(Bloomberg) — Spotify Ltd., the world’s largest paid-music service, is trying to raise more than $500 million with a loan that could be converted into stock if the company goes public, according to a person familiar with the company’s plans who declined to be identified.
Spotify, which said in June that it had more than 20 million subscribers, hired Goldman Sachs Group Inc. as its adviser, said two people, who asked not to be named discussing the private effort and wouldn’t discuss terms such as valuation. Nordea Bank AB is also an adviser, according to the Swedish daily Svenska Dagbladet, which reported on the fundraising on Wednesday. The people didn’t discuss valuation. Spotify, based in Stockholm, was valued at about $8 billion when it raised money last year.
The loans would give Spotify flexibility to grow and make acquisitions as the market for streaming music consolidates. A planned initial public offering is between one and three years away, according to one of the people. Pandora Media Inc., the Internet radio pioneer, agreed in November to buy Rdio’s assets for $75 million. Spotify bought two companies this month aimed at making it easier to discover and share music with friends.
Spotify is also facing new competition from big players. Apple Inc.’s Apple Music has amassed more than 10 million subscribers since summer, while Pandora, the world’s largest online-radio service, is planning an on-demand music service.
Other competitors, such as Deezer SA and SoundCloud, have either raised money or licensed music from record labels in the past month. Record labels have heralded on-demand streaming as the future of the music business, in the hopes that enough people will pay for monthly subscriptions to end nearly two decades of declining sales.
The world’s largest Internet radio service wants to pay artists as little as possible for their songs. But it also needs their support — and music — to keep expanding beyond the U.S.
“The lower the royalty rate, the better it is for Pandora’s business,” Paul Verna, a media analyst at eMarketer, said in a phone interview. “But there’s also a flip side, which is that it risks exacerbating perception problems with musicians that Pandora’s rates are already too low.”
Pandora has run into a buzzsaw of criticism from artists led by Taylor Swift, Radiohead and, most recently, Adele, who claim that Pandora — along with Spotify and Apple Music — are siphoning off revenue from CD sales and digital downloads.
Later this month, the U.S. Copyright Royalty Board will set music streaming fees for the next four years. The ruling is expected around Dec. 15. While Pandora has been paying royalties below the industry standard since 2010, the company plans to abide by whatever the board decides. That likely means it will pay more money to artists and music labels.
But for Pandora, it’s probably worth it. With 78 million unique U.S. monthly listeners, Pandora is keenly aware that it has all but saturated its home market and needs to bring its Internet radio service global, to the U.K., France and Germany as well as Japan, South Korea and even China. (Pandora’s curated music platform is currently available only in the U.S., Australia and New Zealand.)
To expand, Pandora needs to make peace with the music industry over royalties — even if it’s expensive in the short term. Pandora shares have tumbled 29% in 2015 partly out of investor concern that it will have to pay royalty costs that account for more than its current level of 48% of its revenue.
“Pandora will have a good relationship with the industry when the industry feels like it’s getting a reasonable or fair market rate,” said the independent music label executive. “The lower that number, the more the industry think it’s not being treated fairly, and there will be very little good will.”
Either way, it will remove an unknown that has prevented the Oakland, Calif.-based company from negotiating directly with music labels for international streaming rights and for a subscription-based platform that it is building to rival Spotify and Apple.
But the Big 3 — Sony Music, Warner Music and Universal Music, a division of Paris-based Vivendi — as well as the world’s largest independent labels have been loath to negotiate international pricing with Pandora for fear that such settlements could influence where the Copyright Royalty Board sets rates for music streamed in the U.S.
“For a service like Pandora that wants to have a worldwide footprint, it has to be in negotiations with copyright owners,” said Ron Gertz, chairman and founder of Music Reports, a Los Angeles-based copyright fulfillment agency, in a phone interview. “The CRB’s decision will ultimately lead to opening up a worldwide licensing marker, and the parties will figure it out.”
Up until recently, Pandora and the world’s largest music labels have mostly clashed over royalty fees. Pandora currently pays music labels 14 cents for every 100 songs it streams, a rate that is actually lower than fees that the Washington-based CRB, a department of the Library of Congress, set for the past five years.
The industry agreed to the lower rates in 2010 so that Pandora could avoid insolvency. A Big 3 media executive, who spoke on condition of anonymity because he wasn’t authorized to discuss the matter publicly, said the industry “saw value in building their service and getting people accustomed to using streaming.”
But in the years since that agreement was signed, Pandora has sought to lower its royalty fees even further. Soon after its IPO, Pandora pushed for passage of the Internet Radio Fairness Act, which would have classified online streaming platforms as similar to terrestrial radio stations, which only pay songwriters.
In 2013, Pandora purchased KXMZ-FM in Rapid City, S.D., with the goal of being classified as a terrestrial radio operator. Under certain federal guidelines, ownership could provide Pandora with access to lower royalty rates. The Federal Communications Commission approved the deal in May.
“They weakened or lost a lot of alliances with creators and the labels when they were working on IRFA,” said an independent music label executive who also spoke on condition of anonymity.
Despite its differences with the music industry, Pandora’s business has grown as its listener base has mushroomed. By its own estimate, Pandora’s share of all U.S. radio listening reached 9.5% in September. Sales climbed to $311 million for the recently completed third quarter from $38 million during the same period in 2011, shortly after the company held its initial public offering.
While Pandora has paid out more than $1.5 billion in royalties during its 10-year history, music labels are clamoring for a larger cut.
In recent months, Pandora has appeared to be trying to smooth things over.
