Spotify and the Wild Playlist

First published April 3, 2018 by Matt Leibowitz, Founder & CEO of Stake

Pack your ear plugs, bring your helmet and strap yourself in, because this one’s going to be wild.

Spotify is by far the most interesting IPO and no Australians are talking about it. Well, this Australian is.

Spotify (SPOT) is listing on the NYSE on Tuesday, 3 April (US time, so Wednesday 4th in Australia). And the listing isn’t interesting because it’s listing on the US market when it’s a European business. This is normal for the world’s largest companies — they go to the US for their listing. It’s where the world trades.

What is so exciting is that it’s a direct IPO. This means Spotify’s not raising more money or having a bank underwrite the sale of new shares — which also means there is no indicative price for the listing. It’s taking its shares to market and saying “trade us, price us”.

That means come Day 1, you won’t see any bankers or official market makers. Just buyers and sellers going head to head. It’s pure market forces happening in front of our eyes. Freedom. Liberty. Capitalism 101. Call it what you want, no matter what…it’s going to be epic.

The conservative route

In explaining why Spotify’s IPO is going to be so different, it’s worth running through the classic IPO process. Suits, ties and legal fees live here.

An IPO (Initial Public Offering) is where a company takes their shares to the public (on an exchange) to raise more capital while also allowing existing shareholders to sell down some of their holdings. The process of “going public” is normally organised between the company, its lawyers and their investment bank(s).

There’s obviously a lot that goes on with this process, but this is the general gist.

The bank and lawyers arrange for the IPO documents, while the bank underwrites the listing (i.e. they commit to buying any excess stock not bought before the IPO). The banks drum up interest in the company via a roadshow and ensure that there is institutional demand for the raise. It also negotiates the price of the IPO and makes sure that the supply (sellers + company) is met with demand (buyers’ pre IPO). The banks get paid for this, normally handsomely, and gets paid for committing to buy any stock not allocated. Dropbox, had Goldman Sachs, JPMorgan and Deutsche Bank as its underwriting banks during its recent IPO.

What does a normal IPO do for a listing company (think Dropbox)?

1. It sets a ballpark price for your shares when they hit the market.
2. It ensures that you’ll make the capital you need and shares will be sold, as any shortfall is picked up by the investment banks.
3. It puts stock in the hands of institutions, so there is liquidity (aka trading volume) when your shares start trading.
4. A bank is obligated to “stabilise” the price to smooth trading early on. This makes trading less erratic in the first days and weeks of a company listing.

Spotify is doing none of this. Ballers.

Spotify is going with a direct IPO. This means no roadshow, no underwriting bank and no fundraising. Spotify is essentially giving the public the right to buy their stock from their existing shareholders. This also means there is no guidance on where it should or will trade when it lists and nobody is obligated to prevent erratic trading. That is the first reason it’s going to be wild.

Why would they do this?

1. They are not raising money — they are just giving their employees and shareholders a way to sell stock.
2. It saves them $. Underwriting fees are expensive and since they aren’t raising money, they don’t need that guarantee.
3. They obviously don’t see a need for institutions (i.e. banks) to own their stock. Or maybe some already own Spotify through the private market.
4. They don’t need institutional support (think cash) in the future. They are generating cash from subscribers, so I assume they will use that to fund their business. Good on them.

What does this mean if you want to trade Spotify?

It will be wild. No doubt. Without a confirmed raise price to anchor to and no bank stabilising prices, we have a cocktail of uncertainty over price and trading. As I said, seatbelts.

Based on the Form F-1 that Spotify provided to SEC (US regulator) there were approximately 177 million shares of Spotify on issue. In 2017, those shares traded in the private market (between employees and other shareholders) between $37.50 and $125. And if you think that’s a swing, it gets better.

In the first part of 2018 (1 January — 22 February) the stock traded between $90 and $132.50. That’s a 47% price range in just 2 months of trading! At the top level, SPOT is worth $23.5bn or $16bn at the bottom. I’d be more than happy to bank the difference.

When you put all those pieces together, it doesn’t take Einstein to realise it’s going to be an incredibly whippy Day 1 for Spotify. We’ll see the buyers (regular investors and institutions) feeling out the interest of sellers (employees and VC funds selling down). Buyers want to buy for less, sellers want to sell for more. It’s going to be a very interesting duel! Who’s got popcorn?

So what should you do?

As always, that’s up to you!

I don’t know what Spotify should be priced at and I am not the type to dig deep into the books. I honestly have no idea where it will land.

Matt’s take: whatever you think Spotify is worth buying for (or selling for, if you own some) strongly consider only using limit orders(i.e. not market orders). When market conditions are volatile and whippy like they’ll probably be for Spotify’s first days — markets orders are potentially dangerous. You could end up paying across a ridiculous spread until the market settles down. And this could take days.

Patience in these conditions can make a huge difference in your execution price. You can always use a limit order, you just need to set your maximum price above the offer (or in the case of a sell, below the bid). Then you know what price you’ll be buying or selling at, rather than leaving it up to the market to decide.

Here’s an example:

Let’s assume Spotify is trading around $110.

You want to buy Spotify when the bid is $105 and offer is $115. Your market order will buy at $115. If you are prepared to pay more than $115, that’s probably ok for you. But what happens if there is no longer that volume or someone else gets to that $115 before you and the next best offer is at $125. Then your market order executes further away from where you wanted to trade.

So if you want to place a limit order for Spotify shares on day one (or after), just use the advanced tab. Set the # of shares you want to buy and the price you’re willing to buy them at. Boom, that’s it.

Even if you don’t trade the stock, it’s worth keeping an eye on the duel between buyers and sellers. It’ll be in the shop from the moment it starts trading on NYSE on April 3 (US time). For you those of you wanting the worm, that’s 12:35am Wednesday, 4 April.

You can trade SPOT here on Stake and remember those limit orders!