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Spotify’s non-IPO has Wall Street on Edge

By Chirag Gandhi

In my last article, I discussed the anticipated IPOs of Dropbox and Airbnb. In addition to these two, investors are also excited about a potential Spotify IPO, marked by its non-traditional nature. An IPO is characterized by a private company going public to increase its market exposure and to obtain large amounts of capital for growth. The traditional IPO makes shares available to the general public with the help of underwriters. An IPO underwriter is usually an investment bank that gauges market interest and follows a number of regulatory requirements before determining the IPO price. The underwriter is also responsible for determining the specific number of shares that will be sold at that initial price. Based on previous tech IPOs, there has always been a very volatile price adjustment following the opening price. For example, Snap’s (SNAP: NYSE) IPO was set at $17 USD, but opened to the public on the New York Stock Exchange (NYSE) at $24 USD a share (up 41 percent). In the case of Twitter (TWTR: NYSE), the IPO price was set at $26 USD, but it ended the first public day of trading at $45 USD (up 73 percent).  Hence, Spotify has decided to take a unique approach in an attempt to control the IPO price and save cost, which analysts are calling the “non-IPO”.

The Approach of a non-IPO

Sometime around late March or early April, Spotify shares will emerge for trading on the NYSE. There will be no big insider spectacle, there will be no advance institutional buying and there will be no actual “IPO”. This process is known as “direct listing” or “non-IPO” by investors, allowing the stock price to fluctuate depending on the price set by buyers and sellers on the market.  The direct listing process is one in which no new stock is issued (no money is raised) but existing private investors and insiders can trade their shares on the open market. Under a traditional IPO, insiders usually have their shares locked for a certain period, but under the “non-IPO” method, all their shares can be traded from day one.

An important part of a traditional IPO is to raise equity to help a firm grow. However, Spotify is in a unique position as they have been able to raise capital with private equity. Spotify has also been making positive cash in spite of a reported operating loss. Spotify had revenues of $1.24B USD in Q3 of 2017, amounting to $4.95B USD annually. Though they had a speculated loss of $370M USD in 2017, Spotify recently reported 60 million paid users, twice that of its closest competitor, Apple Music.  Based on Spotify's status as a market leader in music streaming services, combined with its 40 percent growth in revenues from 2017, investors have long anticipated an IPO.  Initial reports have indicated that Spotify may be worth close to $19B USD, which is much lower than Snap’s IPO (worth $33B USD), but greater than Dropbox’s anticipated $10B USD IPO later this year.

One Man's Gain is Another Man's Loss

IPOs are a very profitable business for major investment banks, but as the number of IPOs decreased before 2017, banks were forced to lower their fees. The “non-IPO” concept poses a major risk to traditional IPOs if Spotify can show its success. Bloomberg reports that the “non-IPO” can “create a new model for growth companies in which they raise all their money in private markets and do all their trading in public ones” in order become more prominent and allow long time insiders (and private investors) to sell their stakes. By avoiding a traditional IPO, firms do not need investment banks to conduct research or search for potential institutional buyers of their shares. The only task that remains is the legal work required to set up the “non-IPO”. Therefore, investments banks risk losing their importance with a successful Spotify IPO, which may encourage other growing companies to use this cheaper alternative while exerting greater influence on the initial price.

The Bottom Line

Wall Street insiders do not expect to see many other companies following Spotify’s “non-IPO” path, because it does not guarantee stock price stability. Other large growth companies like Dropbox and Airbnb are generally in need of financing, forcing them to undergo a traditional IPO. Yet Spotify’s user and advertising growth has helped it preserve a positive operating cash flow, thereby eliminating this need. This non-traditional IPO has never been attempted at such a large scale, making it susceptible to major risk. In fact, the stock could prove even more volatile than that of a regular IPO. Yet concerns of risk are mitigated by Spotify's longstanding corporate culture. For years, Spotify has operated like a public company, as they have been filing detailed financial disclosure reports every year. Spotify’s management has been transparent with their user growth and revenue figures. In short, though it is a rare move for a company of its size to attempt a “direct listing”, its success could set the stage for other private companies to follow suit.


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