Spotify: Road to Direct Listing

Today was our last class of HKU MBA — Corporate Finance. As a team, we are happy to share our learnings from the Spotify case study. Kudos to my lovely team members: Annie, Monica, Tomo, James, Ann, Alci for making this possible.

Spotify is a Swedish music streaming service provider founded on 23 April 2006 by Daniel Ek and Martin Lorentzon. It is the world’s largest music streaming service provider, with over 381 million monthly active users, including 172 million paying subscribers, as of December 2021. 2008 they started streaming music after signing a licensing deal with Universal Studio, Sony Music, Warner Group, and they also have 15 to 20% shares in Spotify. They have 2 Business Models: Listen to fee songs with Ads or get a monthly subscription of 9.99. The free tier is driving the growth in subs.

Spotify also works with artists to create content and promote documentaries, e.g., Ed Sheeran & Hoier. Their key competitors are Apple Music, Amazon Music, YouTube Music, Google Play Music, Pandora, Soundcloud, Deezer Music, NAPSTER.

Spotify market cap is $50 Billion, stock price trading around 250.89$

Taylor Swift & Spotify Fall out in 2014:

In Oct ’18, Swift launched 1989; at the time, she was arguably one of the world’s most prominent pop artists, and she was making half of a million USD per month just from Spotify. Spotify operates with a FREEMIUM MODEL. They were providing free music to users with restrictions, such that it would boost future subscription sales. This, of course, increases the consumer surplus but results in less producer surplus. That’s why Taylor Swift never launched her new albums on Spotify. She believed Streaming Cannibalized itself. She and her label Big Machine has 2 demands if Spotify wanted to launch 1989:

Spotify executives declined, mainly because it violated their policies. Spotify would never allow artists to pick which markets the products were launched and forgo the free tier in 2014.

As a result, she pulled out all of her albums from Spotify while keeping her albums in iTunes. Following Swift, Beyonce also released her new album in November exclusively on iTunes. Spotify replied they hoped Swift could change her mind and be part of the new music economy.

2014 was the start of a new era — Streaming services were starting to gain momentum and outgrow Digital Sales. Fewer and fewer people were downloading from iTunes or downloading from YouTube. Why bother downloading while you could pay a subscription fee every month? Independent Artists like Ed Sheeran got 100% of the stream’s revenues because they didn’t have to pay the Labels. Taylor Swift, on the contrary, received a small portion of the streams because the entire income from her streams would go to the label, and the title would, in turn, pay a bit for the royalties. Stakeholders need to be rightfully compensated by putting a lot of their skin and getting at least their IRR. But the fact is that the lion’s share of many artists’ revenue never came from album sales anyways; it comes from tours, concerts, etc — Streaming was the new sort of branding and an alternative to Piracy where they could at least extract some gains.

For Spotify’s most prominent rival Apple Music, partially agreeing to the artist’s demands might not have been an issue because Apple Music (iTunes at that time) are COMPLEMENTARY PRODUCTS sold in a bundle with their devices; and they don’t operate under FREEMIUM…

This experience helped the artist realize the power of the music streaming platform. On the other hand, it allowed Spotify to tweak its business model, which offered all the ecosystem players a WIN-WIN situation.

Eventually, Taylor made her way back to Spotify on Jun’17, and Spotify went public on April ’18.

Ways of going Public:

There are many ways of going public — Traditional IPO, Direct listing, SPAC, and many more.

What is a traditional IPO?

IPOs provide companies with an opportunity to obtain capital by offering additional shares through the entire public investment market. It gives the company a remarkable ability to grow and expand by increasing transparency and share listing credibility to obtain better terms when seeking borrowed funds. Improves the company’s exposure, prestige, and public image, which can help the company’s sales and profits. The underwriters are involved, they charge around 3–7% of every share. Underwriters take all the risk, guarantee the sales of shares of the estimated price after marketing and buy the rest of excess and they also help in setting the price of shares.

What is Direct Listing?

