IPO bankers aren't worried that Spotify's unusual public listing succeeded - but there's a 'much bigger threat' facing their industry
- Spotify went public last week using an unorthodox method that attracted a lot of interest for bypassing typical IPO procedures.
- Business Insider spoke with three Wall Street executives that oversee equity capital markets operations for major banks about the lasting impacts of the direct listing.
- Their opinions varied, but one takeaway was unanimous: Spotify's novel move doesn't change anything for the vast majority of companies or the IPO industry at large.
Spotify took its shares public last week using an unorthodox method that garnered a lot of attention.
The company's "direct listing," which valued the company at $30 billion at the opening trade, attracted so much interest because it bucked the traditional public offering process in several key ways.
The process ditched traditional IPO features like underwriters, an opening price range, a set supply of shares sold to specific investors, and a lock-up on existing investors.
"They had more column inches written about this IPO than most IPOs," one Wall Street equity capital markets exec told Business Insider. "If that was one of their goals, they achieved that."
But since taking the plunge April 3 on the New York Stock Exchange, the hype and hoopla has faded considerably. Spotify has traded down from its opening price of $165.90 a share to $154.37. And several questions remain unanswered.
- What did the music-streaming giant's peculiar public debut mean for the companies that would follow?
- Would startups emulate Spotify's unconventional route?
- Did the company upend the IPO industry and create an existential crisis for a corner of Wall Street?
We spoke with three senior Wall Street executives that oversee equity capital markets operations for major banks about Spotify's direct listing. Though their opinions varied, one general takeaway was unanimous: While Spotify's move was novel and successful at generating intrigue, it doesn't change anything for the vast majority of companies or the IPO industry at large.
"My basic view of Spotify's direct listing is that it doesn't tell us much," the head of global capital markets at a top-tier bank told Business Insider.
Why wasn't this a game changer?
The direct listing wasn't a game changer, in part, because Spotify is a unique company whose attributes don't translate to many other firms approaching the public markets.
One bank exec that oversees US IPOs said this is "not a replacement for an IPO" since Spotify wasn't raising any money, which is one of the traditional purposes of an IPO: sell a portion of the company to the public to finance more growth.
"There's a handful of companies that could go this route," they said. "You have to be huge. You have to have a ubiquitous brand - people who bought were mostly retail investors. Then you have to not want to raise capital."
Another ECM exec echoed that sentiment, saying that there was so much "going for Spotify that allowed it to go down this path."
A company whose product is consumed more inconspicuously - a developer of security software, perhaps - "can't do what Spotify has done, because that company has to build up a fan base," the exec added.
And that's part of what IPO bankers do. They take the company on a road show to build up enthusiasm and generate interest among institutional investors.
That didn't happen with Spotify. There was no roadshow, but rather the company held its own "investor day" that was streamed online to anyone that wanted to watch. That's a far more effective route for winning over retail investors than institutional investors - the hedge funds, long-only asset managers, and sovereign wealth funds accustomed to the personal touch and assurances of investment bankers.
It's no surprise then that institutional investors have sat it out with Spotify, according to each of the three ECM heads, opting instead to let the dust settle and let retail investors wade into the unknown territory before buying shares.
"From the institutional side, they're going to wait and see," one of the ECM execs said.
Those with holdings before the public listing - Tencent, Sony, Tiger Global, and founders Daniel Ek and Martin Lorentzen - remain the largest shareholders, according to regulatory filings. No large institutional investor reported buying a stake in the aftermath of Spotify's debut on the NYSE.
This didn't appear to hurt Spotify much given its brand cachet among a wide swath American households, as average-Joe retail investors were willing to gobble up enough shares to get the company's liquidity event rolling.
But it traded less intensely than it likely would have with institutional backing.
Spotify, which has a free float of 104.9 million shares, saw 5.6 million shares trade at the opening price of $165.90, according to Bloomberg data, with 30.5 million shares traded on the opening day in total. On average, 5.7 million shares have traded per day since then.
By comparison, Dropbox, a company less than half the size of Spotify and with a float of 35.5 million shares, saw its stock trade 56.1 million times during its IPO March 23, and an average of 10.1 million a day in the ensuing five days.
"It is big enough for liquidity to enter," the head of global capital markets said. "Smaller or less well-known companies could find this a struggle due to market indifference."
What did Spotify get out of this then?
On one hand, it gave employees and early investors a chance to cash out, and it avoided the customary lock-up restrictions that prevents them from selling for several months in the aftermath of the listing.
As mentioned above, the company also wound up with a torrent of free press. That prospect may prove tempting to some companies, but the media may not approach future direct listings with the same vigor - especially for startups smaller and less well-known than Spotify.
And it also saved millions on bank fees - didn't it? That element is not so clear. The global capital markets exec said "the direct listing didn't save fees."
Spotify still paid its three banks - Goldman Sachs, Morgan Stanley, and Allen & Co. - roughly $35 million in fees.
IPO fees are typically paid out as a percentage of the amount of money raised. Snap Inc. paid the 26 banks that worked on its listing $85 million, 2.5% of the $3.4 billion it raised. Twitter paid 3.25%, just under $60 million, to its seven banks. (Individual shareholders and investors that sell in the IPO bear some of the fees, too.)
It's not an apples-to-apples comparison, but it's not clear that Spotify saved much money for what it got.
The direct listing did solve a thorny capital structure issue, for the firm, the global capital markets exec noted. As Recode has previously reported, Spotify issued convertible notes to investment firms TPG and Dragoneer that entitled the noteholders to more shares of the company the longer Spotify remained private.
The company didn't need to raise money, but it did need to go public to satisfy its stakeholders and avoid paying out chunks of equity that diluted its shares.
It's a very specific scenario - not applicable to every private startup - but the direct listing solved it.
"Spotify is not really relevant."
Yes, Wall Street ECM execs have an interest in Spotify not upending their business and insisting that nothing has changed.
And yes, there are a handful of giant private companies who could feasibly pull off what Spotify did, including the likes of Uber and Airbnb. And these are the marquee mega IPOs that bankers typically care about most, though no major bank's IPO business hinges on the fees either would potentially produce.
But the execs Business Insider spoke with acknowledged that their business faces risks - Spotify just doesn't rank very high in comparison.
The number of companies going public has been steadily declining over the years, and many startups are opting to stay private longer, in part because private capital has become abundant.
Private money going to startups more than four years past their first funding round "has grown by a factor of 20 since 1992," according to an academic paper published last year by the California Institute of Technology and Cornerstone Research. The IPO business in contrast hit a 20-year lower in 2016.
Global ECM deal volume totaled $196.2 billion in the first quarter of 2018, down 11% from $220.4 billion in the first quarter of 2017, according to Dealogic.
In light of these broader trends, Spotify is a fleeting curiosity with little long-term consequence.
"The much bigger threat to equity capital markets revenues is the enormous private pools of capital and lower value attached to market liquidity - fewer companies want to go public; fewer IPOs every year even in good markets," the head of global capital markets said. "Spotify is not really relevant."