Why Spotify Is Skipping Wall Street

The streaming music company is opting for a direct listing when it goes public, bypassing the traditional approach for IPOs — and irritating investment banks. But will it live to regret the unusual move?

Illustration by Nicolas Ortega

Illustration by Nicolas Ortega

Spotify, the Stockholm-based music-streaming company, is planning to go public — and that has Wall Street fretting about the impact on fees and the IPO market.

The concern is over Spotify’s opting for a direct listing — that is, simply putting shares held by current owners on an exchange for trading, typically without the underwriting, road show, marketing push, or lockups of a typical IPO, which are all designed to send prices soaring and keep them there. The low-key approach is bad for underwriter fees, critics say, and could hurt IPO prices. Direct listings are historically a way for small, sometimes dicey companies to list shares. In this case, the New York Stock Exchange is seeking to change its rules to accommodate the Spotify unicorn.

Spotify’s move could chill what some bankers view as an already stagnant IPO market that is in urgent need of hot new listings to push. Banks, which depend on traditional IPOs to generate big bucks, the argument goes, will suffer if other unicorns follow Spotify’s lead.

The listing, not surprisingly, is going down in some Wall Street quarters like ABBA at a polka fest. “If you are a traditional investment banker, you hope this does not become the standard,” says Charles Elson, professor of finance and director of the John L. Weinberg Center for Corporate Governance at the University of Delaware.

In a typical IPO, fees might total 5 percent or so of an offering, according to Renaissance Capital, an investment firm specializing in IPOs. Given an estimated valuation of $16 billion for Spotify, and assuming what Renaissance co-founder Kathleen Smith figures might be a $2 billion listing, bankers would be expected to haul in $100 million in fees from an offering.

However, as currently envisioned, Goldman Sachs, Morgan Stanley, and Allen & Co. will receive far less, about $30 million, for furnishing advice to Spotify on its listing, according to The Wall Street Journal. That represents just 1.5 percent of the prospective proceeds.

But don’t cue the violins for the banker bonuses yet, says Smith. She calculates that half of the total fees in a traditional IPO are paid to brokers flogging shares to investors. That hard sell likely won’t be part of a direct listing, in which buy orders are managed by a designated market maker, or specialist, who sets the stock’s opening price.

The upshot: Bankers may be taking home $50 million, adjusted for the brokers’ sales commissions.

Nor, presumably, will the banks be running extensive road shows or propping up shares in the aftermarket or even providing research coverage. Those are undertakings running into millions of dollars that eat into bankers’ profits too.

“Companies that back their way into being public are not doing it to save money,” says Smith. She suggests the Spotify listing may be defensive. For example, it may be seeking to avoid future litigation from shareholders locked into Spotify stock.

In January news site Recode reported that under the terms of Spotify convertible bonds sold in 2016, the listing will not qualify as an IPO and so will not trigger a clause allowing holders to convert the debt into equity. A person familiar with the situation says that debt covenants provide for an increase in interest rate payments for every six months that a listing is delayed.

Underwriters probably needn’t worry about a string of other unicorns following Spotify’s lead, either. “That’s been a bit overblown,” says Anna Pinedo, a partner at law firm Morrison & Foerster in New York. “It’s only a select group of companies that can do this.”

And it may be only a select few companies that want to do it. Given their executives’ large stock holdings, most are eager for that first-day pop to the share price that will send their net worth into the stratosphere. And companies are generally happy for the marketing prowess, price support, and research coverage that comes with a traditional IPO.

Undoubtedly, companies assume a variety of risks in pursuing a direct listing versus a traditional IPO. Banks won’t be pitching the stock to investors and likely won’t support it after its debut. “There’s the possibility with a direct listing that nobody shows up,” says Daniel Klausner, leader of the capital markets advisory practice at PricewaterhouseCoopers. “They may decide to wait.”

And determining the appropriate offering price will be left largely to the designated market maker. “That’s the big issue,” says Klausner. “The banks have a pretty good idea about price discovery — where there’s value, where there’s not value.”

Still, some applaud a direct listing that at least strikes back at Wall Street’s fees. “All that the issuer likely loses is the first-day run-up in a ‘hot’ IPO,” writes John Coffee, a professor at Columbia Law School, in the New York Law Journal. “The direct-listing procedure will be cheaper, faster, and probably less legally risky to the issuer.”

So will Spotify CEO Daniel Ek skip the traditional ringing of the opening bell for new listings? A spokesperson for Spotify declined to comment on Ek’s plans.