In October, it agreed to a $90 million settlement for its past use of pre-1972 music, and for its continued use of that music. Federal law was never particularly clear about royalties for artists who released music prior to 1972, leading to long-simmering enmity between Pandora and major labels for use of music by the likes of the Rolling Stones, Bob Dylan and Janis Joplin.
“That was like an olive branch,” said a music industry executive. “Pandora was clearly saying, ‘Let’s get this contentious issue off the table.'”
And then last month, Pandora struck a multi-year music licensing deal with Sony/ATV Publishing, the world’s largest music publisher, which is owned by Sony and the estate of Michael Jackson. The agreement was significant because Sony/ATV CEO Martin Bandier had been one of Pandora’s biggest critics.
The Sony/ATV deal was also significant because Pandora will need the music publishers on board if it is to expand internationally.
For Pandora, keeping royalty fees at 48% of revenue or less is integral to building a company that CEO Brian McAndrews has said can help the industry offset declining CD sales and digital downloads that have fallen by 33%, or about $2 billion, in the six years ended in 2014, according to the Recording Industry Association of America.
Toward that end, Pandora in October announced plans to purchase TicketFly, the concert promotion site, so that artists can better publicize their live performances directly with users selecting their songs. In November, it acquired the assets of Rdio, which it plans to use to build an international on-demand service, a feature that labels have been pushing the company to do for a few years.
Pandora declined to comment for this story.
The CRB’s ruling won’t directly affect Spotify or Apple, which operate on-demand services and have already negotiated directly with labels, large and small. Nonetheless, the rate-setting decision will establish a benchmark that will likely remake the global music industry for years to come.
“We all have to sit still and see what the CRB says before we talk directly with Pandora,” said a Big 3 music industry executive. “After they rule, we can start to have those conversations.”
Apple’s decision to create a new streaming service called Apple Music is a recognition of just how much the music business has changed over the last decade. A decade ago, it was widely assumed that people would build collections of digital music just as they previously built collections of records and CDs. Apple was at the forefront of that change, with Steve Jobs convincing record labels to sell their songs for just 99 cents.
But we now know that this whole way of thinking about the music business was wrong. Customers don’t want to buy music, and they don’t want to build music collections. Smartphones allow something much better: services that allow unlimited streaming of millions of songs. These services are rendering traditional music ownership obsolete.
A decade ago, the iPod and iTunes seemed like the wave of the future. But it’s now clear that they were just an awkward transitional stage between the physical formats of the 20th Century and the streaming media services that will dominate in the future.
Music purchases are declining
As recently as 2012, analysts were predicting that paid music downloads would continue growing — albeit slowly — for the foreseeable future. But that’s not how things have worked out. In 2014, revenues from music streaming services surged, but paid song downloads in the US actually fell by 12 percent. Globally, downloads declined by 8 percent in 2014.
Digital downloads appear to be on the same trajectory as CDs, only with a 15-year lag. As this chart from CNN shows, sales of CDs peaked around the turn of the century, and they’ve been steadily declining since then. Paid digital downloads soared in the decade after the iTunes Music Store was introduced in 2003, but they’ve now leveled off:
A key thing to note about this chart is that despite all the hype about digital downloads, they’ve never come close to offsetting declining CD sales. People just spend a lot less money buying music than they used to.
Smartphones are killing music ownership
There are two big ways that the rise of the smartphone is leading to the death of music ownership.
One is the popularity of music streaming services. In the pre-smartphone era, music streaming services weren’t that useful because you could only use them when you were near your computer. So people bought iPods and filled them with music so they could listen to it on the go.
But today’s streaming services work on smartphones that can access the internet wherever they go. There’s little reason for users to have their own copies of the music they love. They can just call up songs they want to listen to on-demand.
Another trend that’s been bad for music ownership is the growing number of users who don’t own a PC. People used to keep their music on their PCs and transfer it from there to their iPods. When people bought a new PC, they’d transfer the music library from the old computer to the new one.
That’s not very practical on a smartphone, which doesn’t have the sophisticated file-management tools of a conventional PC. When people buy a new smartphone, they expect to be able to just throw the old one away.
People can sign up for cloud-based storage services from Google, Amazon, and other companies to synchronize their music from one device to another. But managing these services is a bit of a hassle, especially if you have to do it entirely on a smartphone. And if you’re going to rely on an online service to manage your music, why not just use a service like Spotify or Pandora that already has every song you could possibly want to listen to?
Buying music is for old people
Like most technology trends, the shift from owning music to streaming it has been led by young people. A 2011 survey found that almost half of people between age 16 and 24 used streaming services, compared with less than a quarter of 55 to 64-year-olds:
The ubiquity of streaming services means that today’s teenagers have no reason to get into the habit of buying music. “I haven’t seen someone use iTunes in a really long time,” one college student told CNN in 2012. So as the Spotify generation comes of age, the fraction of consumers buying digital downloads will continue to shrink.
Countries with the best internet access do more music streaming
Another sign that the shift toward music streaming is permanent: some countries are way ahead of the United States.
Overall, downloads still accounted for a slight majority — 52 percent — of digital revenues. But in some countries, streaming has become the dominant revenue source for music labels. In Sweden and South Korea, streaming accounts for more than 90 percent of industry revenues.
It’s probably not a coincidence that streaming is most popular in South Korea and the Scandinavian countries of Sweden, Norway, and Finland. These countries have long been among the world’s leaders in the speed and availability of high-speed internet access. And streaming services depend more on ubiquitous and high-quality internet service than downloads do.
This suggests that as other countries, including the United States, improve the quality and availability of their internet access, we’ll see a similar shift away from music purchases in favor of streaming.