Season 2, Episode 6: Spotify’s Direct Listing

[0] Did you read the mission statement on Spotify's F1?

[1] No. So, whereas last week, Dropbox's mission is to unleash the world's creative energy, Spotify's is to unlock the potential of human creativity.

[2] You definitely should get some digs in on them.

[3] It's an unrestrained hippie world out there.

[4] Welcome to Season 2, Episode 6.

[5] of Acquired, the podcast about technology, acquisitions, and IPOs.

[6] I'm Ben Gilbert.

[7] I'm David Rosenthal.

[8] And we are your hosts.

[9] Today, we are covering a company making history the week it makes history, Spotify and their direct listing, which is not an IPO.

[10] 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.

[11] debuting at about roughly a $30 billion market cap.

[12] Wow.

[13] And almost a billion dollars worth of shares on the first day traded.

[14] Yeah, trading hands.

[15] Big company, big shakeup in the industry over the last few years with the rise of streaming and a big change to the way that companies go public.

[16] So David, I'm excited to dig in and help understand myself exactly why.

[17] they did a direct listing, what a direct listing is.

[18] And probably more importantly, excited to hear from you more about the history of the company itself.

[19] Oh, there's always a story, Ben.

[20] All right.

[21] If you are new to the show, you should join us in our Slack at Acquired .fm.

[22] There's over 1 ,200 people talking about acquisitions, IPOs, tech news as it comes, and helping us do research for the show.

[23] And thanks to listeners who were throwing some interesting stuff about Spotify as David and I were researching.

[24] Okay, listeners, now is a great time to thank one of our big partners here at Acquired, Service Now.

[25] Yes, ServiceNow is the AI platform for business transformation, helping automate processes, improve service delivery, and increase efficiency.

[26] 85 % of the Fortune 500 runs on them, and they have quickly joined the Microsoft's at the NVIDIAs as one of the most important enterprise technology vendors in the world.

[27] And, just like them, Service Now has AI baked in everywhere in their platform.

[28] They're also a major partner of both Microsoft and Nvidia.

[29] I was at Nvidia's GTC earlier this year and Jensen brought up ServiceNow and their partnership many times throughout the keynote.

[30] So why is ServiceNow so important to both Nvidia and Microsoft companies we've explored deeply in the last year on the show?

[31] Well, AI in the real world is only as good as the bedrock platform it's built into.

[32] So whether you're looking for AI to supercharge developers and IT, empower and streamline customer service, or enable HR to deliver better employee experiences, Service Now is the platform that can make it possible.

[33] Interestingly, employees can not only get answers to their questions, but they're offered actions that they can take immediately.

[34] For example, smarter self -service for changing 401K contributions directly through AI -powered chat, or developers building apps faster with AI -powered code generation, or service agents that can use AI to notify you of a product that needs replacement before people even chat with you.

[35] With ServiceNow's platform, your business can put AI to work today.

[36] It's pretty incredible that ServiceNow built AI directly into their platform.

[37] So all the integration work to prepare for it that otherwise would have taken you years is already done.

[38] So if you want to learn more about the ServiceNow platform and how it can turbocharge the time to deploy AI for your business, go over to ServiceNow .com slash acquired.

[39] And when you get in touch, just tell them Ben and David sent you.

[40] Thanks, service now.

[41] 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, you know, several months ago before they priced, before they had a date, before they had an F1, not an S1 to announce.

[42] Foreign company issuer.

[43] Oh, oh.

[44] I didn't realize that the F1 is because they were not a U .S. space company.

[45] Not because of the direct listing, but because they are a foreign issuer.

[46] That makes sense.

[47] Before 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.

[48] So if you're thinking about, you know, what does a company normally do in the IPO?

[49] There's two big reasons.

[50] One, they create liquidity for existing shareholders.

[51] So everybody who's got stock, sometime.

[52] after that has the opportunity to sell that stock and get some liquidity on that.

[53] The other is that the company actually creates new shares, so all the previous shares get diluted, but the company gets to raise money.

[54] So they sell the new shares that they've created.

[55] They raise millions and millions of dollars to have money in their coffers.

[56] With a DPO, a company doesn't take any dilution, and they don't raise any money.

[57] So Spotify doesn't have a dollar more in the bank account yesterday from selling shares that they do that they do today.

[58] I guess, don't create any new shares.

[59] It's literally just, hey, anybody who is a current shareholder can now sell.

[60] There's no lockup.

[61] It's just...

[62] 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.

[63] 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, you 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.

[64] 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.

[65] Yep.

[66] Very true.

[67] On the other hand, Spotify is a 12 -year -old company.

[68] certainly the founders and employees, early investors, they want liquidity.

[69] And also, we'll also talk about this, but there's been a robust private market for Spotify shares for many years.

[70] So trading has been happening.

[71] There has.

[72] Well, before we go into the history and facts, I found one fun bit of trivia.

[73] David, there's a very famous company that did a DPO in the 80s that sort of popularized this.

[74] Do you know who it is?

[75] I do not know.

[76] So in 1984, Ben Cohen and Jerry Greenfield needed funds for their ice cream business.

[77] They advertised ownership stakes through local newspapers for $10 .50 per share with a minimum number of 12 shares per investor.

[78] And their Vermont loyal fan -based ended up funding Ben and Jerry's ice cream in a DPO for its first way to raise capital, raising only $750 ,000.

[79] from 1 ,800 ice cream -loving Vermonters.

[80] Oh, my goodness.

[81] Talk about an addictive product.

[82] I know.

[83] Addictive and viral, as we will get into.

[84] That's right.

[85] And interesting to know, and we'll come back to this later, they then did a $5 .8 million IPO the following year.

[86] So they actually did issue new shares once they were public.

[87] So tuck that one away, and let's dig in.

[88] All right.

[89] Well, history and facts.

[90] So, as probably a lot of people know, Spotify is a Swedish company or founded in Sweden.

[91] Not Switzerland, as the New York Stock Exchange learned this week, unfortunately.

[92] Sweden is a different country.

[93] For those who didn't see the news, there's a chance that a Swiss flag got raised at the New York Stock Exchange.

[94] Yeah, somebody was in hot water.

[95] We'll come back to that at the end of the show.

[96] But it was started in Sweden by two co -founders, Daniel Eck and Martin Lorentzen, started in 2006.

[97] Daniel Eck, the CEO, who's still the CEO, was kind of like a wonderkind of the Swedish tech scene.

[98] 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.

[99] But to really understand Spotify, you have to go even farther back and start with, another company that we've also discussed on this show a little bit, a interesting footnote of history called Napster.

[100] And yeah, yeah, who, I mean, who would have thought that the very thing that, you know, that destroyed the music industry and brought the record labels to their knees could possibly have a hand in saving them?

[101] Well, Unfortunately, it was the record labels that brought Napster to its knees.

[102] But as we shall see, there is a very direct and straight line from Napster to Spotify to today.

[103] So Napster founded in 1999 by The Shons, Sean Fanning and Sean Parker.

[104] Sean Parker is S -E -A -N.

[105] Sean Fanning is S -H -A -W -N.

[106] And then also a third co -founder, who doesn't get talked about as much, but is friend of the show Jordan Ritter, who's based in Seattle now.

[107] And there's a really, really good internet history podcast episode with Jordan about the founding in early days of Napster all the way through the lawsuits with the record labels and shutting down and the aftermath.

[108] I highly recommend that if you want more detail than the couple minutes we're going to spend here on Napster.

[109] Go listen to that episode over on IHP.

[110] So Sean Fanning started Napster originally.

[111] He was a college student at Northeastern University in Boston.

[112] And he and his friends, well, he was really into hacking computers.

[113] This was like the late 90s kind of ended 98, beginning of 99, really into hacking.

[114] He was really active on IRC and in a bunch of communities and forums, sort of trading programs on the internet.

[115] And especially on broadband.

[116] So these were the days most people at home had dial up.

[117] but colleges all had broadband.

[118] And so, you know, having, I was, I was sort of on the tail end of this.

[119] But, you know, I remember, you know, the biggest attraction to going to college, you know, there was the education and all that, but there was getting broadband internet and then stealing files on the internet.

[120] Yeah, I remember evaluating colleges based on that.

[121] Like, they thought it was the most ridiculous thing.

[122] But, you know, nerdy kid going into computer science.

[123] I remember asking, like, on tour guides, like, what's the bandwidth in the dorms?

[124] and it was the whole remember the internet two that was like a separate backbone that only universities had that was like a faster private internet linking universities anyway this all plays into the Napster so Sean is he's 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 burn i mean don't rip because that would be illegal uh yeah don't burn use iTunes buy your music um so he realizes there's no good like front end to this stuff so he's like okay i'm well i'm you know i'm a cs major i'm gonna i'm gonna start coding up a front end client um for trading files peer to peer on the internet he decides to call it napster um he releases the first version of it and it basically just takes off like wildfire first at Northeastern, you know, a college in Boston.

[125] This will, we will revisit social apps on the internet, starting at colleges in Boston and taking off like wildfire.

[126] Spreads to lots of other colleges all around the country.

[127] He brings on two folks.

[128] One is Jordan Ritter, who's also based in Boston.

[129] He takes over back -end programming.

[130] And another friend that he has from the IRC Internet Relay Chat community, a guy named Sean Parker.

[131] And Sean joins, and he's basically kind of the business head of Napster.

[132] And Parker was, he's kind of like a hacker, hustler guy.

[133] He had a whole bunch of internet businesses that he started in high school.

[134] He decided not to go to college.

[135] Apparently he was making like 80K a year while he was in high school just from internet businesses.

[136] So the three them get going.

[137] They raise $50 ,000 from Fanning's uncle, and they move out to Silicon Valley.

[138] And kind of the rest is history.

[139] Again, you can listen to the IHP podcast.

[140] But basically, within a span of two years from 99 to 2001, Napster goes from being like the killer app for broadband.

[141] 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.

[142] 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.

[143] Wow, was that it?

[144] Well, the ashes of Napster kind of live on.

