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Spotify has guaranteed to pay big music labels billions over the next two years

The streaming service posted revenue of $3.3 billion last year; it has promised big checks in exchange for better rates.

Spotify Press Announcement
Spotify CEO Daniel Ek
Michael Loccisano/Getty Images for Spotify
Peter Kafka covers media and technology, and their intersection, at Vox. Many of his stories can be found in his Kafka on Media newsletter, and he also hosts the Recode Media podcast.

Spotify’s revenue grew more than 50 percent, to $3.3 billion last year. And in order to grow more, the music streaming company will pay music labels billions of dollars over the next two years.

In financial filings released this morning, Spotify says it has agreed to pay more than $2 billion in minimum payments to record labels over the next two years.

Spotify doesn’t spell out who that money is going to. But people familiar with the company confirm it is talking about two deals it has recently signed with Universal Music Group, the world’s biggest music label, which has about a third of the market, and Merlin, which represents a large group of independent labels.

That means Spotify will ultimately be on the hook for even more guaranteed payments once it re-signs Sony and Warner Music Group, the two other major music labels.

Spotify figures all of those payments will be worth it, because terms of the new deals will give it better royalty rates, which will ultimately increase its margins — a crucial step as the company prepares to go public later this year or early next year.

Most of Spotify’s revenue goes right back out the door to music rights owners, which is why the company only generated gross profit of $502 million in 2016 (all prices in the story are converted from euros to dollars at the exchange rate from December 30, 2016).

That gave it gross margins of about 15 percent. The year before, the company had similar margins at about 14 percent. (Spotify’s new filings also restate its financials from previous years, because the company says it “identified various misstatements” in earlier reports.)

But Spotify’s new deals with Universal and Merlin give the service the ability to get better rates, depending on different milestones it hits, in exchange for deal terms like the ability to restrict new albums to Spotify’s paying customers for a short window. Spotify figures it will get similar terms from Sony and Warner, and that all of those deals will end up significantly improving its margins in 2017 and beyond.

In the meantime, Spotify’s new numbers, filed to European regulators, remind us that the streaming music business remains a good way to lose money, at least for now. The company posted an operating loss of $390 million last year and a net loss, after accounting for finance charges related to its $1 billion debt deal last year, of $601 million.

If Spotify succeeds as a public company, it will be because it convinces investors that it can eventually turn those losses around — both through better deals with music owners and, eventually, by figuring out how to sell things besides music.

Meanwhile, Spotify announced today that it has 140 million worldwide users; it told regulators that it had 126 million users at the end of last year. In March, Spotify said it had 50 million paid subscribers, but the company didn’t provide a breakdown of paid vs. free users today.

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