Spotify's salutary example on the dangers of debt

Long-term investors should steer clear of companies with too much debt, says Merryn Somerset Webb. The case of Spotify shows us why.

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We have written here several times in the last few years about why long-term investors should steer clear of companies with too much debt. Debt we have said leaning on work done by Andrew McNally of Equitile (see a column he wrote for us on the matter) can change the power dynamics inside a company all too fast. Debt always comes with conditions (interest rates, repayment schedules, penalty arrangements, convertibility, etc), conditions that look fine in the good times, but put the creditor firmly in control in the not-so-good times.

A salutary example of this is currently being provided by music streaming company Spotify. The firm provides a fabulous service: for £9.99 a month you get pretty much all the music you could possibly want delivered direct to your speakers via your phone. The problem? Spotify can't seem to make any money doing this: in 2015 it lost over $170m. And it has a debt problem. Last year, it completed a complicated deal with Goldman Sachs and a few funds. They lent it $1bn. But with some nasty conditions embedded.

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If Spotify does not list by March, the interest rate on the deal (now 5%) goes up by 1% every six months (to a cap of 10%). Worse, the financiers get a larger slice of the initial public offering (IPO) as well: they have the right to buy stock at a 20% discount to the float price already, says Simon Duke in the Sunday Times. That goes up by 2.5 percentage points every six months from March as well. So here's the question: who controls when Spotify goes to market, its technical owners or its creditors? It should be the former. But thanks to the deal it could be the latter.

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