash flow really is how you should be valuing these companies. 100 times it's cash flow today. No, I mean, it's not crazy, like other... It's not crazy relative to other... Other stocks trade that way too, but I think this gets back to something I mentioned a little bit before. Like, what's the tam?

1:36:49how much growth is left in Spotify? To be willing to pay 100 times cashflow for something, you have to be willing to believe that there's so much growth that that's gonna, because essentially what you're doing right now is you are paying for 100 years of cashflow of Spotify. They cashflow will repay your investment in 100 years. You believe that there's a lot of growth that it's gonna be a lot shorter than 100 years, but I don't know, can Spotify double? Probably, can they 10x? I don't know.

1:37:18I don't think so. Yeah, I mean, it's interesting how my anecdotal evidence is so much different than the numbers. Like what I said at the opening of this episode and I said, it feels like pretty much everybody that is on a lineal that is going to buy, you know, is going to subscribe to Spotify is already subscribed to Spotify. But if you look at, you know, what they, they, they're reported user growth. I mean, they, let's see.

1:37:42Our 159 million monthly active users have grown 29% year over year as of December of 2017. And their premium subscribers have grown 46% year over year. So yeah, to your point, will they 2x? Probably, will they 3x? Seems like they could get there. Will they 10x? So then the other bit you're making is like, well, maybe they can improve their margins.

1:38:07That's like a big bet. Or can they offer another product? The other piece here is they've got this audience, you know, can they start meaningfully doing ticket sales to concerts? Can they enter video in some way? Can they become the provider of podcasts and then figure out how to monetize that? I mean, there's Yeah, the quite how much do you model in? Possibility of a bolt-on business. Yeah Whereas, when I look at Spotify's great company, for sure, I think I'm going to be very laudatory in grading this direct listing because I think it was the right thing to do. But just in terms of comparing, I can't help but compare Dropbox and Spotify's first public offerings because they're listings because they're back-to-back. With Dropbox, personally, I feel a lot better making that bet because

1:39:03The bet on Dropbox, to me, is a bet will the tam increase? Will more people have a use case over time to share files in a semi-professional sort of way, versus with Spotify? Are more people going to listen to music and want to pay for Spotify who aren't already? Now they're going into more countries, but how many more countries can they go into? They're not going into China. They did this deal with Tencent, so they do have exposure to China.

1:39:33I don't know. Well, I think it's time to go into grading and listen here. I want to sneak in a couple tech themes first. I'll go for it. All right. I have three sort of interrelated tech themes that really we've covered all throughout the history and facts, but I think are important here. And that's the importance of a couple key product decisions and only a couple key.

1:40:00things like with Spotify, it was the focus on playlists. We didn't talk a lot about this, but it was doing a desktop app, not a web app, because that enabled almost zero latency. When you click play, the file stream didn't play immediately, whereas some of their competitors, because there were competitors, remember Groove Shark and some of the others, they were all web apps. The performance was clergy. People don't want to wait for music. Just like a couple of key product decisions that can really make the difference early on, but then you have to couple that with distribution too. Spotify would have done well without Facebook, but it wouldn't be a $30 billion company without Facebook. And then I think the related one to both of those that we just see time and time again on this show is to do all that, you have to have such tenacity as a founder. You have to have a vision, it has to be right, but then you got to work at it and focus maniacally for

1:40:58Many years years and years took so long for Spotify to even get off the ground and then to go country by country and then five years later come to the US or I guess three four years later come to no five years five years after founding come to the US It just takes a long time Yeah, Daniel X only 35. I thought it was a little older, but yeah, maybe it's only 35. I think that I think I saw that in the F1 I mean looking at those companies, he started those companies before Spotify. Spotify has been 12 years and it's just impressive, passionate, motivated founder. Yeah, totally. All right, that's what I got.

1:41:44All right, so on grading listeners to clarify though, we did just talk about, you know, do you feel like this is actually worth $30 billion? The way that we grade is was, you know, on the typical acquired format was it a good idea for the acquirer to pay this money for the acquirer. The way that we grade IPOs and now DPOs is was it a good move for the company to to do this transaction. Was this the right move for them? We're basically looking at three options here. Do what they did, IPO, or don't do anything. Stay private. Keep doing what they were doing. Sure seems like a great call. They couldn't do nothing. They had to get liquidity. They didn't need to raise money.