[145] It gets resurrected as well, no, but I mean, I'm thinking about the time of my life where I was actually using like Napster Napster, and I had a zip disc that I would store my music on when I would download it and I would like, you know, those are only 100 megs.

[146] I'd like delete the old music that I didn't want anymore so I could get the new songs off Napster, but the, uh, um, I can't believe that was only a two year period.

[147] I know.

[148] It was crazy.

[149] Well, because the, the labels sued Napster.

[150] Um, they couldn't work out settlements.

[151] They sued.

[152] They sued Napster.

[153] They sued all of the individuals who are working at Napster, all the founders, all the investors, the LPs of all the venture funds.

[154] Like, they just went nuts.

[155] Oh my God.

[156] Um, and, and so quickly, and what happens, you know, I remember this.

[157] I'm sure you do too, is Napster gets shut down, but then, you know, a million flowers bloom in its place.

[158] Lymeyer and Kazah.

[159] All this stuff.

[160] Kaza leads to Skype, which also will influence Spotify, which we'll come back to.

[161] Anyway, Sean Parker, though, he exits Napster after all this is happening in 2001.

[162] But he doesn't, you know, he does, he's not one to rest on his laurels.

[163] He founds a company called Plaxo, which we've also discussed on this show, out in Silicon Valley.

[164] all out in California now.

[165] 2002, starts Plaxo, gets backed by Sequoia, raises money from Sequoia.

[166] I believe Mike Moritz is on the board.

[167] But Sean's still a kid, and he's running this now sort of enterprise -y email, you know, identity company.

[168] He ends up getting pushed out after the downturn in 2004.

[169] Sequoia and the other board members push him out of the company, leads to a whole lot of animosity ultimately leads to the infamous Facebook pajama pitch to Sequoia that is covered in the social network, which we'll get to too.

[170] And real briefly for anyone who doesn't have the time to go check that out, basically Sean Parker swore that when he was getting involved with Facebook, they would never go and give Sequoia a piece of this.

[171] And finally, Mark Zuckerberg is persuasive.

[172] to go and pitch Sequoia and shows up in his pajamas as a show of true respect.

[173] Yes, true, true respect.

[174] Now infamous in Silicon Valley lure.

[175] So Parker's pushed out a Plaxo doesn't sit still for long again.

[176] 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.

[177] computer one day, a site called the facebook .com.

[178] And this gets dramatized in the movie The Social Network, where Parker is played by Justin Timberlake, of all people.

[179] And it's so good.

[180] A girl, he's he has a trist with a with a girl on the Stanford campus and then sees it on her computer the next morning.

[181] Supposedly, it was actually his roommate's girlfriend.

[182] But anyway, next thing you know, Parker basically hustles his way into meeting with Mark Zuckerberg.

[183] and then Facebook co -founder Eduardo Savoran, because Facebook is still back on the Harvard campus in Boston.

[184] He goes to New York.

[185] He arranges a meeting with the two of them.

[186] This is all documented in the social network.

[187] The company's a few months old.

[188] And he basically talks his way into joining the company as its president.

[189] And Parker has also become close with Peter Thiel at this point.

[190] Founders Fund doesn't exist yet, but PayPal has already exited to eBay.

[191] And Peter is now investing in the PayPal Mafia and other folks.

[192] And Peter ends up leading the first true investment in Facebook buys 10 % of Facebook for $500 ,000, a quite prescient move.

[193] And then we all know what happens after that.

[194] But I think, yeah, I think Facebook, I think it worked.

[195] That'll be a story actually that we have already told.

[196] You can go listen to our episode on the Facebook IPO.

[197] you.

[198] But I think everyone knows what happened.

[199] But for Parker, though, in the next year, in 2005, you know, remember, he's still super young.

[200] He's got to be like, I don't know, 24, 25 at this point.

[201] He has a party at his vacation home in California, ends up getting busted by the police.

[202] They find a bunch of drugs at the party.

[203] And as a result, he gets ousted from his role as president of Facebook.

[204] Again, all this is in the movie.

[205] in the social network.

[206] So that was...

[207] Sean Parker was born in 79.

[208] So that would mean all this is going down in, what, 2005?

[209] So he's probably 26?

[210] Yeah.

[211] Somewhere between 25 and 27.

[212] So he's like the adult supervision at Facebook.

[213] It's kind of a miracle that Facebook survived all of this because we'll get into some more stuff here.

[214] So, you know, Parker, again, doesn't sit still for very long.

[215] He joins up with Peter Thiel, who had just at this point started Founders Fund, the VC firm that Peter started and after the Facebook investment.

[216] Parker joins in 2006, but he still has music and Napster kind of on his mind.

[217] And if you remember, Facebook, in the original early days, Facebook was actually the Trojan horse to realize what supposedly was Mark Zuckerberg's true vision.

[218] Wirehog.

[219] Which was Wirehog.

[220] Yeah, that's right.

[221] They were co -developing.

[222] I think when 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 Wirehog, the music sharing network, and we're going to deploy Wirehog to everyone who had signed up for Facebook to be sort of the, exactly, David, the Trojan horse, the way that you bring P to P to them.

[223] masses.

[224] Yep, exactly.

[225] And remember, Facebook was only at colleges at this point in time.

[226] It wasn't open to the whole public.

[227] And so Wirehog was essentially Napster 2 .0.

[228] It was file sharing, but mostly primarily music, and then video file sharing have become big at this point.

[229] BitTorrent and other applications were very popular.

[230] 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 but but Parker you know he's 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 uh someday Wirehog Napster it'll all come back but um you know The industry has not changed enough.

[231] We're going to get sued.

[232] The Facebook is working.

[233] Let's do that.

[234] Let's kill Wirehog.

[235] So supposedly Parker was the one responsible for either before or after he left.

[236] He stays really involved in the company, even after he stopped being president.

[237] He's the one who kills Wirehog within Facebook.

[238] All right.

[239] So chapter one, Sean Parker starts Napster.

[240] And that gets brutally murdered by the music industry.

[241] Chapter two, Facebook in its own success.

[242] becomes the dominant thing, and there's no reason to focus on Wirehog there.

[243] Yep.

[244] Wither Chapter 3.

[245] So for Chapter 3, we come back to Sweden now and to Daniel Eck, the CEO of Spotify.

[246] So Daniel, as we said, he started his first company in 1996 at the age of 13.

[247] He was in school.

[248] It was a website web developer for clients.

[249] Uh, sort of like, uh, um, uh, uh, Tony Shea and, uh, the Zappos guys, uh, when they moved out to California.

[250] Um, yeah, man, that was, that was the thing to do in, uh, in high school.

[251] Like that was, you could make way more money than anybody else because it was this highly valued skill.

[252] It was, the work didn't have to be good.

[253] Like, there was no good, I mean, there's no like modern frameworks for doing any web development then.

[254] So you just throw something together and, and adults are amazed that their businesses on the internet.

[255] net.

[256] There's no square space at this point in time.

[257] No. So after a couple years, Daniel's making like $50 ,000 a month and has 25 employees.

[258] He's still a early teenager.

[259] He ends up, he does go to college briefly.

[260] He goes to the KTH Royal Institute of Technology, which is the top engineering school in Sweden.

[261] But he drops out.

[262] He wants to focus on startups.

[263] He joins one startup called Traderah and ends up getting acquired by eBay.

[264] Then he becomes the CTO of a virtual world game called StarDoll.

[265] Remember when virtual worlds were a big thing?

[266] Yeah.

[267] I don't know about you, but I still spend most of my time in second life, David.

[268] Yeah.

[269] You might be just about the only person left who does that.

[270] 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 that is sort of like the PayPal mafia, or I would, we at Wave would say, the Airbnb mafia of Sweden.

[271] And then after that, finally, Trade Doubler will come back in a second, but after that, finally, Daniel becomes the CEO of a company called U -Torrent, and U -Torrent is a BitTorrent client.

[272] So now BitTorrent is basically, it's a peer -to -peer file sharing protocol that is the spiritual successor to Napster, to Kazah, to LimeWire, to sort of the first generation of file sharing companies.

[273] And BitTorrent is, I don't know fully the technical details, but essentially it's shards files, makes it a lot easier to transfer very large files between users.

[274] 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 you know the hogging the entire way to download that one file that you have i can split it into a hundred pieces and and grab a hundred pieces concurrently from different people so the more people that are hosting the file the more people that um can can share to the network the faster it all moves.

[275] And so this is U -Torrent's based in Sweden.

[276] Later that year, this is 2006, after Daniel becomes the CEO, it ends up getting acquired by BitTorrent.

[277] And this is like piracy, you know, which started with Napster has now reached like a fever pitch.

[278] There's actually, I had forgotten about this.

[279] There's a political party in Sweden that is formed, a legitimate political party called the Pirate Party.

[280] That's all I do remember that.

[281] Their platform is like eliminating intellectual property rights from the law, period, globally.

[282] And like, there are a lot of people that support this.

[283] Apparently in the, you know, national elections at the time, they get about 7 % of all votes in the country.

[284] It's crazy.

[285] And so, like, you know, everybody, this is, the music industry has been decimated at this point.

[286] you know, people are worried, Netflix has transitioned into, is starting the transition into video streaming.

[287] People are worried, you know, BitTorrents out there, people are pirating movies, you know, what's next?

[288] Basically, there's no, there's no hope insight for intellectual property on the internet.

[289] So has Apple ridden in on their, their white knight horse yet?

[290] Oh, yeah, totally.

[291] 99 cent downloads.

[292] 99 cent downloads.

[293] So iTunes, you know, is hailed as the savior of the music industry.

[294] but easy beats free the classic Steve Jobsism yep but iTunes is still uh and until the beats acquisition which we covered it's still in the purchasing music paradigm uh where you're paying money per file uh and then you can play that file anywhere but it's only one song or one album um it's not like the best experience and this is where daniel you 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 $99 stuff, it was still restricted to five devices that had to be authorized in kind of a kludgy way.

[295] You literally had to transfer the MP3 around because the cloud hadn't really blossomed yet and certainly not streaming.

