Direct Public Offerings, or Direct Listings, gained attention in the first half of 2018 when Spotify bypassed the traditional underwritten IPO to list their shares on the New York Stock Exchange (NYSE) through a NYSE Direct Floor Listing. While this remains a rare occurrence for U.S. based companies, in this post we look at the mechanics, along with some pros and cons, of a Direct Listing.
What is a Direct Listing?
A Direct Listing is a process in which there is no underwritten public offering managed by a group of banks. In a traditional public offering the underwriters manage a roadshow and book building process to come to a deal price, whereas in a direct listing the deal price is determined by a reference price and the buy and sell orders on the first day of trading.
In the case of Spotify, the company’s prospectus was for the sale of over 55 million shares. However, unlike most IPOs, the company was not selling any shares itself, nor were they receiving any of the proceeds from the offering. As part of the NYSE requirements for a Direct Listing, only existing shareholders may sell, thus creating a publicly traded company while providing liquidity for existing shareholders only.
While there were no underwriters in the traditional sense, Spotify did hire Goldman Sachs, Morgan Stanley and Allen & Co. as financial advisors. In this role, the banks worked with the Designated Market Maker, Citadel Securities, to find a reference price to guide the opening price on the NYSE. Unlike many private companies, Spotify had a history of private transactions that had taken place over the ten months prior to the NYSE listing. While this data could have no relation to the opening public price, it also can be used as a factor to help guide the opening. Ultimately the NYSE set a reference price of $132 (just above the $131.88 high from the previous month’s private transactions) before the stock opened at $165.90 and closed at $149.01 on the first day.
Pros & Cons of a Direct Listing
A Direct Listing can sound very appealing to a company as it is a way to bypass much of the time and expense of the traditional IPO route. Here are some benefits of a Direct Listing:
- No Underwriting Fees. While a company may pay as much as a 7% fee to the underwriters on top of fees to company counsel and other underwriting costs, a Direct Listing has smaller fees.
- No Roadshow. From a management time demand, this can be a benefit, as management will not need to spend time prepping for a roadshow and the two weeks of meetings with investors.
- No Dilution. With the company not issuing any primary shares, there is no dilution to existing shareholders.
- No Lock-Up. For insiders, this can be a positive as they can sell their shares once the stock has started trading as opposed to the traditional 180-day period in which they can’t.
- Publicly Traded Stock Currency. By becoming publicly traded, companies can use stock as an additional form of currency to cash when making acquisitions.
While there are some positives, here are some negatives:
- No Roadshow. While this is listed above as a benefit from a time standpoint, the IPO roadshow is a great opportunity to meet with 40-60 investors one-on-one and more through group meetings. Traditionally from these meetings a core group of investors will be identified who will become long-term shareholders.
- No Price Discovery. The book building process over the course of the roadshow gives the underwriters a way to propose a deal price versus the range on the prospectus. While not an exact science, this process can help find the price that maximizes the proceeds to the company while building a group of happy long-term shareholders.
- Less Support. By working outside of the traditional path, a company may end up losing out on the attention of Wall St., both from a research standpoint and trading/market making. While this may not be as much of an issue for larger companies, it can be vital for smaller companies while they are growing. In addition, in the short-term, if there is a lot of trading volatility, there will be no greenshoe to help support the stock.
- No Lock-Up. A lock-up helps to provide stability for a stock in its early days of trading as investors know there is not a large supply of stock coming to the market immediately that could drive the stock price down. Although insiders may view no lock-up as a positive, early investors typically like to see a 180-day lock-up for large insiders. During this period the company has a chance to report earnings a couple of times, go to investor conferences and continue to grow and create demand for their shares.
What About Small Companies?
Spotify has grabbed the headlines for its Direct Listing, but it has also been a path for a handful of medtech and life sciences companies since 2010. One interesting deal was Coronado Biosciences (now Fortress Bio), which sold up to 14 million secondary shares in September 2011 on the OTC Bulletin Board. Nine months later the company completed an underwritten deal selling company shares. Some other deals include Ovascience, Bioline and most recently, in 2017, Nexeon Medsystems. At the time of listing, none of these companies were traded on the NYSE or the highest NASDAQ tier.
Another negative not mentioned earlier is that for the smaller companies that completed Direct Listings, but did not complete a follow-on offering later, they are stuck with the reporting requirements and expenses of being a public company, but without the benefit of having raised capital.
As can be seen above, there are very few examples of small companies successfully completing a Direct Listing, and it remains an infrequent method of becoming a publicly traded stock. There has been some thought that the Spotify IPO would open the door for other tech “unicorns” or companies with millions of users to do Direct Listings, but so far, we have not seen that happen.
The traditional IPO route, while time consuming and expensive, is a great opportunity for a company to meet with top tier investors, many of whom will become long-terms shareholders and backers of the company and its stock. And while not all investors from the roadshow may choose to participate in the IPO, many of them can go on to be large shareholders at a later time, either buying shares in the open market or on a follow-on offering.
A Direct Listing is an interesting method to become a publicly traded company and provide liquidity to existing shareholders, but it does have drawbacks when looking further down the road in a company’s life cycle. It is our belief that a traditional underwritten IPO is the best method for going public, but contact us to further understand the various options and their pros and cons.
Tom Brennan, CFO