Spotify's Direct Listing

by Simon Adell, CFO of TripleLift 

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Spotify’s Public Listing Spotify (SPOT) listed itself on the New York Stock Exchange (NYSE) this Tuesday to much fanfare. While SPOT did “go public”, it technically did not have an IPO (initial public offering); rather it opted for an unconventional “direct listing” – a first in the 225-year history of the NYSE. Let’s examine this approach to going public, why SPOT chose this approach, and what this might mean for the future of public listings. 

Why go public at all? 

First things first: why bother going public? The usual reasons include raising cash, improving shareholder liquidity, and the gains in perceived stature and institutional permanence that public status bestows - as well as being able to more regularly leverage the capital markets for debt and equity financing. In SPOT’s case two of these reasons likely applied but the company intentionally raised no cash in its public listing (more on this below). Additionally, SPOT’s capital structure made a timely listing particularly desirable as the company had an outstanding convertible debt (a bond that can be traded in for shares of the company's stock) that became increasingly expensive the longer a listing was delayed. 

How does a direct listing vary from a traditional IPO? 

A standard IPO is a carefully stage-managed process. The IPOing company hires investment bankers (in this context, “underwriters”) who drum up interest and pre-sell the shares to institutional investors such as pension funds, thus hopefully guaranteeing that all available shares are sold. The bankers set a recommended initial price they feel is low enough to generate enough demand to ensure a quick “pop” upwards of perhaps 20% upon listing – enough to generate momentum and excitement, but not enough to make the company think it underpriced itself. The company typically issues about 20% new shares to be sold in the IPO, generating cash for itself. In SPOT’s direct listing, the company issued no new shares and simply allowed its existing shares (held by its founders, investors and employees) to be freely sold and bought (in the case of SPOT, as much as 91% of the shares were eligible for trading at the time of the direct listing, though only 3.1% actually transacted the first day). Thus there was minimal banker involvement (relatively speaking), no new “float” (shares issued), no share pre-sale, and no particular expectation of a share price move in either direction. To really drive the point home that this was not IPO, Spotify's executives didn't even ring the opening bell at the NYSE - a prestigious ritual for IPO-ing companies. Also, the NYSE raised a Swiss flag outside its headquarters on the day of SPOT's listing, ostensibly in honor of SPOT, despite the company being Swedish. 

Isn’t this what Google did too? 

No, this is a misperception that’s been common since SPOT’s announcement of its direct-listing approach. Google’s 2004 listing was decidedly offbeat (in classic Google fashion) and unorthodox in how it arrived at its initial price -- it used a formal auction process rather than allowing the underwriters to determine the price -- but otherwise it was a traditional IPO. SPOT’s approach is significantly more unconventional. Without the pre-selling of shares or the new float, there was no guarantee that there would be either enough buyers or sellers to produce a liquid, smooth trade in SPOT shares post-listing. Google took no such chance. 

Why a direct listing? 

There are a few possible explanations for SPOT’s unorthodox choice of listing approaches, including lower banker fees (although SPOT’s fees were still substantial at close to $50M, though this in part was due to the need to prepare the market for such a unique offering) and fewer restrictions on existing shareholders selling their shares. The best guess is that these factors weighed into the choice but the deciding factor was simply a contrarian desire not to follow the standard starched-shirt Wall Street approach. SPOT after all was born a radical departure from prior norms, as difficult as that is to remember now that streaming has taken over the music business. 

How did it work out? 

There are a number of ways to evaluate the success of SPOT's listing. Traditionally, IPO-ing is very expensive from a banking and legal perspective. In this case, because SPOT needed to prepare the market for its unusual proposition and none of the regulatory work was reduced, the cost savings were limited. That said, the next company that pursues a direct listing will probably see materially lower banker-related costs - which is often the largest cost of an IPO. The laborious pre-IPO process is often designed to create significant interest in the stock and drive post-IPO pricing that there is an initial pop and then some predictability because there is sufficient liquidity (in this case, the supply and demand are relatively abundant and sufficiently well balanced). A significant concern for direct listings would be huge swings in the price due to insufficient liquidity. After the initial day of trading, however, there was relatively less volatility than many traditional IPOs. There is an increasing amount of both supply and demand. 

The stock is down about 10% since listing but that is against the backdrop of shakiness across the entire market, and in any case the direct-listing approach never promised a price pop so expectations were managed. SPOT has settled into a market cap around $25BN, a large number and a healthy hike over its previous valuation, so its investors are happy. A lot could have gone wrong with SPOT’s direct-listing but overall it’s been very smooth, really quite anti-climactic. Compared with the messy IPOs of Facebook and Snapchat, it’s been a resounding success. Finally, if you compare SPOT being public to it being private, 7.9M shares of SPOT traded in the first 2.5 months of 2018 in private markets at prices ranging from 48.93 to 132.50. In two days of being public, 42.2M shares have traded at prices ranging from 135.51 to 169. So relative to being private and allowing shareholders to sell, being public is a distinct improvement from liquidity and volatility perspectives.

Will SPOT start a new trend in direct listings? 

Short answer: maybe... SPOT is a rare breed as the company enjoys fabulous brand equity, strong-ish operating metrics and a relatively dominant leadership position in its huge space. While it’s not yet profitable SPOT has annual revenues of $5BN, positive free cash flow and about $1BN in net cash. It didn’t presently need to raise additional funds. SPOT’s successful public debut may encourage other prestigious companies to take a direct-listing approach, or at least portions of it. Companies that are unable to organically attract the level of interest that SPOT could, such as an ad tech company that wouldn't have as much consumer awareness, would likely see significantly increased volatility in a direct listing. There's a genuine question about how much this matters, though large long-term-focused institutional investors are unlikely to invest at material levels until a listing is stable.   

Special bonus track: SPOT and programmatic advertising

SPOT reports 160 million monthly active users, of whom 70 million are paying “Premium” subscribers and 90 million are “Ad-Supported” listeners. Despite making up the majority of active users Ad-Supported listeners accounted for only $500 million in revenue, about 10% of SPOT’s total. Insertion Orders comprise about 80% of SPOT’s advertising revenue but the company’s programmatic component is growing much faster, at 100% annually. SPOT specifies programmatic as a key part of its strategy to increase advertising revenue, but cautions that programmatic technologies are less developed for its core mobile-user customer base than for desktop users. SPOT also calls out the shift to viewability measures as a key risk factor.