[296] So, you know, if you think about sort of step functions to the user experience, I'd say, you know, that iTunes was like 20 % better because I didn't have to go 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 remember all the crappy files you'd get from Napster and you know Kazan it's like somebody like playing like playing something out of their computer speakers and then re -recording it onto a separate things to have this weird like hiss in the background it was great wild west totally but but it really wasn't you know it wasn't a whole step function better.

[297] It was easy.

[298] Sure, it beat free, but it wasn't a paradigm shift.

[299] 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.

[300] Remember organizing your iTunes file library?

[301] I want my life back.

[302] I want all those hours back.

[303] I meticulously cared about this.

[304] I like, I for a while tried 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 like help you by recognizing the audio signature and filling it in, but even that was wrong.

[305] And I'm like so obnoxious and meticulous about keeping that stuff accurate that like I have, I've spent weeks, like cumulative weeks of my life.

[306] 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 libraries.

[307] Well, and I thought I was going to have that with me for life.

[308] Like, I remember, you know, you look at your dad's record collection or, you know, my parents also had this, like, rich CD collection.

[309] And I'm like, this is the way, like, this is my music collection that I'm going to carry with me forever.

[310] 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.

[311] I just, like, have it on an external hard drive somewhere around my house.

[312] And it was like this painful and credible illustration of sunk cost fallacy where I just, I, like, am, 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.

[313] And did anything bad happen from it?

[314] 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.

[315] But, like, you know, I hadn't opened iTunes and listened to any of that in years.

[316] Yep, yep.

[317] So this is really the insight that Daniel Eck has, which is two -pronged.

[318] It's that the user experience for music is not just that the industry is broken, but the user experience.

[319] is broken and iTunes is not great for all the reasons we talked about.

[320] But piracy isn't great either.

[321] You know, BitTorrent and all the spiritual successors of Napster.

[322] You still have the same problem.

[323] You've got to manage the files.

[324] You don't know what you're getting.

[325] It's really, it feels like, you know, all of this feels like technology that's not like productized.

[326] And so he has the vision that there's a better way.

[327] There's actually a better way to, consume music that is better than pirating, better than iTunes, and that is what becomes Spotify.

[328] So he decides, you know, yeah, the music industry is hard, but I'm just going to go for it.

[329] He teams up with Martin Lawrence, his co -founder, who was one of the Trade Doubler co -founders.

[330] Remember, Trade Doubler had acquired Daniel's last company before he joined U -Torrent.

[331] They fund the company themselves.

[332] They figure they can raise venture capital.

[333] And, you know, they'll do some deals with record labels, get launched.

[334] They have this new, you know, new paradigm for consuming music.

[335] Of course, everybody's going to see how much better it is.

[336] And it turns out it's quite a slog to get the record labels on board.

[337] So this was, yeah, shocking.

[338] So this was 2006 when they start the company.

[339] Apparently the name Spotify comes from they're in Daniel's apartment.

[340] They're brainstorming names for the company.

[341] They're sitting in different rooms and they're shouting back and forth.

[342] And with suggestions, Martin, shouts something, and Daniel mishears it as Spotify, and immediately Googles it, realizes that the domain name is available, and thus, Spotify.

[343] I love these stories of how these things come to be.

[344] They later try and justify it as like, well, it's a mashup of spot and identify.

[345] But no, that's not what happened.

[346] It's like, it's like Pierre Omidyar, when asked it in all hands meeting after the eBay IPO, what does eBay stand for?

[347] Well, I was going to, I've been trying to tell people that it's like electronic bay, but I just thought eBay sounded cool.

[348] Totally.

[349] So they build the product.

[350] They're working with the labels, but it takes, as I said, forever to get any deals done.

[351] And the labels in particular don't want to go anywhere near giving the rights to streaming to the U .S. 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.

[352] Remember, Netflix is already around at this point.

[353] Like the model is proven, but only in Sweden.

[354] They won't let them do it in any other companies.

[355] 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.

[356] So they use the invitation growth hacking method for free accounts.

[357] But if you want to pay to subscribe, anybody can come in and pay to subscribe.

[358] 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.

[359] That's a great.

[360] That's so interesting.

[361] 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.

[362] But at the beginning, it's so coveted if you care about being on it and that social.

[363] I mean, it's so clearly not going to be a long -term revenue strategy, but it's like, hey, if people will pay for this, now, we may as well do it.

[364] Great way to start.

[365] Great way to start.

[366] Shortly thereafter, in February 2009, they launched in the UK, and then they slowly kind of roll out in Europe after that.

[367] 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 the summer of 2009 and I remember reading all this articles in tech crunch in 08 and 09 about Spotify and what a disruptive innovative thing this was and sitting in my dorm room in Ohio State being like I have I feel so disconnected like I'm here manually curating my iTunes library and like I keep hearing about the streaming music thing.

[368] And it was like the most awesome experience to go and and do that internship in London and get to use Spotify.

[369] But then when I came back in what September of 2009 to get plunged into the dark ages back into the U .S. again, it was this really weird experience.

[370] Yeah, totally.

[371] Well, so summer 2009, this is when Sean Parker comes back into the story, rises from the dead yet again or rides back in from the sunset on his horse.

[372] So Spotify is growing across Europe.

[373] Their labels are slowly letting them go into more and more countries.

[374] 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 wealthy, I believe Hong Kong based, either Hong Kong or Taiwan, I believe Hong Kong based billionaire.

[375] 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 and but they just closed this round this 50 million dollar round Sean at this time had joined up with Peter Thiel as a as a partner at Founders Fund.

[376] And so Sean writes Daniel this email and we'll link to it.

[377] I believe he hadn't met him because in this email, he says, I look forward to meeting you in person.

[378] I really liked this, but I look forward to meeting you.

[379] I see all these things.

[380] So maybe it was that Daniel met with Zuck and Zuck told Sean Parker about it or whatever.

[381] And then Sean Parker went crazy.

[382] Sean Parker goes crazy.

[383] Fell in love with this thing.

[384] Totally falls in love with it.

[385] And so he writes this email.

[386] which is online, on the internet, published for posterity.

[387] We'll link to it.

[388] It's amazing.

[389] And so I'm just going to, I'm just going to quote liberally from this email here.

[390] It starts off with, you know, I've been playing around with Spotify.

[391] You've built an amazing experience.

[392] As you saw, Zuck really likes it too.

[393] I've been trying to get him to understand your model for a while now, but I think he just needed to see it for himself.

[394] 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.

[395] Remember, Parker has no formal involvement with Facebook at this point in time.

[396] In particular, there's no way that iTunes could enable the right experience on Facebook.

[397] And he continues, he says, ever since Napster, I've dreamt of building a product similar to Spotify.

[398] What's clear, if, oh, go for it.

[399] What's clear is that the labels never quite understood the way people really consume, share, consume, share, and experience digital music.

[400] And they couldn't admit to themselves that this behavior pattern wasn't changing anytime soon.

[401] Rather, they'd have to change the way they did business, essentially, to make it work.

[402] And these are so clearly two kindred spirits, like the way that Sean Parker thinks about music and the way that Daniel Leck thinks about music, like, it is, you are, when you read this thing, you're sort of reading the future product.

[403] roadmap for Spotify as laid out by Sean Parker, which I'm sure Spotify had already thought through.

[404] And if you find the content of this episode interesting, you'll just like love every word of reading this.

[405] So go check it out in the show notes.

[406] Well, and this is what's interesting.

[407] So I don't know.

[408] 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.

[409] But essentially, this is, you know, the first key to Spotify was what we talked about earlier, which is really getting the product experience right.

[410] Like, it's a better product experience than either iTunes or piracy because you don't have to worry about organizing and files and all.

[411] It's just right there at your fingertips, you know, wherever you are on any device.

[412] That's great.

[413] But that's only the first thing.

[414] The second key to Spotify is Facebook and distribution.

[415] So, yeah, 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.

[416] 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.

[417] Anyway, which is funny because he was basically, I mean, he was technically the business dude at Napster.

[418] Like, he was not the product designer.

[419] Yeah.

[420] So my goal for the second generation Napster was to implement social and sharing features.

[421] This would have dramatically increased the volume of sharing happening through the system.

[422] Based on the comment you made to Zuck, I suspect you're moving in this direction.

[423] 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.

[424] That he 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.

[425] Then he says, if you need some...

[426] Which on its own has been quite the topic of discussion.

[427] Well, Cambridge Analytica and all that.

[428] Then he says, if you need some help navigating Facebook platform, in particular, the viral channels, I'm happy to lend a hand.

[429] And this is really how Spotify becomes a $30 billion company.

[430] So also, this email is a masterpiece of, you know, if you're a VC and you're trying to get yourself into a deal, an investment or win a deal, like this is how you do it.

[431] Take notes.

[432] because shortly thereafter Founders Fund comes in and Sean adds another $15 million to the round that was already closed.

[433] Daniel says, of course, I need to have you involved and then Founders Fund and Sean end up investing.

[434] But this is it.

[435] And so at this point in time, this is the end of 2009.

[436] The company, Spotify, believes they're about six weeks away from being able to launch in the U .S. They've been working on deals with the record labels forever.

[437] Sean knows dealing with the record labels takes longer than you think.

[438] He thinks it's about 12 weeks away.

[439] You know, in the next quarter, they'll get out in the U .S. Turns out to take another two years until they're finally able to launch in the U .S. It's not until 2011.

[440] But that also is very fortuitous for the company because they basically take those two years and they do two things.

[441] They foster their relationship with Facebook through, brokered through Sean Parker.

[442] 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 news feed.

[443] And this is really what drives Spotify's viral growth.

[444] This is, you know, it's Farmville for music.

[445] Like you really are just seeing every update that every one of your friends takes in Spotify in your news feed.

[446] Ben, listen to Wake Me Up before you go.

[447] I mean, I seriously, I remember turning publishing on and off specifically when I was listening to certain songs.

[448] Like, oh, I hope this doesn't go out on my Facebook.

