Spotify Could Get a Little Wild When It Goes Public

The streaming service’s direct listing won’t be an all-or-nothing proposition.

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Photographer: Andrew Burton
This post originally appeared in Money Stuff.

It looks like Spotify AB really is going to go public by doing a direct listing on a U.S. stock exchange, and I am starting to get excited. The idea of a direct listing is that, instead of doing an underwritten initial public offering in which sellers (Spotify and its founders and early investors) decide how much they want to sell, sign up some banks, build a book of demand, and then all at the same time sell their stock to investors chosen by the underwriters, Spotify will just one day declare that it is public and that anyone who wants to buy or sell can, on the stock exchange, like any other stock.

In practice I assume this means that Spotify will go public by means of an opening auction on the New York Stock Exchange or Nasdaq: Early one morning, some Spotify shareholders will make indicative offers to sell their shares, and some bold investors will make indicative bids to buy them, and the exchange will publish some tentative price that seems like it will clear the supply and demand, and then other shareholders and buyers can come in and adjust the prices and quantities that they want, and eventually a clearing price will be reached, and the stock will open and trade normally. It's what happens in every other stock every morning, except that every other stock had a closing price the day before, and Spotify won't. So that opening auction will be a bit wild. 

If it is totally wild, that's a little bad: If the opening cross in Spotify is at $10 and then the stock quickly trades up to $30, future companies will be skeptical about direct listing because it "leaves money on the table" (for their shareholders), while if it opens at $10 and then trades down to $3, future buyers will be skeptical about direct listing because it "creates a winner's curse." On the other hand, it's not that bad, just because not that much stock needs to change hands at the opening price. If you're an early investor who owns a million Spotify shares, you can chuck a thousand of them into the opening auction to see what happens, and then sell the rest over the course of the day or week or month. It's not as much of an all-or-nothing proposition as a traditional IPO is, where you sell a big chunk the first day and then are (typically) locked up from selling any more for six months.

My bigger worry with the direct listing is just that: If not much stock changes hands on the first day, then you have a weird situation where the public market for Spotify is a tiny fraction of its market capitalization. Usually when a company IPOs, it sells a lot of stock, and then frenzied speculators and high-frequency arbitrageurs and excited retail investors have a lot of stock to trade back and forth amongst themselves. If Spotify direct-lists and most of its investors decide to wait a while to see how it shakes out, then you'll have a lot of people doing a lot of trades with not very much stock. That could lead to a lot of volatility for a long time.

But if it works! Part of the point of a traditional IPO is that you need the human touch to make trading orderly: Bankers need to allocate shares thoughtfully to a mix of long-term investors, and set a price that gives those investors reasonable upside. A stock exchange’s mechanical auction process – where anyone can buy or sell, and where prices are set by brute supply and demand rather than the experienced judgment of professionals – is fine for the daily opening of a public stock, but obviously inappropriate for something as important as an IPO. Unless it works. In which case, what do you need the humans for?

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