Out With the IPOs, in With the Direct Listings: A Closer Look at Spotify’s Direct Listing
About Spotify
Spotify is a streaming platform where consumers can listen to the latest podcasts and music. Primarily, Spotify generates revenue through their premium memberships which allows consumers unlimited access to a vast music and podcast library. For non-paying members (freemium), Spotify generates revenues through adverts played between listens. According to Lumous business [1] Spotify has 250 million monthly active users distributed across 79 countries [2].
What Is an IPO?
An Initial Public Offering (IPO) is one of the ways a privately listed company becomes a publicly traded company, allowing investors to buy a share of the company. Usually investment banks will underwrite the offering, where a syndicate of investment banks share the risk of the offering by committing to buy and sell the entirety of the stock to the public at the IPO price. This would include the bank undertaking a book building and price stability function through buying and selling shares during the initial offering to prevent price volatility. Throughout the IPO, the financial advisors will go on a ‘roadshow’ with the senior members of the soon-to-be-public company to drum up investor interest and to gauge how to value the firm. Once the bankers have gauged the appetite of the market for the company share, they can begin to value the company and set a share price they will list at [3].
How Is a Direct Listing Different to an IPO?
In a direct listing, no shares are created instead existing shares are sold without underwriter involvement [4]. The existing private investors, promoters and employees holding shares can sell directly to the public, eradicating the need for financial intermediaries, like investment banks, to provide underwriting services like they would for an IPO. This is attractive to listing companies because it bypasses the intermediaries’ fees which can range from 2-8% of the valuation of the company [5].
Despite this, direct listings can be disadvantageous because the company faces the risks of unsupported share sales. With an IPO, the underwriters provide a support function to ensure the stability of the initial share price through the over-allotment or ‘Greenshoe’ option. This is where the underwriters can sell an additional number of shares (up to 15% of the issuance) to reduce upwards price pressure if there is excess demand for the stock. If the price is too low, the underwriters can buy these shares back from the market to stabilise the price [6]. Due to a direct listing only offering current shares, this would not be possible, leaving the company’s shares at the mercy of the markets, which can cause additional uncertainty and volatility when the stock initially lists. Additionally, direct listings have less promotion as they avoid the fanfare of a road show, which could lead to a lower valuation by the market. This may also cause the listing company to lack the safety net of long-term investors who would have been committed after a roadshow. That said, the global brand of Spotify arguably makes the roadshow process irrelevant.
Why Didn’t Spotify IPO?
Spotify publicly listed in April 2018 via a direct listing, leaving it up to the marketplace to determine its price. They opted for a direct listing because it enabled the company to provide a transparent price-setting process that ensured liquidity for shareholders. Furthermore, the company has strongly positive cash flows, with free cash flows of €48m in Q3 2019 [7], meaning they have an abundance of capital and do not require any additional capital-raising support from a bank. Spotify had already been successful in the private markets with a large and diverse shareholder base, since they are a well-known global brand coupled with a simple business model. They have partnerships with numerous record labels and Facebook which consolidated their strong market position in the music streaming industry, outperforming the likes of Apple Music and Deezer. This means that their marginal benefit from a roadshow would most likely not justify the high aforementioned fees. Thus, the fees incurred from an IPO process would be unnecessary, prompting the firm to opt for a direct listing. Although directly listing meant Spotify were leaving their market valuation to the market mechanism the trading price of the share experienced quite low intraday volatility of 12.3% for a technology IPOs [8].
Financial Advisory Role
Despite not using underwriters, Spotify still employed financial advisors to assist in the direct listing. Spotify employed Goldman, Morgan Stanley and Allen & Company as their financial advisors to help define the objectives of Spotify’s listing, assist in preparing presentations and public communications. The financial advisor role was differentiated to that undertaken in an IPO as the financial advisors did not engage in book-building activities, investor meetings, or provide price support stabilisation e.g. over-allotment options [9].
Spotify held their own ‘Investor Day’ which lasted just over 2 hours (twice as long as a regular IPO meeting) where the whole of Spotify’s leadership team pitched to potential investors. Spotify utilised their internal investors team to provide the investor education, as they believed it increased transparency and authenticity in comparison to external financial advisors fulfilling this function. It was live streamed to anyone who was interested, ensuring it had a further reach than an IPO roadshow would have had [10].
Death of the ‘Roadshow’ as We Know It?
The success of Spotify’s direct listing raises questions as to whether IPOs may be a thing of the past and direct listings the favourable method for companies to publicly list. For example, Slack – the collaboration hub where teams can work together remotely – became public through a direct listing in June 2019. Like Spotify, Slack benefitted from low intraday volatility at 8.9% on its first day of trading, despite leaving it to the market mechanism to determine its share price [11].
Roadshows are a part of the IPO process where the underwriter alongside representatives from the company attend a series of group meetings with buy side institutional investors for 1-2 weeks to help build a book and gauge investor appetite. Companies spend between $50,000 – $100,000 on an IPO roadshow [12], streaming it online would be cheaper and have a wider reach.
Due to COVID-19, roadshows have been suspended so financial advisors and companies have had to engage potential investors online. Nordic video conferencing company Pexip publicly listed through an IPO in May 2020 utilising virtual ‘roadshows’ to drum up investors support. The CEO said, “We got to do targeted in-person meetings with people all over the world,”, and he said that 100% of the investors he had a 1-1 call with invested. Pexip was able to save 1,720 hours of travel and 8,199 tons of C02. It seems that holding virtual roadshows and streaming to mass audiences is more efficient and a better utilisation of technology. The pandemic has highlighted the inefficiencies of roadshows as an integral part of IPOs. However, virtual roadshows won’t be applicable for every company or investor base. Without meeting in real life, it may be harder to build a relationship with institutional investors. For example, a banker running the IPO for a software company found it difficult to engage their multi-billion investor base who weren’t tech savvy. They reported investors putting their monitors to their ears as they were unfamiliar with video conferencing [13].
Ultimately, the pandemic forcing roadshows online has highlighted the virtues of virtual roadshows which seems irreversible. It’s highlighted the inefficiencies of the old way, like Gareth McCartney, the global head of equity syndicates at UBS, said “running around 15 countries in 15 days…seems a bit crazy” [14[].](https://www.ft.com/content/5ad15369-a63a-4a97-8c17-0f13d52578f7) It is worth noting, that Spotify had particular characteristics that suited a direct listing; hence it is unlikely that the IPO process will become obsolete. What seems more believable is the implementation of a hybrid system, where roadshows may be held online and require less involvement by financial advisors for investor education but require them for underwriting and book building purposes.