[449] And I was one of those people, David, did you ever use, um, audio scrobberler or last, yes, which became last or move with, yeah, merge with last FM?

[450] I was like, I had that hooked into iTunes.

[451] And so I was always scrobling to my last .fm account.

[452] And then when I realized, so that I enabled the switch for that to get published to Facebook, but like no one else, like, it was very much a like homebrew computer club type thing to be sharing all your music data on Facebook before Spotify.

[453] And then I remember when Spotify lit up in the U .S. It was like, holy God, every single person's listening, you know, habits are showing up here in real time.

[454] You know, it's either like you farmed a root vegetable or you listen to, you know, I don't know, what was popular music at this point in time.

[455] Like, so hard to remember.

[456] Justin Timberlick.

[457] Here's the thing that's actually not hard to remember is I'm pretty sure.

[458] I heard a great quote once that was your music taste for the rest of your life is whatever you're listening to senior year of college.

[459] So I would bet if we go look at what you and I actually listen.

[460] Like, I was listening to a ton of radio head and what I listened to today, a lot of radio head.

[461] No. I think.

[462] That's the way it works.

[463] Colleges.

[464] That's why it's important.

[465] It sets your habits for life.

[466] So 2011, basically, Spotify's now had time to build this relationship with Facebook.

[467] And in July of 2011, they launched in the U .S. But September 2011 is the biggest moment in Spotify's history.

[468] And that is 2011, Facebook F8, their big.

[469] annual conference.

[470] During the keynote, Zuckerberg invites Daniel Eck up on stage and announces a major partnership between Facebook and Spotify.

[471] And it's two things.

[472] One, at that F8, Facebook had announced, launched OpenGraph and the platform the year, well, the platform launched many years before, but OpenGraph launched the year before, that basically allowed lots of people to now insert activities that people were doing in non -Facebook apps like Spotify, like Zinga, into the news feed.

[473] They launched the ticker in 2011, which is basically like a real -time fire hose stream.

[474] I think this was kind of in reaction to Twitter of everything, literally everything, all your friends are doing streaming by you.

[475] And it was like that little, you had your regular news feed, but then up in the top right corner, you also had the real -time ticker.

[476] Yep.

[477] And it was basically just garbage that like got overwhelmed with marketing.

[478] that all these companies were hacking into Facebook.

[479] But so in this partnership, not only is Spotify a launch partner for the ticker.

[480] So, you know, what all your friends are listening to, playlist, they're making, everything, is getting pumped into the ticker and the news feed.

[481] 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.

[482] And in the news feed, you just click the play button on the song right within Facebook.

[483] it starts playing the music.

[484] And so if you don't have Spotify installed, this is a big incentive to now install Spotify.

[485] And you know what?

[486] We sort of, what's the right way to say this?

[487] We sort of criticize and poke fun at the, wow, they really hijacked Facebook for this purpose.

[488] But this is like the exact perfect product usage fit match where it 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.

[489] Like at the very least, it was super valuable to see, to have social music recommendations.

[490] 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 or, you know, a friend will tweet out what they're listening to.

[491] 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 bring them into the primary way that you were interacting online.

[492] And I just think, like, it was a brilliant move on Spotify's part to be able to get this distribution and, you know, partner with Facebook in this way.

[493] But talk about a perfect, a perfect reason for Facebook to have a platform.

[494] Like, Facebook was never going to do this.

[495] They can't wire hog.

[496] They had a million other things to do.

[497] And this made their service so much better, at least in, you know, maybe not as crazy 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.

[498] Actually, I think you're right.

[499] Like, it is unfair to lump Spotify into this whole group of companies, Zing of being, you know, primary offender, number one of just hijacking the news feed.

[500] Like, it actually was a pretty good product experience.

[501] 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, no, so they overdid it.

[502] 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.

[503] All of these companies are dead because they weren't actually, like, useful products that people wanted, but Spotify is still around and is a $30 billion company now.

[504] It's like the only what, I mean, Zink is still around, but that's mostly because of their real estate holdings, but.

[505] Yeah.

[506] And one other point on Spotify is while it's significantly ratcheted back on Facebook, like you don't really see, see this in people's news feeds anymore, Spotify themselves gained enough of a critical mass where, you know, most people, or let's throw out, most millennials in the U .S. who are going to be on Spotify are on Spotify.

[507] I don't know if that's a totally fair assumption, but let's just take that at face value for the moment.

[508] 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.

[509] And so, you know, they're not using 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.

[510] And it's still, you know, hearkening back to that, it added to the Facebook experience.

[511] It adds to the Spotify experience to have a current view of what your social network is listening to.

[512] Yep.

[513] Yep.

[514] Well, regardless, it certainly works for Spotify.

[515] 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.

[516] Wow.

[517] And then within the month, they've doubled.

[518] their user base.

[519] They were, well, almost doubled.

[520] They were just over 3 million users, primarily across Europe at this point in time.

[521] They just launched in the U .S. And by the end of September, they're, I believe, over 6 million users.

[522] And over 2 million of those are paying.

[523] Wow.

[524] U .S. is a heck of a market to enter.

[525] Yeah.

[526] Well, especially on the back of Facebook and Mark Zuckerberg, you know, bringing you on stage on the keynote.

[527] Right.

[528] So 2 million of the 6 million from the U .S. U .S. were, uh, premium.

[529] Uh, that was, I, that was worldwide.

[530] So six, got it.

[531] Six million worldwide, two million paying premium.

[532] And that's a lot of money.

[533] Like that's also, that's not so different from today.

[534] I mean, today it's in the high 40%, but, um, I mean, it's, it's really interesting from the earliest days.

[535] They had an incredibly well -converting premium model.

[536] Yep.

[537] They're incredibly well converting.

[538] Um, and they tweak it over time.

[539] So, originally it was free to listen on desktop and then you had to pay to go mobile.

[540] They tweaked that so that it was free on mobile as well, but only shuffle mode.

[541] So you still can't pick specific songs.

[542] You can only shuffle playlists.

[543] Yeah, it converts really well.

[544] So basically, you know, on the back of that, like that's the rocket fuel that Spotify needs to reach escape velocity and take off into the large company it is today.

[545] So they finished 2012 the next year with 20 million active listeners.

[546] So huge growth, like over 3x from 2011.

[547] Five million paying subs.

[548] So almost 3x growth on paid.

[549] One million paying subs in the U .S. at the end of 2012.

[550] And then they just start raising a ton of money to keep pumping it into marketing and product development too.

[551] 2012, there is $100 million from Goldman Sachs at a $3 billion valuation.

[552] 2013, there raised $250 million at a $5 billion valuation.

[553] They also, funny aside, kind of just like Dropbox, this is the era when everyone wants to be a platform.

[554] So Spotify also gets caught up in this, builds the Spotify platform, allow app developers to build apps based on music.

[555] Wait, really?

[556] Yeah, of course, this is all buried in history now, but...

[557] Completely miss that.

[558] Lots of hype.

[559] They launched it late 2011.

[560] And they kill it in 2014, but it's like, this is the future.

[561] You know, you can build apps with music.

[562] And it's like, what?

[563] Anyway, fortunately.

[564] It's so funny to watch these companies try and launch these like broad -based platforms that don't make sense and then you kill it.

[565] And then yours down the line, launch another platform that is like highly targeted, something that really makes sense.

[566] Like Spotify Connect today is freaking awesome.

[567] Like the ability to play Spotify out to various partners, Sonos and, you know, everyone that can hook a speaker or a playback device into Spotify, it works so well.

[568] And like that turns out that was the killer way to integrate with Spotify for things coming out of Spotify.

[569] Yeah.

[570] Yeah.

[571] Totally.

[572] But they get there.

[573] And they just keep raising more and more money.

[574] They ultimately end up raising, I believe, about two and a half billion dollars in the private markets.

[575] They also, in late 2015 and then into 2016, as, you know, Facebook, is now no longer, Facebook has vastly locked down its platform.

[576] You're not getting all this crazy distribution.

[577] They really catch the next wave really well, too, and time it well with machine learning and recommendations.

[578] They launched the Discover Weekly playlist, machine learning generated, algorithmically generated playlist unique to each user with new songs that they think you'll like, or songs that you don't know well that they think you'll like.

[579] They launched that at the end of 2015.

[580] Radar, which is new music from artists you like, launches in 2016, along with the daily mix.

[581] And this drives kind of the next wave of growth in the company and engagement.

[582] And so by the end of 2016, they have 40 million paying subscribers, which, like, that's huge growth.

[583] And just to take a pause on sort of internal 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.

[584] It was just one of the playlist available to you, like 70s, 80s, 90s, Discover Weekly.

[585] 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.

[586] 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.

[587] It was streaming should be the way that this world works, and we're going to persevere with the music labels to make that happen.

[588] Facebook is this amazing distribution vehicle, so we're going to, you know, that's our sort of innovation number two.

[589] 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.

[590] Yeah.

[591] And I think it also, it's a good point.

[592] We didn't really cover earlier.

[593] This has always been a thread through Spotify's product history, but is best expressed in these, in these playlists in Discover Weekly and Radar and Daily Mix, is this idea of the playlist.

[594] Like, playlist had been around, you know, since recording cassette tapes, you know, in the 80s.

[595] And then certainly iTunes had playlists.

[596] But what was great about Spotify is they really made playlist.

[597] first class citizens.

[598] So like, and this is part of what they got the labels back on board with is, whereas iTunes is a singles focus.

[599] Like you, you are buying individual songs.

[600] You can buy albums, but like people buy songs.

[601] With Spotify, the focus was on playlist.

[602] And that kept people engaged, engaged with artists and listening a lot more.

[603] And when the labels were getting paid, labels and artists, getting paid based on number of streams, keeping people streaming more, listening more aligns incentives a lot better.

[604] Yep, absolutely.

[605] So end of 2016, 40 million paying subscribers.

[606] Now, some of those are family plans.

[607] Some of those are student plans.

[608] We talked about this in the beats episode.

[609] 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.

[610] And that's how much they're making per month.

