Recent indicators suggest that Spotify is considering offering a direct listing where it simply registers its shares on a public exchange. This would mark a departure from typical IPOs and, according to Theorist Hyman Minsky, raise some concerns regarding a debt bubble.
Guest post by David Lowery of The Trichordist
The Wall Street Journal is reporting that Spotify is taking a unique approach towards a potential IPO:
“Spotify is seriously considering a direct listing, in which the company would simply register its shares on a public exchange and let them trade freely, according to people familiar with the matter. The company wouldn’t raise any new money or use underwriters to place new blocks of stock.
That would mark a departure from the typical IPO, in which new investors buy shares from the company or its early investors, or both, the night before they start trading. The initial price is set by underwriters following extensive meetings with potential new investors.”
While this will save the company underwriting fees and on the surface it appears “cooler” and more innovative matching the young company’s style, it also raises some serious questions.
First and foremost the article states clearly “In direct listings, early investors would be subject to less stringent lockups governing the sale of insiders’ shares.” In typical IPOs most insiders can’t sell their shares for 90 days or more. This prevents unscrupulous companies from dumping their shares to unsophisticated investors before problems with the company become apparent to outsiders.
Second, while the underwriting system may often give an unfair advantage to institutional investors, it also helps everyday investors by vetting the company (at least in theory). Banks and other financial experts examine the financials of the company before they agree to buy large blocks of shares. This is something retail investors can’t do. For instance, analysts working for institutional investors might evaluate: the effect that the convertible debt (a fairly nasty way of borrowing money) has on the long term price of the shares; risks associated with contingent liabilities (lawsuits, patent infringement claims or tax penalties); content licensing agreements with the large multinational labels; tax penalties; and the EXACT number of paid subscribers and how those subscribers are counted.
What happens with these rare direct listings is that the financials of a company and associated risk are not likely to be evaluated by third parties, or if they are, not with the same level of scrutiny. Sure Spotify will have to disclose all financials as well as financial risks, but it’s unlikely that ordinary retail investor will read these disclosures. So it seems fair to say that some significant portion of the public buying the stock will be unsophisticated investors. This is likely to exacerbate “information asymmetry” between retail investors and insiders. It’s a recipe for trouble.
Minsky is known for his theories about the unavoidable tendency for markets to develop bubbles (specifically debt bubbles) and become unstable. Indeed the collapse of debt markets and subsequent collapse of asset bubbles is sometimes referred to as a “Minsky Moment.” The question as to whether financial bubbles can be predicted has long vexed economists and been a serious topic of debate for decades. Minksy made a stab at identifying irrationally priced debt supporting asset bubbles before they collapsed. His theories are unique in that instead of looking at the underlying assets themselves he looked at the participants in the market and the market structure. For instance in the case of debt he identified three kinds of borrowers. When those three kinds of borrows are present and active in the market you may have a bubble. From wikipedia:
Minsky argued that a key mechanism that pushes an economy towards a crisis is the accumulation of debt by the non-government sector. He identified three types of borrowers that contribute to the accumulation of insolvent debt: hedge borrowers, speculative borrowers, and Ponzi borrowers.
This is all very technical and it requires complex explanation to directly apply this theory to the Spotify non-IPO situation, and ponder the true value of Spotify stock. Fortunately professional traders have provided us with a much simpler (and vulgar) heuristic, informally known as “The 3 I s” Innovators, Imitators and Idiots. The idea is that a stock is first favored by the innovators; then sophisticated imitators follow them into the trade, and then finally unsophisticated investors who have no business investing in risky stocks pile into the trade. Proponents of this heuristic argue that as soon as the third set of investors (idiots) start buying you should start selling, because the stock is overpriced. It’s really the same idea that Minsky put forward. It’s just applied directly to the stock rather than the underlying debt.
Honestly, I bet a lot of people don’t buy the explanation for the “non-IPO” that has been put forward by the unidentified sources in the WSJ. I certainly don’t think it makes sense. Something else is going on here.
Regardless, insiders and current shareholders (including major labels) should be asking themselves “is this really just a not-so-clever way to sell shares to the idiots?” Dark thoughts yes, but you can never be too careful. I mean what happens if this whole thing blows up? Is someone with a badge gonna come around asking “what did you know and when?”