Whether you’re a stock market junkie or a novice, you may be interested in a “non-traditional’ IPO scheduled for late March or early April that has the potential to turn investment banking on its head. The long and on-going argument is whether the exorbitant underwriting fees associated with an IPO are equal to the value of the service provided. Both Snap and Blue Apron entered the public domain in 2017 with a strong prospectus and high hopes. The results of using the traditional IPO roadmap greatly disappointed investors with no adverse impact on, or accountability for, the companies who performed the due diligence and the roadshows.
Spotify, the undisputed front-runner of on-demand music streaming, obtained approval from the Securities and Exchange Commission (SEC) to move forward with a listing of its shares on the New York Stock Exchange (NYSE) using an unusual method known as a direct listing. The debut of the Swedish-born company’s stock has the potential to be the largest for a tech company in 2018. The route to be taken by Spotify owners to move into the public sector is nothing typical.
In the world of finance, there is a saying “Cash is King.” Companies in today’s market that are cash-rich can think outside of the box as there is no need to raise funds. They float the shares, and the market determines the price while eliminating the need to provide cash to stabilize the stock offering and no need for underwriters to link buyers and sellers. Another positive feature is the substantial savings of Equity-Capital-Market (ECM) fees charged by the bank for these traditional services.
Earlier this week, an article in The Wall Street Journal (WSJ) reported on the decline of ECMs:
“Banks working on Spotify’s unusual public share listing stand to collect a fraction of the fees underwriters typically charge in big IPOs, in a blow to the already beleaguered stock-selling business.
Spotify’s three advisers—Goldman Sachs Group Inc., Morgan Stanley, and Allen & Co.—are poised to share roughly $30 million in fees, though that could change depending on the size of the company when it debuts and the success of the deal, according to people familiar with the matter.
That is a sharp drop from the fees generated by Snap Inc., the last big technology company to go public in the U.S. When the messaging provider went public last year, its valuation was about the same as Spotify’s currently, but it paid banks a total of nearly $100 million. That was roughly 2.5% of what Snap raised, a typical fee for a marquee IPO, which is smaller than the overall average of as much as 7%."
The direct listing is a way for Spotify to give existing investors the chance to cash out with no need to raise additional funds and there are no restrictions on when insiders can sell shares. New investors will be able to buy shares once current investors begin trading based on the suggested price range relayed to the market.
Spotify says it has more than 140 million users and 60 million paid subscriptions in 61 markets worldwide, and the company’s most recent valuation was nearly $20 billion, based on a recent share swap between Spotify and Chinese internet giant Tencent Holdings Ltd.
As with anything in the market, there are risks associated, especially when charting new or unfamiliar territory. Absent is the underwriting “safety net” which sets and props up the price if the stock flops. Companies also will no longer have a say in who buys or how much stock goes to a buyer. The model may also attract short-term investors, like hedge funds looking to flip for a fast profit, instead of the more desired steady, long-term mutual funds which usually buy up large segments of stock.
Depending on the degree of success, investment bankers may become concerned as they watch their portion of the pie dwindle. If the move proves lucrative, other start-up companies with strong cash positions on their balance sheets, like Airbnb Inc. and Uber Technologies Inc., may decide to follow suit.
In an interview with the WSJ, Michael Sobel, co-founder of Scenic Advisement, an investment bank serving private tech companies, he said: “If a company can raise the majority of its growth equity capital privately and float their shares in a broker-free offering, it would be scary for the underwriting business.” He added, “The IPO is the cornerstone of the banking business.”
The direct listing model isn’t a viable path for all companies going public, but it’s a good alternative for those who have strong cash positions and pioneer spirits. It does make one wonder what other “non-traditional” models for taking companies public may emerge in the future and whether decreasing the roles and profits of the big investment banks will turn out to be a boom or a bust.
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