[611] But even if you multiply it by five, be really conservative.

[612] that's $200 million or euros in subscription revenue per month.

[613] That's a lot of revenue.

[614] I mean, that is a serious business.

[615] Wouldn't it be great if they could keep, you know, a ton of it instead of just like, you know, like 10 % of it?

[616] Wouldn't that be great?

[617] Well, they keep 30%.

[618] Yeah.

[619] Well, ultimately, so I guess where I was going with this is ultimately there, during that year in 2016, their gross margins on the premium stuff is 16%.

[620] The ad consolidated stuff, they actually lose, I'm sorry, the ad -supported stuff, they actually lose 12%.

[621] So it's a negative 12 % gross margin, and they're consolidated is 14%, which jumped up the next year due to sort of a deal negotiation.

[622] But the thread as we get into narratives around the IPO, which we'll go to in a few minutes.

[623] I'm sorry, the direct listing, not the IPO, is certainly that it's, you know, that it's incredibly low margin business relative to a lot of these other technology beheemates that have really become huge in the last few years.

[624] Yep.

[625] Well, to get us there quickly, companies growing.

[626] As we mentioned earlier, there's always been a robust secondary trading market for the stock.

[627] They've raised all of this money.

[628] They don't need to raise any more money.

[629] We'll get into the business model and 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, 10 euro a month subscription fee.

[630] They don't pay their revenue share.

[631] Spotify doesn't pay the revenue share out to the labels until after the end of the month.

[632] So just like Amazon in this regard, they have a positive or a negative working cash flow cycle that allows them to be cash.

[633] flow positive, even if they're not net income positive.

[634] And in the meantime, they had hired the guy named Barry McCarthy as their CFO, who is their CFO.

[635] He had been the former CFO of Netflix.

[636] Also took a short detour after that to be the CEO of Clinkle, sad.

[637] We're not going to talk about that one here.

[638] That would be, if we're looking for this episode was to get to yell Clinkle.

[639] Glinkled.

[640] Oh my goodness.

[641] One of my friends in business school did his summer internship at Klingle.

[642] That's for another episode.

[643] Anyway, fortunately for Barry, he moves on quickly from Klingle and becomes the CFO of Spotify.

[644] And Barry is the one who really leads the charge saying, why would we do an IPO and give 7 % of the offering?

[645] A, raise money when we don't need it.

[646] Take delusion in the company.

[647] Give 7 % of the offering to banks.

[648] Let's just do this direct listing.

[649] So they do.

[650] They set a reference.

[651] point.

[652] So there's no, there's no pre -sales like in an IPO.

[653] They set a reference point for trading of $132 share, which equates to a market cap of about $23 .5 billion.

[654] That's where shares have been trading on the private market.

[655] They announced that they're going to do the first trade publicly on Tuesday, April 3rd, which they do.

[656] It opens.

[657] The first trade happens at $165 a share in 90 cents, right around to 30.

[658] Which is totally way higher.

[659] Like the reference price was 132, Reuters reported that it would be between 145 and 155.

[660] You know, it just kept climbing up to the day.

[661] Yep.

[662] And so that's about a $30 billion market cap.

[663] It ends the day at $149 a share or $26 .5 billion market cap still up.

[664] As we alluded to, the folks at the New York Stock Exchange mistakenly raised the Swiss flag outside the exchange.

[665] They both start with S or Europe.

[666] It's fine, David.

[667] Swedish flag.

[668] It's okay.

[669] That's quickly rectified.

[670] But this morning here, we're Thursday morning, two days later, still trading about $150 a share.

[671] So right around just below a $27 billion market cap.

[672] Yeah.

[673] And the really important thing here sort of for the future of direct listings is, you know, will it sort of settle here?

[674] Because the thing that everyone was really worried about is there's going to be all this incredible volatility.

[675] They didn't hire bankers to stabilize, you know, that if it if it ends up falling below $132 a share, that's below the last place it was trading in the private markets.

[676] But, you know, all indicators are positive right now.

[677] 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.

[678] And as you sort of read a lot of these articles, it becomes clear that.

[679] Like, it wasn't one, it wasn't two.

[680] Like, they paid Golden Sachs, Morgan Stanley, Allen and company.

[681] Morgan and Stanley is technically serving as financial advisor.

[682] But ultimately, they're going to pay 44 to 50 million bucks in banker fees.

[683] Yeah, advisory fees.

[684] It's quite comparable to what they would have paid if they had actually IPOed.

[685] It's sort of shy of recently, if you look around Snapchat paid over $60 million.

[686] But if you look, you know, Dropbox was only around 30 million.

[687] Mongo was at like 17 million.

[688] Stitch Fix was at 7 million.

[689] Like they're actually, despite the fact 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.

[690] Yeah, I'm not sure exactly what the banks are doing.

[691] 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 paying them for, which is really what a bank would do in an IPO process.

[692] It's just that they're doing it on an advisory basis instead of taking, literally buying the shares from the company and then reselling them to those investors.

[693] So, yeah, should we get into?

[694] Yeah, one other thing, the other really smart thing that Spotify, I did leading up to this is they, you know, they encourage sort of second market trading for their employees and they, you 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.

[695] And so I don't know exactly what they did.

[696] I think they waived, they waives basically their right to be the ones purchasing when employees are selling their shares and to kind of encourage this.

[697] So, all right, listeners, our sponsor is one of our favorite companies, Vanta, and we have something very new from them to share.

[698] Of course, you know Vanta enables companies to generate more revenue by getting their compliance certifications.

[699] That's SOC2, ISO 2701, but the thing that we want to share now is Vanta has grown to become the best security compliance platform as you hit hypergrowth and scale into a larger enterprise.

[700] It's kind of wild.

[701] When we first started working with Vanta and met Christina.

[702] My gosh, they had like a couple hundred customers, maybe.

[703] Now they've got 5 ,000, some of the largest companies out there.

[704] It's awesome.

[705] Yeah.

[706] And they offer a tremendous amount of customization now for more complex security needs.

[707] So if you're a larger company and in the past you showed Vanta to your compliance department, you might have heard something like, oh, well, we've already got a compliance process in place and we can't integrate this new thing.

[708] But now, even if you already have a SOC2, Vanta makes maintaining your compliance even more efficient and robust.

[709] They launched vendor risk management.

[710] This allows your company to quickly understand the security posture of the vendors that you're choosing in a standardized way that cuts down on security review times.

[711] This is great.

[712] And then on the customization front, they now also enable custom frameworks built around your controls and policies.

[713] Of course, that's in addition to the fact that with Vanta, you don't just become compliant once, you stay compliant with real -time data pulled from all of your systems, now all of your partner's systems, and you get a trust report page to prove it to your customers.

[714] If you click the link in the show notes here or go to vanta .com slash acquired, you can get a free trial.

[715] And if you decide you love it, you will also get $1 ,000 off when you become a paying customer.

[716] Make sure you go to vanta .com slash acquired.

[717] Our sponsor for this episode is a brand new one for us.

[718] Statsig.

[719] So many of you reached out to them after hearing their CEO, Vijay, on ACQ2, that we are partnering with them as a sponsor of Acquired.

[720] Yeah.

[721] For those of you who haven't listened, Vijay's story is amazing.

[722] Before founding Statsig, VJ spent 10 years at Facebook where he led the development of their mobile app ad product, which, as you all know, went on to become a huge part of their business.

[723] He also had a front row seat to all of the incredible product engineering tools that let Facebook continuously experiment and roll out product features to billions of users around the world.

[724] Yep.

[725] So now Statsig is the modern version of that promise and available to all companies building great products.

[726] Statscig is a feature management and experimentation platform that helps product teams ship faster, automate A -B testing, and see the impact every feature is having on the core business metrics.

[727] The tool gives visualizations backed by a powerful stats engine unlocking real -time product observability.

[728] So what does that actually mean?

[729] It lets you tie a new feature that you just shipped to a core metric in your business and then instantly know if it made a difference or not in how your customers use your product.

[730] It's super cool.

[731] Statsig lets you make actual data -driven decisions about product changes, test them with different user groups around the world, and get statistically accurate reporting on the impact.

[732] Customers include Notion, Brex, OpenAI, FlipCart, Figma, Microsoft, and Cruise Automation.

[733] There are like so many more that we could name.

[734] I mean, I'm looking at the list.

[735] Flex and Versel, friends of the show at Rec Room, Vanta.

[736] They literally have hundreds of customers now.

[737] Also, Statsig is a great platform for rolling out and testing AI product features.

[738] So for anyone who's used Notions' awesome generative AI features and watched how fast that product has evolved, all of that was managed with Statsig.

[739] Yep.

[740] If you're experimenting with new AI features for your product and you want to know if it's really making a difference for your KPI's Statsig is awesome for that.

[741] They can now ingest data from data warehouses.

[742] So it works with your company's data wherever it's stored so you can quickly get started, no matter how your feature flagging is set up today.

[743] You don't even have to migrate from any current solution you might have.

[744] We're pumped to be working with them.

[745] You can click the link in the show notes or go on over to stat sig .com to get started.

[746] And when you do, just tell them that you heard about them from Ben and David here on Acquired.

[747] Should we get into narratives?

[748] Yeah, let's do it.

[749] Let's do it.

[750] So one thing that's interesting to take a look at before we're getting, before totally doing narratives is what the cap table look like.

[751] So Daniel X still owned 25 .7 % of shares.

[752] And Martin owned 13 .2%.

[753] So that's almost 40 % among the two co -founders.

[754] That's like a Dropbox level of ownership.

[755] It's more than Dropbox.

[756] Yeah, they took on so much capital.

[757] Yeah.

[758] I mean, they've raised $2 .5 billion and it's been 12 years.

[759] Yeah.

[760] Well, they raised at such high valuations along the way.

[761] And again, you know, this is narratives here.

[762] They raised at such high valuations.

[763] Their revenue numbers were so impressive.

[764] But the question is how much of that is, you know, going to flow down to the bottom line after the labels take their 70 % cut.