In a direct listing, a company’s outstanding shares are listed on a stock exchange without either a primary or secondary underwritten offering. No additional capital will be raised; existing shareholders, such as employees and early-stage investors, become free to sell their shares on the stock exchange but are not obligated to do so; lock-up agreements and price stabilization activities — are not present in the direct listing. The market gets to decide the stock of the price.

What is SPAC?

SPAC (Special Purpose Acquisition Company) is a shell company created to merge the existing “target company.” With the listing of the SPAC in the early stage, the target company with operation would also be listed with the merge with the SPAC. Compared to the traditional IPO, the SPAC listing candidate will approach a listing status faster, lock investors in an earlier stage and save money for underwriting expenses that SPAC promoters would pay. While the SPAC promoters are bearing underwriting expenses, the massive return from the SPAC listing will cancel off the expense and bring the initial investors a considerable return. For example, WeWork experienced a traditional IPO failure in 2019 and success in SPAC in 2020. Higher returns always come with higher risks; if the target companies have not been identified, all the acquisitions cannot be completed within the requested timeline. SPAC needs to pay back the fundraised while still bearing the underwriting fee.

We recently saw the biggest SPAC happen this year with Grab going public.

Spotify Direct listing:

Spotify went public on the stock market in April 2018 using a direct public offering rather than an initial public offering. These were their goals for going public:

1. They didn’t want to raise additional capital.
2. Wanted to offer greater liquidity for its existing shareholders without the restrictions imposed by standard lock-up agreements
3. Provide unfettered access to all buyers and sellers of its shares
4. Conduct its listing process with maximum transparency and enable market-driven price discovery

Having enjoyed great success in the private capital markets, Spotify had no immediate funding needs. With a large and diverse shareholder base, a well-known brand, global scale, a relatively easily understood business model, and transparent company culture — Spotify felt that reimagining the process of going public through a direct listing was the path that best enabled it to achieve these goals.

This was the first time a company wanted to do direct listing — so after disrupting the music industry, Spotify was out there to disrupt the IPO market. With a listing ecosystem designed around a traditional underwritten IPO process, Spotify had to work closely with the US Securities and Exchange Commission (SEC) Staff, the NYSE, and its financial and legal advisors to achieve its goals for the direct listing within the confines of the Securities Act, the Exchange Act, NYSE listing rules, and investor expectations.

After making its debut on the New York Stock Exchange on 3 April 2018, CNBC reported that Spotify opened at $165.90, more than 25% above its reference price of $132. There are some pros and cons to Direct listing:

Pros of Direct listing:

• A direct listing is much cheaper as compared to traditional IPOs. You don’t have underwriters’ fees, Roadshow. Hence Spotify saved 1/3 of the price, which came up to 100$ Million
• It’s more transparent and with the market drive price. Where else in traditional IPOs, iBankers get to mark up the share price and goof around with share allocation
• No lock-up period. Investors get to liquidate their shares and make money. You get to reward your investors for supporting the company.
• There was a reference price; Spotify opened at $165.90, 25% above the reference price of $132.

Cons of Direct listing:

• The price of the stock and availability depend solely on supply and demand bring high volatility to the stocks.
• Financial advisors are less regulated and less liable.
• A company won’t be raising any additional new capital.
• No roadshow — less awareness and branding opportunity
• It might not fit every company

Take Away from the Spotify Direct Listing Case study:

• There are some critical differences between Direct Listing, Traditional IPO, and SPCA. Choose what best fits your firm when you are ready to go public.
• If you don’t need more capital, have a strong brand and transparent business model, attractive company, offer liquidity to your stack holders, and finally don’t want to make I-Bankers more rich — direct listing is a good option.
• Hong Kong Stock Exchange in the coming months might introduce SPAC, expect it to be much more regulated than NYSE.
• Don’t be afraid to be a disruptor in the IPO market — more power to you if you want to!
• Do all the possible calculations that you can; having a strong intuition in finance can help you WIN big.

BTW that's me having some fun while presenting some part of our case study.