Spotify opens with a bang

Streaming music leader Spotify'sfirst trade was processed at about 12:45 pm on the New York Stock Exchange Tuesday, in what's been a direct listing that avoided the traditional path to a stock listing, eschewing costly investment bankers. 

Spotify made its splash despite a warning by Chief Executive Daniel Ek that the stock might be heading for a potentially rough stock market ride on its first day of trading, following Monday’s steep sell-off of technology stocks on Wall Street. 

In a public letter published ahead of its unorthodox listing, Ek cautioned employees and fans that "Sometimes we succeed, sometimes we stumble" and "I have no doubt that there will be ups and downs."

Nonetheless, in trading on Tuesday, pricing for Spotify appeared to be holding up, changing hands at about $165 (€134) a share, Based on the total number of shares outstanding after the listing, Spotify has a market value of about $28.7 billion.  

In February, the shares were valued at about $20 billion based on private stock transactions among existing investors. "Nothing ever happens in a straight line — the past 10 years have certainly taught me that," Ek, the Swedish company's co-founder and CEO, wrote in a blog post on Monday evening.

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Since launching its streaming music service a decade ago, the Stockholm-founded company has overcome heavy initial resistance from big record labels and among some major music artists to transform how the industry makes money. Spotify offers access to vast libraries of music rather than making users pay for CDs or downloads of individual albums or tracks.  

New market unicorn

Spotify is the third unicorn to go public this year following Dropbox and the cybersecurity provider Zscaler.

"Unicorn" is market slang for a startup valued at €807 million ($1 billion) or more. Both Spotify and Dropbox have experience raising billions in the private market. In a 2014 funding round Dropbox hit $10 billion in market value, and Spotify has been valued at $19 billion before its IPO.

"This incentive is needed," says Kathleen Smith of Renaissance Capital, an IPO-focused analytics firm, "because there are many risks for investors." Both Dropbox and Spotify have powerful competitors and compete with the likes of big dogs Apple, Google and Microsoft. These are old hands on the stock market and offer both music streaming and cloud sharing, each as part of their broad portfolio.

The 'non-IPO' IPO

One difference in Spotify's transition to the public sphere is that it is not a traditional IPO but actually a Direct Public Offering (DPO). This means that instead of creating new stock to sell and hiring underwriters to handle and represent the stock, Spotify instead listed its shares directly to Nasdaq. By direct listing, Spotify also avoids lock-up periods and trade dilution.

But no new capital is created. "That's risky," says Kathleen Smith of Renaissance Capital, "because Spotify actually needs new capital." In addition, the issue price is not determined by banks, which base it on predetermined supply and demand ratios. Banks buy stocks themselves in a normal IPO to generate demand, but in this instance supply and demand will lead to fair pricing, in theory.

It is rare for a large, established startup like Spotify to opt out of the grand IPO celebration and the hype generation that accompanies it, but Spotify will save on the hefty fees of hiring a bank and underwriters, costing on average between 5 and 8 percent of gross proceeds.

Better to keep the money

Most significantly, Spotify and Dropbox are yet to make a profit. In 2017, Spotify lost $1.5 billion and Dropbox registered a $111 million loss. Dropbox CEO Drew Houston says the focus is on growth, not profit.

"In the private market this is tolerated, unlike the stock market," says Kathleen Smith. Private investors are oriented towards the long term, while stocks on the stock exchange would have to be liquid. Investors are generally on the look out for short-term profits that they can make with the quick buying and selling of stocks. For listed companies, there is also a duty to keep quarterly numbers transparent. A loss cannot hide there. 

Last year, investors shied away from these risks. The company behind Snapchat, Snap, entered the NYSE in March 2017. It was listed at $17. And shares of the meal delivery service Blue Apron fell 80 percent after its June IPO. 

Still hesitant to go public

This shunning offers one example why so many companies don't go public. In 2017, only 37 tech companies listed themselves on the stock exchange, bringing in $9.9 billion, while in 2014, there were 56 IPOs bringing in a total of $32.9 billion. America's two most valuable startups have chosen to remain private — Uber with a market valuation of $72 billion and the housing rental platform AirBnB valued at $31 billion.

And yet another reason to stick to the private market lies in market conditions. Right now the private market is more convenient than ever for businesses. "In times of low interest rates, the venture capital of private investors flows particularly abundantly," says Smith. According to the analysis firm CB Insights, there are currently 228 startups in the private market, each with a valuation of over $1 billion. There is so much capital that there is a veritable bidding war of investors to be in the next round of financing, says Smith. Often, large private investors come late, but with large sums of money. "That leads to these high ratings," says Smith. 

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Now or never

Nevertheless, Spotify and Dropbox have decided to leave the private market. "Now or never," says Smith, referencing the current window of opportunity. It makes sense to enter a strong market in which enough willing investors ride the stock market. The American economy is at the end of a growth cycle, the unemployment rate is low, the economy is growing, and interest rates are still low. Signs that the bull market has neared its end are on the horizon. If the economy cools, it could also take the momentum off the stock markets, says Smith.

Dropbox's IPO seems to have succeeded, a week after the IPO, the stock has risen over 60 percent. For Spotify, over the past two months, private shares have traded between $132.50 and $90. Media outlets like TechCrunch continue to stir hopes by predicting that the Spotify IPO might put the price per share at the higher end of the scale. After all, there is already a firm amount of shares and the investor market is broad. Yet Smith, on the other hand, remains cautious: "One has to wait and see how investors react to direct listing."