[765] Well, it's so funny to be doing this right after Dropbox, because if you look at them, you know, these ownership percentages are so high and you say, why are they so high?

[766] growth is an amazing leverage point, and profitability or close to profitability or at least running a lean operation and generating a lot of cash is also a really high leverage point.

[767] So both of these companies grew like wildfire, monetized from an early day, and, you know, that just gives them a lot of ability to raise a really high valuations and bring a lot of cash to the business with a lot of certainty in the future.

[768] Yeah.

[769] But the difference between Dropbox and Spotify, as I'm sure you'll get into, I actually didn't look up.

[770] Do you know offhand what Spotify's overall gross margin is?

[771] I do.

[772] I do.

[773] So it actually went up last year because of a renegotiation with the labels where Spotify said, look, we want a higher take rate.

[774] But if we don't grow and hit our numbers, you get to take more money.

[775] 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%.

[776] So they're definitely betting the farm on future growth here right now, and, you know, being nicely compensated for it from the labels.

[777] Yep.

[778] So it's 21 % gross margin?

[779] 21%.

[780] Yeah.

[781] And 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.

[782] So that would be a really high gross margin because your actual cost of revenue is very low.

[783] So if you look at something like a Facebook, they tend to hover around an 85 % gross margin.

[784] Google, I think, is high 80s, low 90s.

[785] But Dropbox, getting back to that comparison, is just under 70.

[786] So 67 % gross margins currently at Dropbox.

[787] So all of this is significantly higher.

[788] And Ben, just like you were saying, like the reason this is important, is like, you know, 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.

[789] But then the business models tend to be so scalable on a marginal cost basis.

[790] Like, it doesn't cost Facebook anything to sell another ad or Google anything to sell another ad word.

[791] Dropbox, it does cost them in storage to bring on new customers.

[792] But especially after they've moved off AWS, it doesn't cost them that much.

[793] You know, they're still making 70 % gross margins.

[794] Right.

[795] Not the case with Spotify.

[796] That's right.

[797] That's right.

[798] So getting into the narratives, a quick snapshot of their business today.

[799] They're unprofitable.

[800] In 2017, they did $5 billion in revenue, which is awesome.

[801] But they took a $1 .46 billion loss.

[802] So, you know, you would, you would, hope to see that sort of change soon where they were 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.

[803] On their balance sheet, they have $582 million of cash available, so about half a billion bucks of cash.

[804] Now, 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 every year, or at least at their current run rate.

[805] So unless they get profitable fast, they will actually need more money to continue funding the business.

[806] Now, yeah, I think there's a yes, but here.

[807] Um, yes, but if you look at, you know, because of some of the adams we were talking about earlier with the negative working cash cycle, they actually are cash flow positive, operating cash flow positive.

[808] So in 2017, they generated 179 million euros in operating cash flow.

[809] Now, they still lost money on a cash basis for the year because they're having to pay off interest on the debt that they have, the convertible debt that they have.

[810] So, you know, yes, they will eventually need to turn that income positive.

[811] That's the bet here.

[812] But they are cash flow positive.

[813] They are cash flow positive.

[814] But it's not anywhere near the levels that Dropbox is at.

[815] I believe, well, I can look it up quickly.

[816] I believe Dropbox is generating right around half a billion in operating cash flow right now and growing quickly.

[817] Spotify growing too, but like they're kind of hamstrung by these margins.

[818] Yeah.

[819] Yeah.

[820] And thanks for that correction.

[821] That's a great point and not to be overlooked.

[822] And the last thing I'll say is growth is spectacular.

[823] Like if you look at revenue growth from 2016 to 2017 they went from 3 .6 billion up to that that five billion number you know when you're generating that much revenue to be growing like that is really i mean they're they're in a they clearly uh um you know hit a high pressure valve when they were uh looking around for what market to enter um this doesn't look like it's going to stop flowing anytime soon um they uh they have 159 million monthly active users 71 million of those which is almost half are uh our payment paying premium subscribers, which means they've switched off the ad tier and into the paying tier, which is they have double the number of Apple music subscribers.

[824] I actually don't know if that's subscribers or monthly active users, but they sort of brag that they're double Apple music.

[825] So, you know, that, that, that, I think it's huge growth business.

[826] I think it's subscribers.

[827] I think it's paying.

[828] Yeah, I think that, I think that's true too.

[829] So real quick, I looked up Dropbox.

[830] So Dropbox, 2017, $330 million in cash flow from operating activities.

[831] Spotify, $179 million.

[832] So roughly, a little less than twice as much for Dropbox.

[833] Cool.

[834] Thank you.

[835] So if you look at what Spotify says in their F1, you know, they're, they're advertising that streaming is the title wave on here.

[836] And it's very early days.

[837] and it's growing globally, that smartphone growth is a huge driver, that Spotify's the market leader in a huge way, and even this behemoth, Apple, can't catch them.

[838] They use data in a huge way to provide this personalized experience.

[839] They're running as an operationally lean business, and that they really saved music.

[840] They are not shy about this story.

[841] The way that they open their F1 is really by talking about the incredible decline that the music industry was in and and how streaming sort of pulled them out of it and saved the music industry.

[842] And so the way they talk about themselves, you know, 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.

[843] And what Spotify says is, look, like the music labels love us because we save the industry.

[844] 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.

[845] Yep.

[846] And I think all that is true.

[847] You know, it's Sean Parker and Napster 2 .0 working with the music industry.

[848] Yeah.

[849] So what would the skeptics say?

[850] You know, I haven't heard as much about this in the last call it six months.

[851] But for the few years before that, it was like Spotify was a trope.

[852] It's a terrible freaking business.

[853] The suppliers have all the leverage.

[854] The music labels take a huge cut.

[855] Not only do they take a huge cut, but there's a most favored nations clause in their agreements where basically for Spotify to get a better rate, they have to go and get all of the major labels, the sort of four or five major labels that make up 85 % of the music listen to on Spotify to agree to this new lower rate.

[856] Um, it's a cartel.

[857] You know, it's a total cartel.

[858] And unlike, uh, the, the technology business of, uh, let's, let's look at Netflix, for example, where they actually, um, license the shows and pay an upfront cost of, you know, you look at house of cards, a hundred million dollars to create house of cards internally or a license.

[859] Or a license that Netflix creates the shows.

[860] That Netflix creates the show or, or pays a license fee.

[861] Sorry, I conflated those to, uh, existing back catalogs of from, from, from, from, um, other existing produced shows, they pay a one -time fee up front and they own that for a certain number of years.

[862] Whereas, and so they can generate as much revenue as they want for it.

[863] They get to keep the revenue and it's just a sort of a one -time cost.

[864] But if you look at what Spotify is doing compare and contrast, every single stream, you know, has a percentage that's paid out to the music labels and therefore, you know, Spotify cannot outrun their costs.

[865] It's this, yeah, it's this difference between variable and fixed costs.

[866] Like Netflix has an even greater amount of fixed cost versus Spotify, both because they're paying up front a fixed price to license the shows and movies that they didn't make.

[867] And then a lot of money to actually make their own content.

[868] But then when they all their revenue, they just keep all the revenue.

[869] They don't have to pay a percentage of their subscription fees to the movie studios.

[870] It's the opposite what you're saying with Spotify, where, a percentage, a large percentage of their subscription revenue is getting handed right back to the labels.

[871] So as the subscription revenue grows, so does the amount that they have to pay.

[872] Yep.

[873] That's a good, good succinct explanation.

[874] You know, skeptics also argue they have catalog parody with Apple Music, whereas if you look at something like in Netflix, I have all this great stuff available on Netflix.

[875] Oh gosh, there's this entirely non -overlapping subset of stuff available on HBO Go.

[876] maybe I'll pay for both.

[877] I'm sorry, HBO now.

[878] Maybe I'll pay for both.

[879] And there's actual people actually do subscribe to multiple of these things.

[880] And if you look at a music subscription service, basically no one subscribes to multiple because they have the same back catalogs.

[881] And skeptics would say that congratulations, you have algorithmically generated playlists.

[882] I don't think that's differentiating enough to make people switch or make artists want to launch with, you know, 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.

[883] And lastly, that music is something that's just going to be owned by the platform owners.

[884] So sure, 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.

[885] They will catch you soon.

[886] I think when we did the beats episode, was it 36 million subscribers, I believe that Apple Music is at now.

[887] So roughly half of Spotify is paying subscribers, and that's in two years, two and a half years since it launched.

[888] Yeah, I mean, it's a bit of a farce for Spotify to say we have twice as many subscribers as Apple Music.

[889] Like, you are almost a decade older than Apple Music.

[890] Yeah.

[891] And they're coming up fast.

[892] 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.

[893] But then also, you know, there's another, there is another, I don't, so that, who, that was what the skeptics would say.

[894] I mean, I use Spotify.

[895] I don't pay for Apple music.

[896] I'm, uh, highly ingrained in the Apple ecosystem.

[897] Like, maybe they're the ones who can do it.

[898] Yep.

[899] Well, I was going to say there is another, um, player, you know, lurking in the shadows here, uh, which is what do I do?

[900] Uh, I use Amazon music.

[901] And that's Jeff Bezos.

[902] Your margin is my opportunity.

[903] Even if your margin is very, very, um, small.

[904] David, that's because you don't like music.

[905] I do like music.

[906] I actually converted.

[907] I now pay for Amazon music, but it's cheaper.

[908] I think it's seven bucks a month, six or seven bucks a month.

[909] But because it's baked into Prime, either.

[910] So when you pay for it, your, your 12 % gross margin is my opportunity.

[911] Like, well, welcome to, welcome to Bezosland.

[912] Yeah.

[913] Because it's all bundled.

[914] It's all part of Prime.

[915] Amazon can have a totally different business model.

[916] So Amazon Music Unlimited, which is what you pay for, is cheaper than Apple and Spotify, just as good.

[917] 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.

[918] But, like, ultimately, especially with in an Alexa world now, being the default on Alexa, that's very powerful.

