Spotify raises $1 billion in new debt financing

A major financing deal will help Spotify extend its lead in the growing streaming music market as it prepares for a possible initial public offering of stock.

The Stockholm company has raised $1 billion in new debt financing led by private equity firm TPG and hedge fund Dragoneer Investment Group, according to people familiar with the matter.

The new financing deal — the biggest to date for the streaming music industry — comes in the form of convertible debt, or bonds that the lenders can exchange for equity in Spotify.

Spotify executives declined to comment, but analysts said the funding would enable Spotify to acquire companies, expand globally and offer promotional pricing schemes to attract more users. “Spotify needs to have a good growth-momentum story,” said Mark Mulligan, a music industry analysts at MIDiA Research.

Fast-growing Spotify has long been expected to have an initial public offering, but that option would be more attractive once the company increases its global reach and secures a critical mass of users.

Spotify has yet to show that it can make a profit by charging a monthly fee for virtually unlimited access to online music. It also faces growing competition from tech titans such as Apple, Amazon and Google, as well as upstarts like Tidal.

Private companies are increasingly turning to such deals to avoid diluting their equity as they wait longer to go public. Ride-sharing firm Uber did such a deal in January 2015 to raise $1.6 billion.

Because the Spotify deal was done with debt and not equity, the company’s valuation does not change. That decreases the risks of going to the public markets with a sky-high valuation at a time when stocks in the U.S. are volatile. Spotify was valued at $8.5 billion last June after a funding round of more than $500 million.

“Spotify needs to have a successful IPO in order to prove the viability of the model,” Mulligan said.

Spotify, founded in 2006, is the clear leader in terms of subscribers, with 30 million paying customers so far, up from 20 million as of June 2015. Meanwhile, though, Apple Music has grown to more than 11 million subscribers after launching last summer. Jay Z’s Tidal, which relies on exclusive releases from artists like Kanye West and Rihanna to draw customers, has about 3 million. Other players vying for position include YouTube, Rhapsody, Pandora and SoundCloud, which just launched a subscription option this week.

The growth of Spotify and its rivals has helped accelerate the shift of consumers away from owning CDs and digital tracks to essentially renting access to music on the Web.

According to the Recording Industry Assn. of America, streaming made up 34% of U.S. music sales last year compared with 27% in 2014. Subscriptions are a big part of the trend, growing more than 50% to $1.22 billion in U.S. revenue in 2015. The music industry is counting on Spotify to boost those numbers. It also remains to be seen whether streaming can be a profitable business.

Although Spotify is growing at a brisk pace, its heavy royalty payments to the record labels and spending on expansion efforts have weighed on its finances.

Spotify’s revenue rose 45% to about $1.2 billion in 2014, the latest year for which financial figures are available. But its operating loss nearly doubled from the previous year to $185 million. Spotify says it pays about 70% of its revenue to rights holders, including artists and songwriters.

TPG and Dragoneer, both based in San Francisco, are supplying 75% of the new funding, while other investors are buying into the rest. TPG is a giant in the tech industry that has made major investments in disruptive companies, including Uber and Airbnb.

According to the terms of the deal, first reported by the Wall Street Journal, TPG and Dragoneer will be able to convert the bonds into equity at a discount to Spotify’s share price when it has its IPO. That discount increases over time, giving Spotify an incentive to do an IPO sooner rather than give up more of its equity to the lenders.

ryan.faughnder@latimes.com