Introduction
This year, Spotify, the Stockholm-based music streaming giant, is making waves both physically and financially. The company plans to relocate its Manhattan headquarters from Chelsea to the Financial District while also making history on the New York Stock Exchange (NYSE) through an unconventional financial move: a direct listing. This approach, rather than a traditional initial public offering (IPO), has sparked widespread intrigue in Wall Street and the music industry. As what is expected to be 2018’s largest tech public debut unfolds, the implications of Spotify’s decision could have long-term ripple effects across industries.
This article provides an overview of Spotify’s bold strategy, including the traditional IPO process, the distinct nature of a direct listing, why Spotify chose this unconventional route, and the potential outcomes and ramifications of its decision.
The Traditional IPO Process
To understand Spotify’s direct listing, it is essential to explore the traditional IPO process.
An IPO, or initial public offering, involves a company raising funds by selling shares to the public for the first time. Before the IPO, ownership consists of founders, employees, and early investors. The influx of capital helps the company expand but comes at the cost of diluting ownership stakes.
In a typical IPO, the company works with one or more investment banks (underwriters) who manage the process. The underwriters:
- Generate demand for the stock by courting institutional investors,
- Help establish a fair price for shares,
- Allocate shares to large investors, and
- Facilitate the company’s public entry to the stock market.
This lengthy process includes preparing detailed documentation for the U.S. Securities and Exchange Commission (SEC), conducting extensive roadshows to gauge investor demand, and determining an offering price for the stock. Once public trading commences, the opening price may differ from this set IPO price depending on market conditions. While often uneventful, mispriced IPOs (e.g., Facebook’s 2012 botched debut) can create dramatic volatility.
Spotify’s Unique Take on Going Public
Spotify has defied conventional norms by opting for a direct listing, a rarely used strategy, especially for a company of its size and stature. Typically employed by smaller firms with modest trading volumes, direct listings have been uncommon—just 11 companies have attempted them in the past two decades.
Spotify, however, breaks the mold. The company filed confidentially with the SEC in January 2018, signaling its intent to list on the NYSE in the first quarter of the year. With an estimated valuation of $19 billion, this decision separates Spotify from the traditional IPO route in several key ways:
- No Capital Raise: Spotify does not intend to raise funds through its listing.
- No Underwriting Process: The company is skipping the usual role of underwriters in pricing and allocating shares.
- Open Market Trading: Spotify’s share value will be determined by the open market, based on supply and demand.
- Enlisted Advisors: Despite bypassing underwriters, Spotify has engaged Goldman Sachs, Morgan Stanley, and Allen & Co to advise on the listing.
The opening day of Spotify shares will look significantly different from a standard IPO. Existing shareholders may offer to sell, while new investors bid to buy. The stock will open at a price determined entirely by the market, without a closing price from prior trading to guide valuation. Fortune Magazine has likened this approach to “eloping” instead of the structured “wedding” that is a typical IPO.
Why Did Spotify Choose a Direct Listing?
Spotify’s decision to break with tradition was likely motivated by a combination of the following factors:
1. No Immediate Need for Cash
Spotify boasts 60 million paying subscribers and 80 million users of its ad-supported platform, decisively outperforming rivals like Apple Music (30 million subscribers). While Spotify generated $3.3 billion in revenue in 2016, it has yet to turn a profit. Importantly, Spotify’s strong brand recognition reduces its reliance on the roadshow and institutional support typical of a standard IPO.
2. Reduced Fees
Traditional IPOs come with substantial costs, including underwriting fees. For example, Snap Inc., with a valuation close to Spotify’s, paid $100 million in fees for its 2016 IPO. Spotify’s advisors are set to split just $30 million in fees, presenting a significant cost-saving. This reflects the declining activity and profitability in the underwriting business, as more technology companies opt for private financing.
3. Liquidity Without Dilution
Direct listings allow existing shareholders to sell their shares on Day 1 without the “lockup period” of 3-6 months usually required in IPOs. This provides investors such as venture capitalists and employees the opportunity to cash out immediately without falling victim to stock dilution resulting from the issuance of new shares.
4. Addressing Convertible Debt Obligations
In 2016, Spotify raised $1 billion via convertible debt from investors such as TPG and Dragoneer. The terms of this debt included a conversion into equity at a discounted rate (20% below the share price) upon going public, making a delay in listing costly for Spotify. The direct listing allows Spotify to satisfy these debt obligations while sidestepping the risks of a traditional IPO.
Potential Risks and Implications
Challenges for Spotify’s Debut
While direct listings allow Spotify to save on costs and remove restrictions, they introduce new risks:
- Price Volatility: Without underwriters ensuring demand, prices may fluctuate wildly. Existing shareholders dumping shares on Day 1 could drive the share price down, while hype could result in short-term overvaluation.
- No Deal Support: With no greenshoe option (a feature that stabilizes IPO prices), Spotify will lack safety nets if demand is lower than anticipated.
- Profitability Questions: Spotify has yet to achieve profitability, reporting a $601 million loss in 2016. Lawsuits, management changes, and rising competition from Apple Music and Tidal add to investor concerns.
Implications for the Music Industry
Spotify’s innovative streaming model has revived the music industry, contributing to three consecutive years of growth after a decade of decline. If Spotify performs poorly post-listing, the impact could ripple across record labels and artists who rely on its platform to thrive.
Influence on Tech Companies and Public Markets
A successful direct listing could inspire other high-growth tech companies to follow Spotify’s path, reducing traditional barriers to public markets. However, this trend could hurt investment banks, which already face declining IPO activity. While skeptics warn against the disruption of an established practice, optimists see opportunities for innovation and evolution within the financial markets.
Conclusion
Spotify’s decision to pursue a direct listing is bold, potentially born out of necessity but also reflecting a shrewd understanding of market dynamics. Whether it paves the way for other tech companies or highlights the limitations of this approach, the move by Spotify marks an important inflection point in how businesses approach the public markets.
Everyone from Wall Street to the music industry is watching eagerly. If Spotify succeeds, it may revolutionize how companies go public. If it falters, the consequences could reverberate across industries, leaving many to rethink whether certain businesses are primed for public life. Regardless of the outcome, this bold move has changed the dialogue around IPOs and the future of tech financing.