Spotify is bound to be one of the biggest arrivals on the stock market in 2018. It should be publicly trading on the New York Stock Exchange by December — but there won't be an IPO. And that's a good thing.
Initial public offerings have become the traditional route by which companies debut on public stock markets. But IPOs also involve paying Wall Street firms hefty fees, a big cross-country roadshow to talk up the stock to investors, and then an offering of brand new stock for people to buy. Spotify will skip most of that hullabaloo with a direct listing instead. The company won't offer any new shares; instead, Spotify's existing investors will simply be able to publicly sell the shares they already own.
Direct listings are extremely rare compared to IPOs, and Spotify has raised plenty of eyebrows by going this route. But no one should be surprised. Spotify is just being unusually honest about the purpose of the modern economy, and the modern stock market in particular.
Companies engaging in IPOs typically say that they're taking on new shareholders to raise capital. The shareholder gives the company money with which it can expand operations, create jobs, and so forth. In exchange, the shareholder gets a vote on company strategy, a cut of future profits in the form of dividend payments, and owns a portion of the company, which they can sell for a profit later if the company increases in value. And in a broader way, an IPO is a company announcing that it's arrived: It's growing, it's happening, it's got big dreams, and it needs money to act on them. The whole reason we have stock markets is ostensibly to facilitate that very ambition.
For a fair amount of time in the mid-20th century, this story was arguably true. But in recent years, this reality has been flipped on its head. Rather than a way for shareholders to pump money into companies, equity has become a way for them to extract money out.
The primary vehicle for this is the rise of stock buybacks. Instead of putting earnings into new investment and capital and jobs, companies are increasingly using the money to purchase stock back from shareholders on a mass scale. That provides a payday for the shareholders who get bought out, and it raises the price of the stock held by the remaining shareholders. (Same demand, less supply.) Stock buybacks can also make the company look good to investors, since fewer shares drives their earnings-per-share ratio up.
But this isn't good for the underlying economic activity of the company, not to mention the pay and jobs of its workers. In 2014, the total amount companies spent on stock buybacks and dividends exceeded their combined net income. The trend has continued every year since. Over the same time period, the money spent on payouts to shareholders also exceeded the money spent on capital investments. Shareholders are taking more out than they're putting in, and equity has become a net drain on company finances.
In this context, the idea that the traditional IPO still functions as a way to raise capital looks decidedly fishy. "The most basic reason for a company to IPO is to cash out," as Owen Davis put it at Dealbreaker. "Founders, equity-holding employees, angel investors — everyone gets itchy to sell once a valuation is sufficiently stretched. This incentive obviously doesn't feature prominently in road-show presentations, but practically speaking it's one of the strongest catalysts for a company to go public. People wanna get paid."
The stock market now functions as a way for wealthy shareholders to trade in their investments for cold hard cash — generally at the expense of a business' real-world operations and its workers. Investors and people on Wall Street are still human, and most probably don't want to admit their day jobs and industry amount to a form of high-tech vampirism. They want to believe they're providing a needed and valuable social function. The new share offerings that come with IPOs are basically a song-and-dance everyone engages in to tell themselves that the classic feel-good story of the stock market still applies.
Spotify's direct listing represents a strange form of courage and honesty. Skipping all the rigamarole of an IPO avoids a lot paperwork and headache and fees. But mostly it allows Spotify to just skip the bull and get to the point: Going public is about allowing existing investors to cash out, full stop.
Of course, why Spotify's investors want to cash out could be an interesting question. Despite a mammoth user base of 60 million subscribers — plus another 80 million who use the free ad-driven version — Spotify has yet to turn a profit. That's largely because of hefty licensing fees Spotify has to pay record labels. And the company still faces a major lawsuit claiming it hasn't obtained proper licensing rights in some cases. So maybe the direct listing is a way for Spotify's investors to quietly jump ship without calling too much attention to the company's situation.
But ultimately, the simplest explanation for why Spotify's investors want to cash out is, well, everyone else does too.