Music streaming service Spotify has finally moved forward towards going public, as investors have waited for the music streaming service to make this move for a long time. As Reuters reported, Spotify is aiming to go public at some point in the first half of 2018 and is valued as much as $19 billion.
Spotify has successfully competed with tech giants like Amazon (NASDAQ:AMZN) and Apple (NASDAQ:AAPL) in the streaming services battle, has helped revitalize the music industry, and boasts tens of millions of subscribers. But the company has made the very interesting decision to target a direct listing instead of going through the traditional IPO route.
This new route could set a precedent in how companies in general handle IPOs, but Spotify’s decision to go for a direct listing is a very concerning sign. Investors should note this decision, consider other negative factors, and look to stay away from this company.
The Direct Listing Precedent
A direct listing is different enough that to state that Spotify has filed for an IPO as some reporters have done is technically incorrect. In a normal IPO, a private company works with a bank to offer new shares available to the public. Public investors buy into the company, hoping to be a part of Facebook (NASDAQ:FB) or Google (NASDAQ:GOOGL) and sell their shares later if the company grows in value.
In a direct listing, the private company offers no new shares. All Spotify will do is make it legal for VCs who already own Spotify stock to sell it on the market. Spotify will not have to pay the usual Wall Street fees, though Axios reports that it is involved with several investment banks. But the important matter is that Spotify will not receive a single cent from going public.
In some ways, this is a culmination of certain trends happening within the IPO market already. Plenty of companies over the past year crowed about the huge totals they raised by going public, but a closer examination at their numbers showed that a large percentage if not the majority of the raised funds went not to the company, but by existing investors looking to cash out.
Despite all the hype which surrounds IPOs, they all too often represent not a young company looking to announce that they have arrived, but investors who are tired of holding the stock and want to dump it on someone else who will watch it fall in value once the initial hype fades away. As long as companies, especially rising tech companies like Spotify, can easily get funds from private investors, this will likely continue. It could be argued that what Spotify is doing is thus more honest than many other companies going public.
But while honesty is a laudable virtue, the fact remains that Spotify is going public not to raise money, but to help its preexisting investors cash out. And if Spotify’s investors are eager to cash out, potentially interested investors should be worried.
Preexisting Problems
Spotify filed confidentially with the SEC, so a detailed breakdown of its financial numbers is currently unfeasible. But there are plenty of reasons for why their existing investors may wish to leave now.
The first problem is that like many emerging tech companies, Spotify remains highly unprofitable. Bloomberg reported last June that Spotify’s net losses in 2016 more than doubled to over $600 million while sales increased by just 52 percent. A tech company facing rising losses is hardly unusual, but it remains a negative sign as Spotify faces intense competition from tech giants on one side and smaller, independent companies like SoundCloud on the other.
Furthermore, Billboard reports that “Spotify’s IPO could be complicated by the copyright-infringement lawsuits it faces for streaming songs without licensing mechanical rights from publishers.” Spotify is facing multiple lawsuits which could see it lose up to $2 billion in damages in the worst case scenario. These lawsuits are only going to make investors and Spotify more nervous, which will pressure Spotify to settle quickly and thus end up paying more.
Spotify has been successful so far, but there are significant negative pressures on the company. And that does not even factor how direct listing should negatively affect investor confidence.
Nothing to Gain
Another disadvantage of the direct listing approach, similar to car title lenders, is that Spotify will not be going on the usual IPO roadshow where it attempts to assuage investor concerns. Spotify will have to assuage investor concerns about its losses, lawsuits, and competition, but above all else it faces the problem of persuading outsiders to invest in a company where the insiders are trying to leave. Spotify’s decision to go for the direct listing is certainly bold. If this IPO is successful, it may persuade other companies to adapt this approach to assuage their investors and so should be monitored for that reason. But in the short term, investors should stay away from this company and its many warning bells.