Remember those crazy days when mobs of eager investors would drive tech stocks to dizzying gains in their first few hours of public trading? Believe it or not, we haven’t seen the end of such episodes.
This may come as a shock if you’ve wallowed in recent coverage of Facebook Inc. and its well-deserved woes. It’s easy to emerge from the deluge of negativity with the impression that all tech stocks now face a chilly new environment.
The evidence on hand, though, suggests otherwise.
One case in point is Dropbox Inc., the digital file storage company, which soared more than 35 per cent in its public debut on Friday. An even more interesting case will occur next Tuesday when Spotify Technology SA, the music streaming service, begins trading on the New York Stock Exchange. Based on optimistic guidance unveiled Monday, Spotify shares are likely to be greeted warmly despite the company’s persistent losses.
All of this underlines a key point: While regulators are circling social media giants with renewed interest – and for good reason – the primary attraction of many tech plays remains intact. They represent one of the few sectors where companies are achieving double-digit growth in revenue. At a time when many companies are struggling to show much revenue expansion at all, tech stocks are still powerfully alluring.
Consider Spotify. In its first-ever guidance on Monday, the Stockholm-based streaming service predicted its sales would jump to between €4.9-billion ($7.8-billion) and €5.3- billion this year, a leap of more than 20 per cent over last year.
Even more enticingly, Spotify says it will end 2018 with as many as 96 million paid subscribers, up by more than a third from the 71 million it reported last year. The enormous size of the company’s audience – roughly twice the size of its nearest competitor – gives it unparalleled clout in negotiating terms with artists and music companies. Gross margins could reach 25 per cent by the end of this year, up from 21 per cent in 2017, according to Spotify.
To be sure, there is the niggling issue of profitability. Spotify expects an operating loss of between €230-million and €330-million in 2018 and it may be a long time before it generates a sustainable profit. But if there’s one thing that investors have learned from the likes of Netflix Inc., it’s that markets are quite willing to tolerate losses so long as a company is growing sales at a rapid clip.
So what is Spotify worth? In filings last month, it noted its shares had sold in recent private transactions for prices ranging from US$90 to US$132.50. A detailed analysis in mid-March by Aswath Damodaran, a valuation expert at New York University, arrived at a fair value of US$115.31 per share.
Prof. Damodaran’s model figured Spotify will be able to achieve increased economies of scale and continue to reduce its costs for content. More pessimistically, it also assumed the company’s growth will slow dramatically in five years. To reflect the competitive threat from the likes of Apple Music, Prof. Damodaran also built in a 20-per-cent chance that Spotify will be forced to sell itself at a big discount over the next 10 years.
But perhaps the greatest risk is something that is difficult to quantify − the motivation of Spotify’s top management. Unlike most companies, which hire investment banks to price and manage their initial public offerings, Spotify is choosing to go directly to market, letting supply and demand set the price on the opening day. This avoids forcing the company to sell shares. Instead, it will be individual shareholders who will put up their stock for sale.
Spotify argues this is the best approach since its primary purpose in going public is to let employees and private investors cash out with the least amount of hassle possible. The company itself doesn’t need cash. It has no debt and €1.5 billion in the bank.
That all sounds quite impressive. However, Prof. Damodaran noted, it also raises questions. Why would a fast-growing, money-losing company turn away from the chance to raise an additional billion dollars or so? Also, why would existing owners want to sell unless they know something the public investors don’t?
These are excellent points. Spotify’s debut next week should demonstrate exactly how much of an appetite investors still have for technology stocks. Despite all the current negativity about the sector, be prepared for the stock to soar.