Startup unicorns, defined as those nascent companies with valuations greater than $1 billion, are increasingly undergoing IPOs and listing on national exchanges. ((Joe Ciolli, Tech ‘Unicorn’ IPOs are Booming, Bus. Insider (Aug. 15, 2017), http://www.businessinsider.com/tech-unicorn-ipos-are-booming-2017-8.)) Following the high-profile failures of the Snap ((Shawn Tully, How Snapchat’s IPO Became One of Wall Street’s Biggest Flops, Fortune (Mar. 21, 2017), http://fortune.com/2017/03/21/snapchat-snap-ipo-wall-street/; Corrie Driebusch, Snap Shares Tumble Further Below IPO Price, Wall St. J. (July 11, 2017), https://www.wsj.com/articles/snap-shares-tumble-further-below-ipo-price-1499784971.)) and Blue Apron ((Rani Molla, Blue Apron is the Worst-Performing Major U.S. IPO This Year, Recode (Nov. 13, 2017), https://www.recode.net/2017/11/13/16630074/blue-apron-worst-performing-ipo-2017.)) offerings, the next unicorns to turn public are being intensely scrutinized. At the end of 2017, digital music giant Spotify announced that it was going public in early 2018. ((Leslie Picker & Lauren Hirsch, Spotify Files to Go Public, CNBC (Jan. 3, 2018), https://www.cnbc.com/2018/01/03/spotify-ipo-confidential-sec-filings-in-december.html.)) In a deviation from the norm, the company will directly list its shares on the NYSE instead of undertaking an IPO.
Spotify offers music streaming services. It has a library of over 35 million songs and is available in sixty-five countries around the world. ((About, Spotify, https://press.spotify.com/us/about/. (last visited Feb. 18, 2018).)) The company currently has over 157 million users and 71 million fee-paying subscribers. ((Id.)) Industry experts give the company a $19 billion valuation. ((Spotify Price Tag Rises Ahead of Filing for NYSE Listing: Sources, Reuters (Dec. 14, 2017), https://www.reuters.com/article/us-spotify-listing/spotify-price-tag-rises-ahead-of-filing-for-nyse-listing-sources-idUSKBN1E82AI.))
In choosing a direct listing instead of an IPO, Spotify is trailblazing a path that could disrupt the investment banking industry and influence the decisions of future unicorns considering going public. Indeed, such a strategy has never before been utilized on such a large scale. ((Jem Aswad and Janko Roettgers, With 70 Million Subscribers and a Risky IPO Strategy, Is Spotify Too Big to Fail?, Variety (Jan. 24, 2018), http://variety.com/2018/music/features/spotify-ipo-wall-street-music-industry-1202674266/.)) No new stock will be issued and no money raised. A direct listing is where a company’s shareholders sell their stock directly onto an exchange, without any outside involvement. ((James Royal, Spotify IPO: Music Company Won’t Be Cashing Out to Same Old Wall Street Tune, CBS (Jan. 16, 2018), https://www.cbsnews.com/news/spotify-ipo-music-company-wont-be-cashing-out-to-same-old-wall-street-tune/.)) So, the flow of shares will be tempered by the desire of insiders and institutional investors to sell. The number of shares available will be the amount that these groups put up for sale. On the flipside, Spotify will be able to skip the IPO roadshow and has no need to enlist the services of investment banks as underwriters.
Overall, this means that Spotify shares won’t debut with a price based on investor feedback, with buyers lined up. ((Matt Levine, Spotify’s Non-IPO Really is Novel, Bloomberg (Jan. 4, 2018), https://www.bloomberg.com/view/articles/2018-01-04/spotify-s-non-ipo-really-is-novel.)) There will be no previous trading price, no IPO price established, and no coordinated supply from selling shareholders. ((Id.)) Without the structure of an IPO, stock prices can easily fluctuate and become susceptible to volatile changes. The market will determine the company’s stock price and no protections will be available.
The offering isn’t devoid of Wall Street involvement though. Goldman Sachs Group Inc., Morgan Stanley, and Allen & Company are all acting as financial advisors. ((Sam Warren, Disrupting the IPO Market: The Spotify Effect, Seeking Alpha (Jan. 17, 2018), https://seekingalpha.com/article/4138042-disrupting-ipo-market-spotify-effect.)) The firms are expected to share a $30 million fee, a sharp decrease from an underwriter’s usual 7% of the IPO. Investment bankers traditionally receive 25% of their annual business from IPOs. ((Id.)) Analysts predict that this strategy will save Spotify up to $300 million in fees. ((Spotify’s Unusual IPO Model Will Test the Company’s Strength, NPR (Jan 25, 2018), https://www.npr.org/2018/01/25/580263402/spotifys-unusual-ipo-model-will-test-the-companys-strength.))
To carry out a direct listing on a public exchange, a company must have $100 million of publicly held shares ready to sell. ((Sam Warren, Spotify Says No to an IPO, Seeking Alpha (Dec. 25, 2017), https://seekingalpha.com/article/4133746-spotify-says-ipo?page=2.)) Currently, NASDAQ is the only exchange that allows this, but the NYSE is in the process of altering its listing standards to accommodate Spotify and any progeny. Last March, the NYSE filed a motion with the SEC to allow direct listings, which change the agency approved. ((Maureen Farrell and Alexander Osipovich, Bankers Begone! Spotify to get Clearance for an ‘Underwriter-Less’ IPO, Wall St. J. (Dec. 21, 2017), https://www.wsj.com/articles/bankers-begone-spotify-to-get-clearance-for-an-underwriter-less-ipo-1513852210.)) That said, the SEC is still worried that companies with risky financial profiles will take advantage of the new policy, so its approval is only preliminary.