1:42:37it seems like they're not seeing any of the downsides that would have come from potentially doing this direct listing instead of the IPO. I mean the whole Wall Street community was a little freaked out and trying to naysay that gosh there's gonna be all this volatility and it's gonna drop below the last price that it was trading in the private rounds and the demand's not gonna be there and you know lots of things but I don't think we're seeing any of that so It seems like it was a great decision and a gutsy one at that. Yeah, caveat that we're still early. It's only two days in a period. So a lot will depend on what happens over the next couple of weeks, but thus far, you know. Yeah, thank you for that because we may need that clause. We may need that clause. But the fears were about what happened immediately after trading. Like the whole point of doing an IPO, the argument of the bankers is we're there to stabilize the stock, stabilize trading.

1:43:33If you go back and listen to our Facebook IPO episode, they definitely needed the bankers to stabilize drifting in the stock because it was a rocky, rocky start. But you know, without the bankers there, what'll happen? And like everything's been stable. So yeah. Yeah, I don't know. I don't know how to assign a grade to it per se. Like it feels weird to grade this against. We got to figure out what our actual sort of format is for.

1:44:05for these IPOs because it, you know, it's sort of like either it was an A, probably not an A plus or it was like a C. It seems rare that we're gonna ever have an IPO decision that was an F or a DPO decision that was an F. We might, maybe if we revisit the Snapchat IPO. There you go, there you go.

1:44:28Well do you want me to yeah, I mean I'll say a we just have like a lot bit It's kind of silly for these on the scene ones to do any grading at all, but you know all signs are positive right now. Yeah, I mean if There is stability now now I do have some questions personally about a $30 billion valuation for Spotify But that's what it's you know the market is saying But at least that's what three three point two percent of shareholders who have sold have managed to get the market to say. Right, right, which is not a large float. So that may be artificially, artificially supply, constraining the stock and raising the price, driving the price up. But as long as there's not panic trading, which it seems like there's not, this seems like a good new path for companies to get liquidity, get out on the public markets.

1:45:21It would be great for Silicon Valley if like this becomes a viable path. Um, so, so far so good. Yeah. Hey. And if it does like Barry McCarthy, the CFO is going to be hailed as a genius. Yeah. Yeah. No kidding. Yeah. Formal clinical, former clinical employee hailed as genius story 11 coming, come a long way. Let's come a long way. Uh, Carvots. Carvots. Um, So I can't remember if I've actually mentioned on the show or not, but I know I've talked a bunch about my wife Jenny. She is the head of audience engagement and education at San Francisco Ballet here in San Francisco. And the ballet, so if you live in San Francisco, you should come to the ballet anyway because it's awesome.

1:46:15The athletes, the dancers are amazing. It's wonderful to watch always. But they're doing a big festival at the end of the season, coming up at the end of this month in April. And Festival of New Works, it's going to be really cool. And Jenny is hosting a number of panel discussions around it. But one is going to be called Silicon Ballet.

1:46:38bringing ballet and technology together, the intersections of tech and ballet. And it is, uh, it's at the end of the month, April 28th at 530 PM. Uh, is it starring you and Jenny? Uh, actually, neither of us are, are speaking on the panel. Um, but they're going to be some really cool, uh, participants. So, uh, if you're in San Francisco and Silicon Valley, uh, come, come to the ballet always, but, uh, but come see this panel. It'll be really cool. Awesome. Well, I finally saw Black Panther.

1:47:08And that movie was amazing and everybody should go see it and it's remaining few few days and theaters. And even more awesome was the so Kendrick Lamar put together the soundtrack and he did a couple of songs himself and guessed it on a couple of other songs and then hand picked a bunch of other artists and it's just powerful like it's a really It's maybe one of the best, maybe the best Marvel movie. I mean, the amazing sort of societal themes that are going on right now that they manage to pull into the movie and make extremely accessible and deal with really difficult topics and have a really cohesive story with great character development and stunning visuals. I think I'm like the last person to like

1:47:58be talking about this and be aware of this. But if you haven't seen Black Panther yet, I highly recommend it before it leaves theaters. It's awesome. Yeah, I haven't been able to get to the theater to see it, but I definitely want to. It looks awesome. Or go on Spotify and listen to the soundtrack. What I was going to say is can you get a playlist of the soundtrack on Spotify? You can. You can. All right. We'll link to it in the show notes. We will. Spotify's new viral growth mechanic via the acquired podcast.

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