On April 3, the music-streaming subscription service Spotify went public on the New York Stock Exchange. It did so using a direct listing process, which allows a company, along with existing investors and employees, to sell shares directly to the public without the aid of intermediaries known as underwriters. In a company blog post, CEO Daniel Ek — whose words were not those of a hype man but a captain with a steady hand on the tiller — said the direct listing “doesn’t change who we are, what we are about, or how we operate.” Ek’s tone comes as no surprise, since investor confidence in Spotify’s long-term profitability is key.
The case immediately puts students in the shoes of a portfolio manager for a hedge fund focused on growing technology companies. Knowing a direct listing is an unusual choice for a large tech company, students need to determine whether their fund should invest in Spotify and, if so, what maximum price and investment horizon the fund should accept.
We asked Stephen Foerster, professor of finance at the Ivey Business School, for his opinion on Spotify and on the case. Foerster and co-author Craig Dunbar, associate professor of finance at Ivey, have produced a combined total of over 130 case studies.
Ivey Publishing: After disrupting the music industry, Spotify is in a sense disrupting the financial markets by taking an approach to going public that affects investment bankers. It chose to stream its investment presentation to the public, not Wall Street. Do you think we'll see an increase in direct listings — less common for large tech companies — or Dutch auctions after Spotify? Are investment banks in trouble?
Stephen Foerster: I don’t think there will be a huge rush to direct listings or auctions, but Spotify’s approach may be a route for selective tech “unicorns” – private firms valued at more than $1 billion – that are high profile, well-funded, and looking to go public primarily for liquidity reasons. Google’s IPO auction was a success for them back in 2004, but didn’t open the floodgates to other auctions. So I don’t think investment banks need to lose too much sleep.
IP: In general terms, in a direct listing, how long until fundamentals take over compared to a traditional IPO? Is it important for students to learn these and other differences?
SF: With traditional IPOs, there are a couple of factors at play. The underwriters are there to help stabilize prices and provide somewhat of a floor, at least in the short-term. There are also lock-up periods whereby major initial shareholders can’t sell their shares, for at least six months or a year. In Spotify’s case, the pricing fundamentals appeared to kick-in quite quickly.
IP: Spotify opened at a red-hot $165.90 per share, blasting through the ceiling of its private share sale price, which as disclosed in its F-1 filing to the SEC was 25% lower at a high of $132.50. Do you think other companies will follow suit in facilitating private trading to aid in price discovery and to reduce volatility?
SF: When a firm is private, by definition it doesn’t have access to public markets and so it needs to rely on private investors to provide capital for growth. It is these various rounds of financing that help to set a price, but their purpose is for the firm to access capital. In Spotify’s case there was some trading of debt for equity. Private capital raising is available to any firm that can attract it, and it does help to set a price and hence implied value of the entire firm. However, there is no guarantee that the “key” round of financing—the traditional IPO—will be at a higher price than the last private round, for example, if economic conditions or company-specific conditions change.
IP: With so many great cases on valuation out there, why should instructors use your Spotify case?
SF: I wrote an IPO case twenty years ago—also with Craig Dunbar—about The T. Eaton Company’s 1998 IPO. I was delighted when we got permission to include an excerpt from Roch Carrier’s classic “The Hockey Sweater”—about the young and excited Montreal Canadiens fan who orders a jersey through the Eaton’s catalogue, only to be distraught when he mistakenly receives a Toronto Maple Leafs jersey. It’s still one of my favourite cases but I haven’t taught it in a long time. Within a year of the IPO, Eaton’s re-filed for bankruptcy protection. The department store model has since been upended by big box stores and e-commerce. So while the valuation fundamentals remain the same, the context is completely different. Our Spotify case focuses on an innovative company that’s disrupting an industry, so it’s relevant to what’s happening today and it gives the instructor a lot to talk about beyond valuations—perhaps even to share their favourite Spotify playlist with the class!
IP: With much more secondary information covering public companies now readily available online than in years past, do you find you're writing more cases using publicly-available information?
SF: There are trade-offs between cases written from an insider’s perspective and those from publicly-available information. You give up some richness but, as in the case of Spotify, you can act quite quickly when you don’t have to get insiders to sign-off on a case. For the Spotify case, Craig and I talked about writing the case as soon as we heard it was considering a direct listing, so with the help of our case writer, Ken Mark, we were able to gather a lot of public information and write a draft of the case, with the intent of having a published case—complete with a teaching note and instructor’s spreadsheet—within about a week of the actual event. We believe this is a record turn-around between the time of the case event and the actual publication, certainly for Ivey Publishing and perhaps for any case. We expect to see more like this, and I know this is something Ivey Publishing would love to see.
To review or purchase the case for your course, view the abstract at the link below:
Spotify's Direct-Listing IPO (9B18N006) | Teaching Note | Instructor Spreadsheet
Stephen Foerster - Biography | Cases
Craig Dunbar - Biography | Cases