The Risky Side of Spotify's Unusual IPO Plans
This article first appeared in Term Sheet, Fortune’s newsletter on deals and dealmakers. Sign up here.
Spotify is planning to go public, but rather than go through the whole media-circus-road-show ordeal, the company is considering something called a direct listing, according to the Wall Street Journal and Mergermarket. It’s an unusual move among high profile tech companies, who see their public market debuts as a bit of a coming out moment – a time to capture the attention of the business press, investors, potential customers and maybe even potential employees.
In such a deal, Spotify would likely issue no new shares. It wouldn’t have to hire an underwriter. Existing shareholders won’t pre-sell any of their shares to new investors. No lock-up periods or dilution for shareholders. Rather, shares will simply begin trading at their current levels.
If an IPO is like a wedding, a direct listing is running off to elope. A faster, easier, cheaper route to the same result. On Twitter, venture investors applauded the deal: Albert Wenger of Union Square Ventures said “Great to see, we are long overdue for some innovation in the IPO process.” Howard Lindzon of Stocktwits said “Love this from Spotify- more companies should do this and end the lame game of investment bank robbery.”
But the move carries a lot of risk: First-day trading performance is particularly crucial for high-profile listings of consumer tech brands like Spotify, and a direct listing leaves the share performance entirely to chance. There’s no “deal support,” i.e. no guarantee of a nice, healthy first-day pop engineered by careful banker maneuvers. No CNBC commentators gushing that the deal was “priced to perfection.”
Moreover, the IPO process is designed to make it easier for big, long-hold funds to buy into the stock. Companies want their stocks in “safe hands,” aka, the funds that have a long term view and “won’t puke it” at the first earnings miss, an IPO banker explained to me. Big funds like to invest in IPOs because they can get a “starter position” via share allocation and then buy in the open market to get to a full position size. Beyond that, a banker explained, “building a full position from zero takes a long time, especially if 25 of your biggest competitors are doing the same thing. Some funds will just buy the stock like a jerk and push it up, some will just pass completely.”
And lastly, with a direct listing there likely won’t be a “greenshoe” option that allows underwriters to dampen volatility. (Remember how Facebook’s stock tanked on their first day and its bankers kept the price at the IPO level?)
So why take the risk? Perhaps one ugly day or week of trading is worth the savings on the underwriter fees to Spotify. Perhaps this is simply the fastest way to do it, and Spotify is in a hurry: The interest rate on its debt apparently rises by 1% every six months it doesn’t go public. Perhaps the company doesn’t want to be diluted by issuing more shares.
One (unlikely?) theory floating around is that by avoiding a traditional IPO, Spotify can avoid having to issue shares at a discount to its convertible debt holders. The company signed that onerous arrangement last year with TPG and Dragoneer Investment Group. If it never technically holds an IPO, does that mean it TPG and Dragoneer’s debt never converts to equity? The Journal article notes that in such a deal, those terms would have to be renegotiated.
A number of Spotify’s equity holders were dismayed by the debt deal when it happened. But one posited yesterday, “Maybe this was their plan the whole time.”