Spotify, a music sharing service, has more than 60 million active customers worldwide. Spotify is considering a potential IPO in 2015, but has had second thoughts given the unsettled conditions in financial markets and the mixed experiences that recent IPOs have had (many of them closed below their initial offering price).
T Rowe Price, an investment company, has one business unit that specializes in mezzanine equity investments. They try to invest in companies at the final stage before going public, and then cash out with the IPO.
Spotify's 2014 revenue is estimated to be $1.3 billion. The company had 2013 revenues of $842 million in 2013 and a net loss of $65 million.
In 2013, Spotify raised $250 million in venture capital from TechnologyCrossover Group, at a postmoney valuation of $4 billion.
Goldman Sachs (Spotify's financial adviser) has asked T Rowe Price to lead a group in an investment of $500 million. Goldman Sachs estimates that the value of Spotify after such an investment would be in line with Pandora, another music sharing service whose stock trades at 4 times revenues. Music-sharing service stocks are quite volatile, with high costs of equity and standard deviations of 50% (or more). Current financial market rates have expected market returns of 6%-8%; one year Treasuries are yielding 0.25% and two year Treasuries are yielding 0.66% annualized.
a. What ownership stake is T Rowe Price being offered?
b. Concerned about the timing (and potential delay) of a future IPO, T Rowe Price has countered with an offer to provide the $500 million on the above terms, but with a "ratchet" that would allow T Rowe Price to force Spotify to buy back its investment in 2 years for $600 million. (A "rachet" is a finance term that increases or decreases the value of an investment by a fixed amount.)
What is the value of the "ratchet"?
c. Why is T Rowe Price interested in the ratchet? Given your answer in (b), what counteroffer might Spotify make? (You don't need any calculations here, just a conceptual answer.)