Spotify’s low-cost listing raises awkward questions about banks’ role in IPOs
London — After shaking up the music industry, Spotify is now prompting investors to question the value they get from investment banks underwriting new listings with its low-cost initial public offering (IPO).
The music-streaming company effectively deprived banks of hundreds of millions of dollars in fees by shunning them in its $26.5bn New York Stock Exchange float on April 3.
Banks can charge companies as much as 7% of the amount raised in a US listing, and fund managers in London, another of the main centres for IPOs, say Spotify’s success means underwriters will now have to show more clearly what value they bring to companies and their backers.
"Besides saving the right type of company a lot of money, the real positive demonstrated by this kind of listing is the level playing field it creates," says Trevor Green, head of institutional equities at Aviva Investors.
Banks have been richly rewarded for co-ordinating IPOs and ensuring companies raise the money, pocketing annual fees of $33.6bn in the US and $14.4bn in Europe over the past decade, Thomson Reuters data shows.
And although tussles between investment banks and asset managers over these fees are not new, changes could now be on the cards, driven by evolving technology, more freely available capital for privately held companies, and regulatory pressures.
But while critics claim that high costs have discouraged some firms from joining the stock market, crimping their prospects and hindering the growth of the economy, bankers say few are likely to be able to replicate Spotify’s direct listing.
This was possible only because a large number of founding shareholders wanted to sell and it was not raising a large sum of capital, meaning that for now, the route may be open only to well-known, highly valued internet firms like Spotify.
"It’s a one-off," Suneel Hargunani, head of EMEA (Europe, the Middle East and Africa) Equity Syndicate at Citigroup, said on Wednesday of Spotify’s listing.
"There’s not a lot of companies that would tick all those boxes, hence why we don’t think it’s going to become too common," he told a Thomson Reuters/IFR briefing.
Old school ties
The problem facing fund managers is that, while they would like to see the companies they invest in pay less to be publicly listed, they are bound by longstanding ties to bankers who vet potential new fundraisers, influence the allocation of new stock and manage access to company executives.
And many are cautious about speaking out publicly for fear of being frozen out of highly competitive new issues.
Banks help to make trading in newly listed shares less volatile by handpicking institutional investors that are likely to hold them over the medium to long term, and by limiting the volume of stock sold to day traders keen to make a quick buck.
Early indications from Spotify’s post-listing performance are mixed, with its shares down 8% from its $166 opening price and trading volumes down to a trickle, while the stock is vulnerable to bouts of volatility.
While this may not be a problem for Spotify, bankers argue that where underwriters often show their value is in helping lesser-known companies through their earliest days as a publicly quoted firm.
"I would rather pay the banks their fees, accept a little dilution and have the benefit of a tried and tested ecosystem with a network of sponsors that will be there to help," says another investment manager, who declined to be named.
But concern about transparency and competition led the Organisation for Economic Co-operation and Development (OECD) to call last year for a review by regulators of signs of parallel pricing, which it said were "akin to tacit collusion".
Others say companies downplay the longer-term relationship value they could offer banks when negotiating IPO fees, with further paydays for credit facilities, buybacks, debt issues and even merger and acquisition activity later on.
Green says he expects banks to fight harder for the big paydays offered by blue-chip names and do more to convince investors of the value they offer in a typical listing process.
"The reason why the Ubers and Airbnbs of this world have been able to stay unlisted is because there is so much private money available to finance their growth right now," he says.
"Many of these types of well-known firms could easily go public without the support of the banks, and losing those fees would certainly sting."
Spotify’s success would at the very least prompt other high-profile companies to reconsider their options before rushing into costly bank-led IPOs, the second investment manager says, adding that other alternative models were also evolving.
"Initial coin offerings (ICOs) point to another possible route in the future to raise money with less bank sponsorship."
In an ICO, a company attracts funding by offering investors virtual currency known as tokens. If the cash raised does not meet the minimum funds as set out in its prospectus, the money is returned and the ICO is deemed to be unsuccessful.
"It is healthy for people to try different things; that is progress," says Steven Magill, head of European Value at UBS Global Asset Management.
"If we see more situations like this, they will enable us to gain a better perspective on the advantages and disadvantages."