[919] Apologies to all the speakers of our listeners who we just activated, Lady A. you know and price is 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 uh you can play on any devices um you know it's it's a big disruptive force yep yeah i'm not going to bet on it but um good case i think it's why wouldn't you bet on it i don't think amazon gets music like i think um i mean we we've seen them try with amazon mp3 like they've taken multiple stabs at music i think it's a it's a um 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, though, there's an element of segments of the market.

[920] Like, there are a lot of, like, how big is Spotify's Tam, really, of people who are going to pay 10 bucks a month in the world for music?

[921] Like, they already have 70 million people doing it.

[922] How many more people will do it?

[923] Especially when there's an alternative out there of, like, I could get something that's like 60 % as good for free.

[924] Yeah.

[925] I mean, for free that, yeah.

[926] So I think Amazon will take share.

[927] 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.

[928] I don't I wouldn't bet on them for the the subscriber revenue.

[929] Yep.

[930] Well, I think there you have the narratives on Spotify.

[931] Yep.

[932] All right.

[933] Into what would have happened otherwise?

[934] Let's do it.

[935] Um, well, they could have IPOed.

[936] They could have IPOed.

[937] They could have IPOed.

[938] Yeah.

[939] Now, they are generating cash from operations, so they don't need the capital.

[940] They've already raised a lot of capital.

[941] Here's a crazy thing that could happen.

[942] I was foreshadowing this a little bit earlier with the Ben and Jerry's thing, but they could IPO.

[943] 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 a, you know, delutive secondary offering that a public company would do in a secondary offering.

[944] Yeah, yeah.

[945] And they could just do that as their IPO.

[946] And as I was thinking through this, David, like, I want to make sure I'm thinking about this right.

[947] So let's hypothetically say they do this, they did this direct listing and started trading at, what, 165?

[948] And it's up to 150, right?

[949] It's It fell to 150, but it's at 150 right now.

[950] Let's say it goes up to 180 or 200 in the next year or so.

[951] And then they go and do an IPO at 200.

[952] They basically get to raise cash later and take less dilution.

[953] Yep, yep, yep.

[954] 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 think we actually need the cash right now, so let's not take the dilution.

[955] Let's take some dilution later if we do need to raise capital.

[956] You could see that this is maybe only chapter one and that the dilutive offering happens later.

[957] Yeah, I mean, I think the question, though, is will they need capital?

[958] 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 going to develop our own artists and make our own content.

[959] Now, that's been bandied about in music, and, you know, there was the famous Taylor Swift, you know, exclusive with Apple, and then that didn't work out.

[960] Ben Thompson's written a lot about this.

[961] Does it make sense in music to have exclusive content in the way it does with video?

[962] Unclear.

[963] Yeah, because here's the thing is in video, since people are used to paying for multiple are switching between, if somebody launches something like Stranger Things, then you're going to switch to that provider or you're going to add provider if you want to watch that.

[964] If you're an Apple music subscriber and Taylor Swift drops her new music video only on Spotify, you're not switching.

[965] Like you're highly, highly ingrained with all these playlists and configuration and friends that you've made in one service or the other.

[966] You're probably not going to do it for a new album.

[967] I mean, maybe for like two or three.

[968] artists that are all, like if Jay -Z and Beyonce, here's the thing they actually do with title.

[969] Like if you look at like, it hasn't worked for anyone yet.

[970] Well, I think it doesn't work because it doesn't make sense for the artists.

[971] Like, especially in today's industry, as an artist, you make your money from shows and from branding and merchandising.

[972] So you need maximum exposure.

[973] Maximum reach.

[974] You wouldn't want to artificially limit, you know, your audience.

[975] Whereas in video, it's a lot different.

[976] Like, you have a lot more niche content, uh, and people are used to, you know, oh, this will be, this is an HBO exclusive or whatever.

[977] Like, you know, they're, uh, the paying directly for content is a lot more ingrained in, uh, in people's psyche.

[978] Yeah.

[979] Plus, you also have the actors who actors act in content across, uh, you know, creators and publishers, essentially.

[980] Like, just because, um, yeah, Will Smith did that exclusive movie, I forget what it's called with Netflix.

[981] That doesn't mean Will Smith can't go do his next movie with Disney or Fox or, well, Fox is part of Disney now or, you know, Universal or whoever.

[982] Whereas in music, like Taylor Swift becoming a Apple exclusive or Spotify exclusive, that means she's not going to ever release content on the competitors.

[983] Like, that doesn't make sense.

[984] Yeah.

[985] Yeah.

[986] something would have to change in the ecosystem where people would have to actually subscribe to multiple providers, which I don't think is going to happen, or 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.

[987] So, yeah, I don't think they need the cash.

[988] Yeah, well, then it makes sense that they didn't do an IPO.

[989] Yeah, which I think was the whole argument of Barry McCarthy, the CFO.

[990] Right, right.

[991] 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 don't have this six -month lockup period.

[992] In fact, the only group, I think actually, I think 10 cent is restricted from selling shares for some amount of time.

[993] But that was a one -off thing in their agreement.

[994] And all employees were free to trade on day one.

[995] Yeah.

[996] So Tencent is a, I think, seven and a half percent shareholder of Spotify.

[997] They did a deal with Tencent at the end of last year and of 2017, where they essentially swapped equity stakes in Spotify and with Tencent Music Entertainment, which is their Spotify competitor in China.

[998] And this is, Spotify was never going to be able to launch in China, just like Facebook and Google haven't.

[999] This is a way to get access, you know, to likewise Tencent, TEME, Tencent Music Entertainment was not ever going to be dominant in the U .S. or Europe or the like.

[1000] This is a way to, go global essentially for both companies.

[1001] So it makes sense that there'd be a lockup for those.

[1002] Well, should we get into tech themes?

[1003] Let's do it.

[1004] Let's do it.

[1005] Well, mine, so in these IPO ones, I want to broaden to sort of tech and investing theme.

[1006] This big, 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?

[1007] Because, you know, 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.

[1008] 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.

[1009] And so to the extent where, you know, Spotify can put up one stage presentation on that they video recorded and then everybody can just look at that.

[1010] 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.

[1011] Like, maybe this is the way of the future.

[1012] Yeah.

[1013] Yeah.

[1014] Well, there are a bunch of problems too.

[1015] Like, you know, the Dropbox IPO last week.

[1016] Like, you know, as a big day as we said in Silicon Valley here lots of Dropbox employees and investors but like it wasn't too because they're all subject to the lockup like you know uh right and then and then you know depends then the lockup comes off but like maybe that depresses the stock a lot of people are selling sometimes companies you know will relock up their employees investors to prevent the stock being depressed traders build the lockup into their models yep yep it just you know it kind of sucks and you know the plus the 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 seven percent of the company like why would you do that you know i mean in these later rounds that drop by that spotify was raising they were selling you know one percent or less of the company why would you now sell a huge amount of the company yeah i mean it the criteria that i basically came up with is fourfold for uh will we see this in the future.

[1017] One is, I think you have to be a household brand name, like Spotify.

[1018] Like, one of the things the bankers do on the road show is, like, really familiarize the institution and large blocks of potential share owners with the company.

[1019] Lots of people were already very familiar with the company.

[1020] You have to not need the cash.

[1021] So, you know, that already limits lots of companies.

[1022] You have to have this very cash efficient business model.

[1023] And we need this Spotify price to hold steady.

[1024] And if it doesn't, I think it'll scare off people from doing this for a long time.

[1025] And it's not that volatile right now.

[1026] It's done a nice job of staying around where it should be.

[1027] But it's bounced around a little bit.

[1028] So I think the next few days are going to be telling.

[1029] Very telling.

[1030] Yeah.

[1031] Well, I think there's one nuance I'd add to your first point, which I totally agree with, is you have to be a known name.

[1032] I don't think you have to be like a consumer household name.

[1033] You have to be known amongst the institutional investor community.

[1034] But that's also happening because those mutual funds, those hedge funds have been investing in private companies over the last five years.

[1035] So they know these names, these stocks, you know, whether it's, whether it's Tiro Price or Tiger or Wellington or, you know, like all these.

[1036] I don't know about Tiro, but all those other firms were already shareholders in Spotify.

[1037] So they already, and these are the biggest owners of POS.

[1038] public stocks in the market.

[1039] So a lot of that education and marketing is kind of already happening while companies are private.

[1040] Mm -hmm.

[1041] Mm -hmm.

[1042] I have one self -serving tech theme that I thought was just fun to read in their F -1.

[1043] Do it.

[1044] So they list podcasts and they have a services section and they list new content offerings and one of them is video and one of those podcasts.

[1045] And I have been noticing, like, you know, as much as I have held the belief that Spotify and SoundCloud, anyone else that's starting to work in podcasts, just doesn't do it well relative to dedicated podcast apps.

[1046] You know, it's now the, I don't know if it's like this on everyone's app, but at the top of the home screen on my little homepage for Spotify, it's listen to these podcasts.

[1047] And they say in their F1, which this is a big market stat about podcasts, that there were 348 million podcast 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 a year.

[1048] Wow.

[1049] 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.

[1050] Seriously, I mean.

[1051] Which is notoriously the problem in podcasts.

[1052] Think about the dynamics are very different.

[1053] The problems are very different.

[1054] 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.

[1055] The podcast, this is where the podcast industry is today.

[1056] Like, the market is there.

[1057] It's growing, like, there's huge.

[1058] But, like, the industry from a product perspective is completely broken.

[1059] Like, somebody needs to come along and just fix it.

[1060] 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 hard for big companies to do this Anyway It's kind of hard for me to believe that Spotify is worth $30 billion I mean maybe I'm getting into grade the DPO right now But like I mean think about like Uber just has the share tender for like 50 -ish billion and like you look at Airbnb's most recent private valuation like I I I is Spotify really a 30 billion dollar 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 30 billion dollar company if you if you value it on a revenue multiple 100%.

[1061] But their margins, their gross margins are structurally very different from, you know, other tech and software companies.

[1062] So if you value it on a, you know, well, you can't do a PPE basis because they don't have earnings.

