The Direct Listing Has Shaken Up Public Markets. What’s Next?

By September 27, 2019 February 9th, 2021 No Comments
The Direct Listing Has Shaken Up Public Markets. What’s Next?

Spotify ushered in two revolutions in its young lifetime. It popularised streaming, radically changing the economics and distribution models of the music industry. And then, in 2018, it sold its shares on public markets through a direct listing, bringing into the mainstream an alternative way for a company to go public.

Spotify’s listing didn’t exactly open the floodgates, with tens or hundreds of companies immediately getting on the direct listing bandwagon – Slack, the widely-used workplace messaging service, is the other well-known tech “unicorn” to do so, having gone public early in 2019. 

But it was enough to get the conversation going. Besides Barry McCarthy, Spotify’s (now former) CFO and prominent evangelist of the direct listing, investment industry notables such as Benchmark’s Bill Gurley and Sequoia Capital’s Michael Moritz voiced their support for the new model. In fact, all three of them appeared at an invite-only symposium on direct listings in October 2019, which shows how serious the investment community is about them.

The Future of IPOs

Why is the direct listing making such waves? It has a lot to do with independence – a bit of a theme here at Smartkarma. Direct listings free issuers from being beholden to underwriters and the fees they charge, as well as lengthy road shows to woo investors. They also liberate shareholders from lock-in periods, during which they can’t sell their stocks to investors.

Those were some of the main points McCarthy emphasised in a blog post after Spotify went public. “Avoiding the lock-up period was a very important part of our decision to list Spotify directly, but there were also clear financial benefits,” he wrote. “First, we saved on the underwriting fees, which range from 3.5 to 7 percent of the money raised. But the bigger cost-saving was avoiding the IPO discount.”

Spotify’s example was important because it succeeded in breaking Wall Street’s “hammerlock” on public listings where even Google could not. In his piece in the FT, Moritz cites the Silicon Valley giant’s failed attempt to get investment banks to run an open auction to determine its eventual price. 

But times have changed since then, and dissatisfaction with investment banks has only grown, he argues. Spotify’s direct listing is a signal that some in the market have had enough.

“These direct listings, largely controlled by the company that is selling shares, occurred because the shrewd and the brave caught on to the idea that, for stock offerings, investment banks occupy the same position in the investment universe as a scalper does in the theatre world,” Moritz writes.

“No actor, theatre owner, producer, or audience member enjoys knowing that a ticket tout has run off with money that should belong to them. The same goes for the people involved with private companies.”

Direct Results

Enthusiastic observers are hailing direct listings as the evolution of the IPO. This might well be the case, but not enough of them have taken place so far to have a verdict. 

Neither Spotify’s nor Slack’s stock price has exactly been a rocketship, with the latter especially facing a disheartening drop after its 2Q2019 results. So in terms of a direct listing being more successful than a traditional IPO, we don’t know enough yet.

Regardless of their stock performance, both Spotify and Slack managed to complete their listings on their own terms. It helped that neither company needed the extra funding an IPO usually brings in. Spotify’s total revenue rose 31 percent year-on-year in 2Q2019, hitting €1,6 billion, while it hit its expected Q3 revenue target with €1.7 billion. 

Slack didn’t fare as well in its first earnings report after listing, as the stock price took a dive after outages during the second quarter shaved some US$8.2 million (given in the form of credits to customers affected by the downtime) off its revenue of US$145 million.

“Though the company performed above market expectation at its direct listing, the company’s share price has continuously declined since then,” wrote LightStream analyst Shifara Samsudeen in an Insight on Smartkarma. Slowing revenue growth and an unclear path to profitability make it “difficult to understand if the company’s operating efficiency is improving or not,” she noted.

Read Shifara Samsudeen’s full Insight: Slack’s First Post-DPO Results Reaffirm Our View on the Company; Growth Is Slowing Down

While revenue jumped back up in 3Q2019, hitting US$168.7 million, the company’s share price has still been taking a hit over concerns of competition from the likes of Microsoft.

“Microsoft is negatively impacting Slack’s growth, but not because it’s a better product,” wrote Aaron Gabin in an Insight on Smartkarma. “The reason is the existence of Teams increases the barrier of adoption for Slack within large organisations – lengthening sales cycles – thereby slowing Slack’s potential growth rate.”

Read Aaron Gabin’s full Insight: Slack: Microsoft No Longer Cutting Them Any, Flipping to a Short.

Slack direct listing on NYSE

Photo credit: NYSE

Straight to the Source

It’s too soon to tell if others will follow down the direct listing path these companies carved out. Some of 2019’s highest-profile IPOs, like Uber’s, followed the traditional road to public markets. On the other hand, Airbnb seems a prime candidate for a direct listing, now expected in 2020. And the less said about WeWork’s IPO-that-almost-was, the better.

It’s not surprising that tech startups would be the ones to break new ground with direct listings. Nothing says “tech” more than eliminating the middleman, after all. And when it comes to rules, tech startups are the ones that famously “move fast and break things” and “ask for forgiveness, not for permission”.

They also have loads of private market investment to play around with, making a public listing less pivotal to their continued growth. With an abundance of venture capital available to them, they can go on for years without the added scrutiny that public markets regulations impose. Left to its own devices, WeWork could have probably continued bleeding money and raising new funding from SoftBank for a while yet.

Ironically, having a strong brand name like those “unicorns” as well as a full war chest makes a direct listing a lot more feasible. 

“The success of Spotify’s direct listing was due in part to Spotify being a well-capitalised company with no immediate need to raise additional capital, while also having a large and diverse shareholder base that could provide sufficient supply-side liquidity on the first day of trading,” writes Latham & Watkins, the law firm that advised the Swedish startup on its listing, in a case study on the Harvard Law Review.

So what’s the way forward? While it’s certain that more companies will try the direct listing approach, it’s unlikely it will become the norm in the short term. However, its prevalence is a sign of the inefficiencies and grievances of issuers with the traditional model. Perhaps a hybrid form will be the way forward – combining elements of the direct listing and the traditional public offering, as described by Axios

What’s certain is that the evolution of capital markets will continue unabated, and this includes IPOs.

Lead image by dnorton

This post was updated on 22 January 2020 with new developments and details.

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