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American investors love companies that have growth potential but may be losing money: Amazon, Pandora, etc. Is Spotify next?

Amazon doesn’t really make profits, and investors love it. Pandora is having strong growth in monthly active users, but was a company in 2005 and just had a profitable year in 2013 — and that’s only if you remove certain one-off expenses. Meanwhile, look at their stock:

Pandora

Now, Spotify and Pandora are different animals, for sure — Pandora is 88 percent advertising, 12 percent subscriptions and Spotify is essentially the inverse of that — but now Spotify is trying to hire a U.S. filings expert, which means … an IPO is coming. It’s had big revenue growth, but also loses about $78 million per year, give or take. It has 23 million active users (Pandora has over 200 million), but six million of Spotify’s 23 million are paying subscribers. Pandora’s IPO, back in the summer of 2011, was strong — and now it trades at about $36, which is almost 2.5x the value of its opening only about three years ago. If you look at the chart above and realize that ultimately American investors like to see growth as opposed to actual, documented profits, then the iron is probably hot for Spotify to strike soon with an IPO.

There are comparisons between Twitter and Spotify in that Twitter was losing money before its IPO, and the valuation was still solid. Its first public quarter saw an increase in revenue but a slow growth in user base, and here’s how investors tend to conceptualize that:

So revenues and profits are going in the right direction and beating expectations; but user numbers and activity rates are going in the wrong direction. Which matters more?

For a company at Twitter’s stage of monetisation this poses a problem. To continue to grow revenues, and to turn the losses into profits, Twitter needs to keep and grow its user base. Both in terms of active users of the platform, and the frequency with which they use it. With no users on the site there would be nobody to advertise to.

This quarter’s numbers are not disastrous for Twitter by any means, but they should raise an alarm. They need to focus on the users and on increasing user numbers and activity at a faster rate. Only by focusing on the users will they ultimately see the financial payoffs that their investors now seek.

As of now, Spotify has raised $538 million from investors, and is valued somewhere around $7 billion despite the losses.

Ted Bauer

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