Spotify Dancing To Its Own Tune
January’s news that Spotify had filed a registration with the SEC so that it could publicly list its shares was greeted with some trepidation by equity markets. Not because Spotify was going public, but how it was choosing to go public.
The Swedish music streaming company isn’t planning to raise capital. Rather, its direct listing, which will see shares listed without a call to raise funds, is seen by some as a challenge to the traditional IPO model of equity fundraising. Spotify’s peers – tech-led unicorns with valuations over $1 billion – will watch the coming months with interest. The FT reckons there are more than 200 private companies like this worldwide, which adds up to a lot of capital.
Should equity capital markets be worried? If this much capital begins to sidestep ECM desks at investment banks, they will miss a lot of business. For reassurance, ECM should look to history.
Spotify isn’t the first – and it won’t be the last – to employ a novel method of equity fundraising. Google’s 2004 IPO was innovative. Their ‘Dutch auction’ benefited retail investors as well as institutions, allowing both to bid for a certain number of shares at a price without knowing what others were offering. When bidding closed, the highest price at which every share could be sold became the IPO price. The sale was a success, raising $1.9 billion at $85 a share.
And in 2016 Metro Bank eschewed the traditional IPO model by raising money from the ‘grey’ market, offering shares to existing investors privately, a move known as an “introduction to the stock market”. Unrestricted trading then followed, and this method proved successful for Metro, as they raised $400m that has fuelled growth.
Like Google and Metro Bank, Spotify won’t change equity markets. The IPO will likely end up being more mundane than revolutionary. But, to be fair, what Spotify is doing is unique.
Unlike a traditional IPO, they are not raising new money, so they are not looking for capital to fuel growth, which is interesting considering that growth should be near the top of their ‘to do’ list, seeing as they are unprofitable, Apple Music looks set to overtake them in the US as the largest streaming service, and they are facing ever-growing copyright lawsuits.
Given that they are now too big to be acquired, Spotify’s IPO will provide liquidity for employees and early investors. True, most companies who IPO seek liquidity, but they’re mostly seeking new capital to fuel growth. A company raising money in this way will have rational, economic reasons for employing a bank to manage the process, who they know will assess the market and price shares so early investors get an uplift. As a result, if the company ever needs more capital (like, for example, Tesla might), they have a strong relationship with a stable of investors.
Spotify’s IPO shows that for the high-growth, tech sector populated by unicorns, private capital is funding the later stages of growth and so public markets are being considered as a source of liquidity only. Interestingly, this could be another unintended consequence of the increased regulation on public companies, which is increasing the incentive to stay private. Airbnb delayed their IPO which led them to profitability. Other private companies might follow their lead.
Ironically, this could end up hurting the retail investors that the regulation was introduced to protect. Rather than being able to buy into the growth story of a company, if companies only use retail money to provide liquidity and fund near an exit, then there’s a chance that retail “buys the top”, and the huge, positive returns accrue to the VCs and institutions that got in early.
Here’s an example that provides an interesting mirror image. Augmentum Capital is listing on the public markets. Of course, this could give retail investors exposure to the early stage of the growth story. Or, it could be the only way that general partners at VC firms can access liquidity on their holdings, as their portfolio companies struggle to reach an IPO or an acquisition.
How Spotify’s stock reacts will tell us much about the viability of this sort of IPO. Other unicorns will be taking note. And whilst Spotify’s method is an interesting development, we would caution against reading too much into what it means for equity capital markets. In short, this isn’t the death ECM or DCM, just as previous iterations did not spark a wave of disintermediation.
Google’s innovative IPO was a success. It raised a lot of money and the company used the money to effectively grow and take over the world. But instead of being the first in a slew of pioneering IPOs that put investment banks out of business, the Google deal is an historical anomaly. It didn’t change the equity capital markets. It’s likely that Spotify’s IPO won’t either.