With no underwriter protection, Spotify’s vulnerability to stock fluctuations could be drastic due to its financial status. Although a private company, Spotify is unique in that it is incorporated in Luxembourg. Due to local law stipulations, it has been filing yearly financial disclosures with local regulators. ((Aswad and Roettgers, supra note 8.)) While this does not mimic the extensive regime crafted by the SEC, it has given financial analysts information to gauge the progress of the company.
In its most recent annual financial disclosure, from 2016, Spotify showed some mixed signals. The good news was that the company’s revenue was on pace to reach $4.9 billion by the end of 2017, a 40% increase over its 2016 performance. ((Cherie Hu, Spotify Records Surging Revenues, Continued Losses in First Half of 2017, Billboard (Oct. 12, 2017), https://www.billboard.com/articles/business/7998441/spotify-revenues-losses-first-half-of-2017.)) Also in 2016, TPG, Dragoneer and Goldman Sachs lent Spotify $1 billion via convertible debt financing. ((Theodore Schleifer and Peter Kafta, How Spotify Solved a $1 Billion Debt Problem that will Help it IPO, Recode (Jan. 3, 2018), https://www.recode.net/2018/1/3/16847786/spotify-tpg-tencent-debt-dragoneer-ipo-music-streaming.)) Thanks to this, Spotify now has almost a $2 billion war chest with $838.6 million in cash and $874.5 million in short-term investments. ((Ed Christman, Inside Spotify’s Financials: Is There a Path to Profitability or an IPO?, Billboard (June 22, 2017), https://www.billboard.com/articles/business/7841155/spotify-financial-analysis-profitability-ipo.)) It should be able to continue its current performance for at least four years.
On the other hand, the company’s losses are mounting. In 2016, Spotify’s net loss was approximately $600 million, up from $257 million the year before. ((Ben Sisario, Spotify is Growing, but So are Its Losses, N.Y. Times (June 15, 2017), https://www.nytimes.com/2017/06/15/business/media/streaming-radio-spotify-pandora.html.)) The company attributed this increase to the costs of servicing its debt, namely the $1 billion last year in convertible debt, and to the effects of foreign exchange rates. ((Id.)) There is some truth to this. If you overlook the charge of $258 million to write down the discount on the $1 billion in notes, which are due in 2021, the adjusted net loss was $310 million or a 27.1% increase. ((Christman, supra note 20.)) Spotify’s EBITDA has held steady with a loss of $169.2 million in 2016 versus a $180 million loss in the prior fiscal year. ((Id.))
The company’s largest expenditure involved the costs of paying record labels and artists for licensing rights. The catch-22 is that the greater the number of users who listen to these tracks, the more Spotify will pay to those parties. Spotify loses nearly 70% of its revenue to royalty payments and publishing royalties. ((Id.)) It then spends $900 million in salaries, marketing, product development and other costs. ((Sisario, supra note 21)) The company’s strategy has been to ignore rising internal costs (employee expenditures are continuously rising) and instead negotiate with music rights owners for lower royalties. The success of such a strategy remains to be seen. Spotify has successfully negotiated a reduced rate with Sony Music Entertainment. ((Ben Lovejoy, Spotify Successfully Negotiates Lower Royalties as it Seeks to Maintain Lead Over Apple Music, 9to5Mac (July 12, 2017), https://9to5mac.com/2017/07/12/spotify-royalty-rate-sony-music-entertainment/.)) But well-known artists, like Taylor Swift, have been quick to criticize their low compensation rates. ((Hannah Ellis-Petersen, Taylor Swift Takes a Stand over Spotify Music Royalties, The Guardian (Nov. 5, 2014), https://www.theguardian.com/music/2014/nov/04/taylor-swift-spotify-streaming-album-sales-snub.))
For its part, the company has continuously affirmed that its model supports profitability at scale and that increased revenues will result in improved margins. Regardless, industry experts are skeptical of Spotify’s path to profitability. ((Christman, supra note 21.))
Spotify’s entrance into the U.S. public capital markets will be intensely followed by a myriad of parties. Music industry executives believe that “as Spotify goes, so goes the music industry.” ((Aswad and Roettgers, supra note 8.)) Indeed, the music business will post its third consecutive year of growth after fifteen years of a downturn due to illegal downloading. ((Id.)) The move will also be closely watched by other tech unicorns who are considered the next candidates to go public—Airbnb and Uber—and Wall Street’s investment banks. If Spotify is successful, these companies will eschew IPOs in favor of direct listing, greatly changing the IPO landscape.
Spotify is taking a risk. There is surely going to be a lot of interest from potential buyers because of the company’s ubiquity in pop culture. The strategy signals that the company believes the public already understands its value. That said, the big risk is that with middling finances and an unclear path to profitability, the company will be subject to wild stock fluctuations that could have been mitigated in part by underwriters. A sharp drop in stock price after entering the market is not a harbinger of success. The timing of the public offering is suboptimal; private equity firms are eager to cash out their investments and are pushing the company to go public regardless of its financial situation. ((NPR, supra note 14.)) Time will tell whether this risky strategy will pay off, but it has the potential to reinvent the relationship between big tech and investment banks. It is yet another example of the growing power of the technology industry.
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