Research out of Schulich supports disruptive financing option for Spotify

Research out of York University’s Schulich School of Business shows that although Spotify’s option to go public via a “direct listing” challenges conventional wisdom, it works.

Ambrus Kecskés

Finance Professor Ambrus Kecskés says a disruptive financing option would reduce the music streaming company’s cost of going public, pass savings on to investors and increase strategic market timing options for issuing new equity.

Research supports Spotify choosing to take its equity direct to market by listing existing shares publicly on the stock market, rather than using an underwriter to issue new shares.

Numerous reports suggest the music streaming company is seriously considering this option.

The research suggests that going public through a direct listing would benefit Spotify and its current investors, said Kecskés, who has studied companies that have gone public through this unconventional process. This is especially the case, he said, if the firm decides at a later date to sell new shares to the general public.

“Introducing the existing shares of a company like Spotify to the stock market, or direct listing, without simultaneously issuing equity using an underwriter challenges conventional wisdom and would be virtually unprecedented in the United States. It could be considered a form of disruptive financing,” said Kecskés. “However, if Spotify takes this route and is successful, its existing investors will benefit and it could set a new trend in the way firms go public.”

While a common practice in the United Kingdom, taking a company public without raising additional money or issuing shares just prior to a market listing is unprecedented in the U.S., said Kecskés.

Kecskés is the co-author, with François Derrien, of “The Initial Public Offerings of Listed Firms,” published in the Journal of Finance. The 2007 study, which examined firms in the U.K., found that the two-step process reduced financing costs when the firm eventually did raise financing, and it provided firms with the flexibility to separately list and issue equity at more opportunistic points in time.

There are several advantages of taking this two-step approach rather than doing a traditional IPO, said Kecskés. Spotify would avoid paying juicy fees to the underwriting banks. It would largely eliminate the vertiginous underpricing of the firm’s shares, minimizing the dilution of the firm’s pre-listing investors.

Doing so would avoid leaving “money on the table” for the institutional investors and high-net-worth individuals, who typically get shares at the IPO price from the underwriter and then flip their shares for a handsome profit once the firm starts trading on the stock exchange. The firm might even be able to continue to communicate with investors and other outsiders rather than going quiet before and after listing, as required by securities regulation.

Finally, if and when the firm did decide to issue equity in the future, its issuance costs would be minimal compared to an IPO, both in terms of what it would pay the underwriter and the underpricing costs it would bear on the shares it sold.

Spotify’s direct listing strategy, if successful, could lead to other U.S. companies following suit, setting a new trend, said Kecskés.