Business Insider

Spotify cuts out big banks for its stock release

Stock prices are up strongly this year, and most of the gains are due to technology companies. As of early December, the S&P 500 index of U.S. corporations was up 17 percent, year-to-date, but the sub-index of just information technology corporations was up more than 34 percent.

With this kind of warm welcome it’s not surprising that a technology-based music company is ready to sell shares. The successful music-streaming service Spotify will release its stocks to the public in 2018 through a direct offering instead of the traditional IPO.

Spotify came on the scene in 2006 with a singular focus on music. It has grown faster than its competitors. Spotify now has 60 million subscribers, compared to Apple Music’s 27 million as of July 2017.

Part of its recipe for success is to cut out the middleman. And that’s just what the company will do to the financial markets. The company plans to list its shares directly on the New York Stock Exchange instead of selling them through financial underwriters, such as JP Morgan and Goldman Sachs.

Using an investment bank for is an easier way for a new company to raise cash. Investment banks help the issuing company fulfill all legal requirements, which can otherwise be costly and time-consuming. Also, the underwriter will most often buy all the newly issued shares from the company so that the business knows exactly how much new capital it has raised.

For these services the underwriter earns a “spread,” or commission. The current owners of Spotify must not think this fee is worth it.

Why? The underwriters often get the price wrong. IPOs are usually underpriced, meaning the stock trades during its first days or weeks at a price much higher than the initial offer by the company.

Instead, Spotify simply will deliver shares to the exchange, and current owners of the private company can start selling them, or even buy more. In this manner, the price is set by willing buyers and sellers, not an investment bank analyst.

As is true in all markets, Spotify will get a better deal by cutting out the middleman. But no one knows for sure what the price will be. Direct listings aren’t new, but Spotify’s innovative IPO is the first for such a large, well-known business.

We’ll see whether the new price is music to their ears.

Peter Crabb is a professor of finance and economics at Northwest Nazarene University. PRCRABB@NNU.EDU.