On Tuesday, Spotify (SPOT) went public in the US as the third-largest tech company ever to do so based on its market cap of $32 billion. Its direct listing wrested control from Wall Street’s investment banks, and put institutional investors on the same playing field as everyone else. In the words of Spotify CEO Daniel Ek, "We set out to reimagine the IPO process." Like Google in 2004 and, to a lesser extent, Facebook in 2012, Spotify chose an unconventional way of going public. And just like those internet giants, Spotify’s transaction was met with initial skepticism.
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A spotty start: Spotify declines for first 3 days
Spotify opened for trading at $165.90, and steadily declined to close its first day at $149, a 10% drop. Without any lockup agreements to restrict selling pressure, the stock had two more consecutive down days, finishing Thursday at $144. It can happen to any IPO, but this is not a ringing endorsement for the reimagined process. The founders, employees and private investors accomplished their goal of being able to cash out at a high valuation, but public investors generally lost money.
Spotify, Google, Facebook: Investors prefer a traditional IPO
Spotify’s decline is not disastrous, but it is another example of how adding uncertainty to the IPO process typically does not lead to good results.
Google’s unique route didn’t pay off. It planned a $3.3 billion offering, but raised just half that amount amid investor pushback to its anti-Wall Street attitude and auction-style pricing. The company slashed its price by roughly 30%, unheard of for such a large tech IPO, before trading up 18% on its debut.
Facebook thumbed its nose at Wall Street during its IPO, and generally ignored its underwriters’ advice throughout the process. Its roadshow featured a 30-minute video while the CEO famously wore a hoodie and sneakers and avoided questions. Shortly before the IPO, Facebook raised its price range and added more insider selling, at the same time as several analysts at the underwriters were reducing their revenue estimates based on cautious commentary from the company. Despite pricing well above the initial range, the stock was flat on its first day and within months lost half of its value, finally recovering to its IPO price more than a year later.
Compare these to recent large traditional IPOs from tech firms like Dropbox (2018; +36% on first day), Snap (2017; +44%) and Alibaba (2014; +38%), all of which had smoother initial pricing and trading.
Facebook and Google’s stocks recovered well from the initial uncertainty, and there is no guarantee that strong first-day performance translates into long-term returns (just ask Snap investors). But it does seem that their attempts to “disrupt” the IPO process did not endear them to institutional investors and forced them to gain the market’s confidence over time.
The lack of a lock-up should scare investors
Spotify chose to forego the normal 180-day share lock-up on insiders, which it claims distorts stock prices. While Spotify’s owners did not dump shares on the market, investors should still be cautious about the lack of any lock-up.
Removing lock-ups opens the door for hot tech names with questionable fundamentals to fleece investors before underlying issues become apparent. There’s a long list of high-profile tech IPOs that fell drastically within six months of their offering: Snap, Blue Apron, Etsy, Castlight Health, Groupon and Zynga. Lock-ups force managers to establish a track record, setting and meeting goals. They help prevent the IPO market from being a dumping ground for VCs to cash out as soon as possible.
Spotify may have also set a risky precedent by encouraging trading in private secondary markets, where share purchasers don’t have a prospectus.
Bright spots
We endorse the "radical transparency" Spotify offered by publishing its presentation and estimates online, so that institutions had less of an informational advantage. Although, we note that any IPO can choose to do so.
We also recognize that without lucrative IPO fees, investment banks have no incentive to shower newly-public with praise after the quiet period.
At the time, the third-largest-ever tech listing
The Company: "Spotify has never been a normal kind of company."
The Mission: "To unlock the potential of human creativity"
The Roadshow: None. Spotify published an "investor day" presentation online. It had no bell-ringing ceremony.
Noteworthy Phrases: "We envision a cultural platform where professional creators can break free of their medium's constraints and where everyone can enjoy an immersive artistic experience that enables us to empathize with each other and to feel part of a greater whole." and “Harder, better, faster, stronger."
Transparency: Individuals were able to buy at the same price as institutions. 2018 estimates released online.
The IPO: No offering. As a direct listing, no new capital was raised, and insiders were able to sell.
Internally valued at about $120 in December, shares privately traded as high as $132 in 2018. The NYSE set $132 as a "reference price." The stock opened at $165.90, where the company commanded a market cap of $32 billion, and closed at $149.01 (-10% from opening price, +13% from private reference price).
At the time, the largest-ever tech IPO
The Company/Mission: “Facebook was not originally created to be a company. It was built to accomplish a social mission - to make the world more open and connected.”
The Roadshow: Tight security. Initially played a 30-minute video. Afterward, 27-year old CEO Mark Zuckerberg appeared wearing a hoodie and didn’t answer many questions.
Noteworthy Phrase: "Move fast and break things."
Transparency: Video was widely available. One-fourth of shares went to retail investors.
The IPO: Traditional IPO structure. Dual class. Insiders sold 57% of the deal.
Proposed terms: 337mm shares at $28-$35.
Actual terms: 421mm shares at $38 raising $16 billion at an IPO market cap of $104 billion
Early trading: Opened at $42.05 and closed at $38.23 (+0.6%).
At the time, the largest-ever tech IPO
The Company: "Google is not a conventional company. We do not intend to become one."
The Mission: "Organize the world’s information and make it universally accessible and useful."
The Roadshow: Founders wore suits and sneakers. During marketing, Sergey Brin gave an infamous Playboy interview.
Noteworthy Phrases: "DON'T BE EVIL" and "MAKING THE WORLD A BETTER PLACE"
Transparency: Roadshow slides and Q&A provided in the prospectus.
The IPO: Auction. Dual class shares, which at the time was unusual for a tech company.
Proposed terms: 24.6mm shares at $108-$135.
Actual terms: 19.6mm shares at $85, raising $1.7 billion at an IPO market cap of $24.6 billion.
Early trading: Opened at $100.01 and closed at $100.34 (+18%).