[1063] But if you value it on a cash flow, multiples of cash flow basis, it's still nutty, you know, like even, so let's say they do 300 million of operating cash flow in 2018.

[1064] I don't know.

[1065] know if that's what they're projecting, but let's just assume, you know, then that's a, what, 100 times, 100 times operating cash flow that they're trading at?

[1066] So like, you're telling me that if you buy Spotify today, uh, you are assuming, you know, so much growth that you're willing to pay a hundred times the cash flow, because cash flow really is how you should be valuing these companies.

[1067] A hundred times it's cash flow today.

[1068] No, I mean, it's not crazy.

[1069] like other other um 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 how many how much growth is left in spotify you know to to be willing to pay a hundred times cash flow for something you have to be willing to believe that there's so much growth that like that's going to because essentially what you're doing right now is you are paying for 100 years of cash flow of Spotify like the cash flow will repay your investment in 100 years.

[1070] You believe that there's a lot of growth that it's going to be a lot shorter than 100 years.

[1071] But like, I don't know.

[1072] Can Spotify double?

[1073] Probably.

[1074] Can they 10x?

[1075] I don't know.

[1076] I don't think so.

[1077] Yeah.

[1078] I mean, it's interesting how my anecdotal evidence is so much different than the numbers.

[1079] Like what I said at the opening of this episode and I said, it feels like pretty much everybody that is a millennial that is going to buy, you know, is going to subscribe to Spotify is already subscribed to Spotify.

[1080] But if you look at, you know, what they, their reported user growth, I mean, they, let's see, our 159 million monthly active users have grown 29 % year over year as of December of 2017.

[1081] So, and their premium subscribers have grown 46 % year over year.

[1082] So, yeah, to your point, will they 2x?

[1083] Probably.

[1084] Will they 3x?

[1085] Seems like they could get there.

[1086] Will they 10x?

[1087] Ugh.

[1088] Yeah.

[1089] So then the other bet you're making is like, well, maybe they can improve their margins.

[1090] that's like a big bet you know or can they offer another product or the other 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 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 uh possibility of a bolt on business.

[1091] Yeah.

[1092] Whereas, like, when I look at Spotify's a great company, for sure.

[1093] I think I'm going to be very laudatory in grading this direct listing because I think it was the right thing to do.

[1094] But it just in terms of like comparing, I can't help but compare Dropbox and Spotify's, you know, first public offerings because they're listings because they're back to back.

[1095] With Dropbox, like, I feel, personally, I feel a lot better making that bet because the bet on Dropbox to me is a bet, like, will.

[1096] the Tam increase?

[1097] Will more people have a use case over time to share files in a semi -professional sort of way?

[1098] Versus with Spotify, like, are more people going to listen to music and want to pay for Spotify who aren't already?

[1099] Now, they're going into more countries, but like how many more countries can they go into?

[1100] You know, they're not going into China.

[1101] They did this deal with Tencent.

[1102] So they do have exposure to China.

[1103] I don't know.

[1104] mm -hmm hmm well I think it's time to go into grading and listen I want to I want to sneak in a couple tech themes first yeah 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 I think are are important here and that's the importance of a couple key product decisions and only a couple key things like with Spotify it was you know the focus on playlists It was, 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.

[1105] When you click play, the file streamed and played immediately, whereas some of their competitors, because there were competitors, remember Grooveshark and some of the others, they were all web apps.

[1106] The performance was clujy.

[1107] People don't want to wait for music.

[1108] There's like a couple of key product decisions that can really make the difference early on.

[1109] But then you have to couple that with distribution too.

[1110] like Spotify would have done well without Facebook, but it wouldn't be a $30 billion company without Facebook.

[1111] Yeah.

[1112] And, and then I think the related one to both of those that we just see time and time again on this show is like, to do all that, you have to be like, you have to have such tenacity as a founder.

[1113] You have to have a vision.

[1114] It has to be right.

[1115] But then you got to like work at it for and focus maniacally for many years, years and years.

[1116] It 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 U .S. or I guess three, four years later come to, no, five years, five years after founding come to the U .S. It just takes a long time.

[1117] Yeah.

[1118] Daniel X's only 35.

[1119] I thought he was a little older, but yeah, maybe he's only 35.

[1120] I think that, I think I saw that in F1.

[1121] I mean, looking at those companies, he started those companies before Spotify.

[1122] Spotify's been 12 years.

[1123] And it's just impressive, passionate, motivated founder.

[1124] Yeah, totally.

[1125] All right.

[1126] That's what I got.

[1127] All right.

[1128] So on grading listeners to clarify, though we did just talk about, you know, do you feel like this is actually worth $30 billion.

[1129] The way that we grade is, was, you know, on the, on the typical acquired format, was it a good idea for the acquirer to pay this money for the acquiree?

[1130] The way that we grade IPOs and now DPO's is, was it a good move for the company to do this transaction?

[1131] You know, was this the right move for them?

[1132] And so, you know, we're basically looking at three options here.

[1133] Do what they did, IPO, or don't do anything.

[1134] Stay private.

[1135] You know, keep doing what they were doing.

[1136] sure seems like a great call.

[1137] I mean, they couldn't do nothing.

[1138] They had to get liquidity.

[1139] They didn't need to raise money.

[1140] It seems like they're not seeing any of the downsides that would have come from potentially doing this direct listing instead of the IPO.

[1141] I mean, the whole Wall Street community was a little freaked out and trying to naysay that, gosh, there's going to be all this volatility, and it's going to drop below the last price that it was trading in the private round.

[1142] and the demand's not going to be there and, you know, lots of things.

[1143] But I don't think we're seeing any of that.

[1144] So it seems like it was a great decision and a gutsy one at that.

[1145] Yeah.

[1146] Caviote that we're still early.

[1147] It's only two days in.

[1148] Very early.

[1149] So a lot will depend on what happens over the next couple of weeks.

[1150] But thus far, you know.

[1151] Yeah, thank you for that.

[1152] Because we may need that clause.

[1153] We may need that clause.

[1154] But the fears were about what happened immediately after trading.

[1155] like the whole point of doing an IPO, the argument of the bankers is we're there to stabilize the stock, stabilize trading.

[1156] If you go back and listen to our Facebook IPO episode, they definitely needed the bankers to stabilize trading in the stock because it was a rocky, rocky start.

[1157] But, you know, without the bankers there, what'll happen?

[1158] And like, everything's been stable.

[1159] So, yeah, I hope.

[1160] Yeah, I don't know how to assign a grade to it per se.

[1161] like it feels weird to grade this against we got to figure out what our our actual uh sort of format is for for these ipos because it you know it's it's sort of like either it was an a probably not an a plus or it was like a c it's it seems rare that we're going to 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 ipio oh there you go there you go um well do you want the first you want me too yeah i mean i'll say a we just have like a lot it's kind of silly for these on the scene ones to do any grading at all but um you know all signs are positive right now yeah i mean if there is uh stability now now i do have some questions personally about a 30 billion dollar valuation for Spotify but that's what it's you know the market is saying um but at least that's what three three point two percent of shareholders who have sold, have managed to get the market to say.

[1162] Right, right, which is not a large float.

[1163] So that may be artificially, uh, artificially supply constraining the stock and raising the price, uh, driving the price up.

[1164] Um, but, you know, as long as there's not like panicked 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.

[1165] It would be great for Silicon Valley if like this becomes a viable path.

[1166] um 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 clinkle former clinkle employee hailed as genius story 11 come a long way it's come a long way it's true uh carve outs um so uh i can't remember if i've actually mentioned on the show or not but uh I know I've talked a bunch about my, my wife, Jenny.

[1167] She is the head of audience engagement and education at San Francisco ballet here in San Francisco.

[1168] And the ballet, so if you live in San Francisco, you should come to the ballet anyway because it's awesome.

[1169] The athletes, the dancers are amazing.

[1170] It's wonderful to watch always.

[1171] But they're doing a big festival at the end of the season coming up at the end of this month in April.

[1172] and a festival of new works.

[1173] It's going to be really cool.

[1174] And Jenny is hosting a number of panel discussions around it.

[1175] But one is going to be called Silicon Ballet, Bringing Ballet and Technology together, the intersections of tech and ballet.

[1176] And it is at the end of the month, April 28th at 5 .30 p .m. Is it starring you and Jenny?

[1177] Actually, neither of us are speaking on the panel.

[1178] but there are going to be some really cool participants so if you're in San Francisco and Silicon Valley come to the ballet always but come to see this panel it'll be really cool awesome well I finally saw Black Panther and that movie was amazing and everybody should go see it and it's remaining few few days in 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 handpicked a bunch of other artists and it's just powerful like it's a really uh um it's maybe one of the best maybe the best marvel movie i mean the the the the um the amazing sort of uh societal themes that are going on right now that they managed to pull into the movie and make extremely accessible a deal with really difficult topics um and have a really cohesive story with great character development and stunning visuals.

[1179] I think I'm like the last person to like be talking about this and be aware of this.

[1180] But if you haven't seen Black Panther yet, I highly recommend it before it leaves theaters.

[1181] That's awesome.

[1182] Yeah, I haven't been able to get to the theater to see it, but I definitely want to.

[1183] It looks awesome.

[1184] Or go on Spotify and listen to the soundtrack.

[1185] Well, that's what I was going to say is can you get a playlist of the soundtrack on Spotify.

[1186] You can.

[1187] You can.

[1188] All right.

[1189] We'll link to it in the show notes.

[1190] we will spotify's new viral growth mechanic via the acquired podcast that's right all right listeners if you aren't subscribed and you want to hear more you can subscribe subscribe from your favorite podcast client um if you feel so inclined we'd love a comment on breaker um if you haven't tried that out to cool podcasting app um please comment or like this episode and uh um create some virality of our own.

[1191] And if you're on iTunes or Apple Podcasts, we'd love a review there too.

[1192] And of course, always appreciate sharing with your friends if you like this episode.

[1193] So thanks so much for joining us.

[1194] And we will see you next time.

[1195] See you next time.