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Apr 07

Spotify IPO: A new day is dawning for US capital markets

The dawn of a new era in democratizing stock offerings may have been reached with the landmark Spotifly Technology S.A. direct listing on the New York Stock Exchange (NYSE).

Many will debate the success or failure of this novel approach to setting prices for trading its stock. However, it will be remembered for the latest attempt to give access of an in-demand stock to the average investor.

This, in contrast to the negotiated discounts to professional traders and money managers offered in the traditional Wall Street initial public offering (IPO) process that has faltered in recent years.

The Spotify direct listing lets existing private-equity stakeholders, venture capitalists, early employees and institutional investors that took risks to fund and support an idea of streaming music, to monetize their risks by exchanging their shares on an established public exchange. In turn, it gives the general public an opportunity to buy Spotify shares directly at its offering price.

 

But this optimism may be short-lived as other novel attempts at taking on the IPO machine have met with limited success. But this time it may be different. Things have changed. For one, the NYSE and many other exchanges have become public shareholder-owned companies.

This on the heels of the investment bankers who had already exchanged their partnership interests in their companies for a public offering of their stock. Prior to this, Wall Street partnerships prevailed with partners being members in an exclusive privately controlled members-only NYSE. What the Spotify listing portends is that investment banks and exchanges have become competitors.

Another change has been the internet’s instantaneous access to information about companies, their business proposition and their market value. Even more remarkable, certainly in the case of the new-age, digital companies, hundreds of millions, even billions of users have access to their products online and in real time.

As consumers of these online products, the public can value their worth for themselves. In turn, they can extrapolate this worth to the company’s stock value. To quote the famous Fidelity stock picker Peter Lynch: “Only buy what you understand.” 

A remarkable set of digital marketing and distribution mechanisms — the internet, the web, social media platforms, streaming media, etc. have supplanted the investment banker’s process of the road show and the personal solicitation of the privileged few.

Those who previously would be solicited in private to buy “in bulk” at a reduced price in anticipation of an IPO has been supplanted by the millions who can be solicited directly through digital platforms. 

Internet pioneers E-Trade and Wit Capital were first to create a more even playing field for the individual investor in garnering a fairer share of IPOs at the dawn of the internet age. Wit Capital began offering IPOs to their internet clients by placing an offering document on the newly developing internet in 1995.

Wit Capital eventually participated in a traditional IPO and received a portion of the allocation for distribution to its clients, which had mainly been attracted to Wit through its early internet presence. 

E-Trade, a pioneering internet stock broker that went public in 1996, sold its stock to the individual investors that came through E-Trade’s online brokerage service. This allowed E-Trade clients, who were allocated 50 percent of its shares, to become part of the privileged few that enjoyed the benefits of the large run-ups in the early days of public-market trading in those days of high-flying internet issues.

Another venture, that of W.R. Hambrecht Co., set IPO prices and allocation of IPOs online through an auctioning process known as a Dutch auction. Bids were taken for the number of shares wanted and at the price the bidder was willing to pay.

This last approach represents a real solution for IPO mispricings by making it possible to allow all available demand to set the most balanced initial public offering price. Until Spotify, the most memorable IPO auctioned done in this way was that of Google (now Alphabet) in 2004.

Notwithstanding the improved access afforded to bidders, the offering still fell short of accommodating all the demand in the market, as witnessed by the subsequent day’s public market trading, which saw a further run-up in Google’s stock price.

Like the Spotify pricing, the logic behind such an approach is that it would allow all investors to bid for shares directly, rather than leave it to an investment bank to decide on the price of the shares and who should receive them.

Google’s IPO was considered a failure as it underpriced its shares. Bankers drummed home the message that money saved in underwriting fees was dwarfed by the amount Google left on the table through the underpricing. 

It was a hollow argument given the behavior of investment banks during the dot-com boom of 1998-2000. Back then, critics accused them of underpricing IPOs — discounting the share price on the day of the offering — to curry favor with the institutional buyers, effectively failing to maximize profits for the issuing company.

In 2010, the U.S. government missed a great opportunity to promote capital market innovation. General Motors’ IPO in 2010 was a return to public trading after its bankruptcy and subsequent government bailout. It was done through the conventional IPO process.

Given that it was “the people’s money” that bailed out GM, some thought the “people” should have had a chance to buy the new GM shares at the IPO price similar to the process with Google’s IPO in 2004.

The same question was present at the time of Facebook’s IPO in 2012. This time the “people” were its customers, nearly a billion of them. Surely, they could run an internet auction and get enough interest to get a reasonable price for whatever shares they wished to sell.

Had CEO Mark ZuckerbergMark Elliot ZuckerbergFacebook apologizes to Myanmar rights groups Facebook’s appearance before Congress is great, but where’s Google? Zuckerberg announces support for regulating political ads on social media MORE used an internet auction, Facebook would have set itself apart in the internet space of financial services as it had done with its innovative trend-setting social networking service.

It was left to Spotify CEO Daniel Ek to lead a hybrid IPO approach using the NYSE’s computer systems to receive electronically sent trades to its own automated auction process and set Spotify’s IPO price with no investment banker involved.

Allan Grody is the president of Financial InterGroup Advisors — strategists, consultants and researchers in financial services with particular focus on bank regulation and the design and implementation of innovative enterprise solutions. 

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