Friday, September 21, 2018

Spotify’s Tencent Risk | Music Industry Blog

On Thursday (September 20th) Spotify grabbed the headlines with its announcement that it is launching a free-to-use direct upload service for artists. While it is undoubtedly a big move, and one that will concern Spotify among others, it was not a surprising move. In fact, in April we predictedthis would happen soon:“Spotify will take a subtler path to ‘doing a Netflix’, first by ‘doing a Soundcloud’, i.e. becoming a direct platform for artists and then switching on monetisation”. Will labels be concerned, sure, because although Spotify might not be parking its tanks on their lawn yet, it is certainly slowly reversing them in that general direction. However, they must just have a way of clipping Spotify’s wings and waiting in, er, the wings…Tencent.

Still waiting for IPO metrics

Tencent is prepping its music division (TME) for a partial US IPO but announced earlier this week that it will be reducing the amount it is seeking to raise from $4 billion to $2 billion, though still against a reported valuation of around $25 billion. Regular readers will know I have a healthy scepticism of Tencent’s music numbers. It has only ever reported one subscriber number officially – 4.7 million for QQ Music in Q1 2016, therefore it has plausible deniability over all the non-official numbers it puts out via the press. So, the fact there still isn’t an F1 filing revealing TME’s metrics is intriguing to say the least.

Go west

The likelihood is that the numbers will show a relative flattening in music subscriber growth (though other areas of its business should be robust). If so, they fit a wider narrative of Tencent nearing the limits of its potential in China. Video subs, which have grown superfast, will soon slow, messaging is saturated and the Chinese government is curtailing Tencent’s games operations. The title of our April report says it all: “Tencent Has Outgrown China: Now Comes the Next Phase of Growth”. Until last year’s change in Chinese regulations, Tencent could quite happily have spent its time strolling across the globe buying up companies to spread its global wings. But now, operating under limits of how much it can spend on overseas companies, Tencent is restricted to taking minority stakes in companies like Gaana and Spotify. But those efforts do not deliver Tencent the scale of global growth it needs. You can probably see where this is heading: to grow its music business TME will have to roll out internationally, which is quite possibly part of the story it will use to justify its $25 billion valuation.

Tencent’s Spotify non-compete clause

So far so good, an implicit risk for Spotify…except that the risk is a little more pronounced than that. When TME did its equity swap it somehow persuaded Spotify to agree to an incredibly one-sided non-compete. You can see the clause in full, as it is helpfully posted on the SEC’s Edgar portal here – Section 4.02. If you don’t have the appetite for reading a 450-word sentence – TME’s lawyers may be sharp legal operators but they suck at grammar – here it is in a nutshell. Spotify is not allowed to compete with any Tencent company or controlled affiliates, defined as “offering audio or video streaming or download services to consumers and businesses.”. Yep, that’s Spotify’s current business and potentially its future business too. But where it gets really interesting is that the non-compete is unidirectional, Tencent is not bound by any such constraints.

Ring fencing Spotify’s global reach 

Let’s for the moment assume that there is some parallel non-compete clause for Tencent in some other document. Even with that theoretical counter-balance, the possibilities are intriguing. For example, should TME decide to use the $2 billion it raises via IPO as a war chest, it could then go on a global roll out to all the markets where Spotify is currently not present. And because of that non-compete, Spotify would be unable to launch there, as that would bring it into direct competition with TME, which it is contractually forbidden from doing. This would have the effect of ring-fencing Spotify’s global roll out plans. For fans of the board game Risk, the board would look something like this:

Spotify tencent risk 1

But Risk’s map doesn’t really do it justice. Using a political global map, the respective footprints would look more like this:

Spotify tencent risk 2

The major labels have proven unwilling to license Spotify for India because they weren’t happy with Spotify offering direct deals for a small number of artists. Imagine how they are going to feel with this latest move. With TME waiting patiently on the side lines, they may just see it as an opportunity to carve up the global streaming landscape into two halves, creating a cold war stalemate. Your move Spotify.


No comments: