We’ve had some requests on the blog for specifics. Specific thoughts about shares themselves – as well as concepts such as IPO choice, that CT & I don’t usually comment about. We’ve also heard that you want more analysis.
We’ve listened to your views, and we’ve asked our friend, Matt Leibowitz from stake.com.au to help us out. We like Matt, respect his views, and are behind his plan to give Australian traders better, more affordable access to the US markets.
I asked him to comment on the Spotify IPO, and here’s what he has to say…
Spotify – no market orders in our playlist
Spotify’s upcoming IPO is very intriguing. Not for the fact that it’s listing on the US market when it’s a European business. This is normal for the world’s largest companies – they go to the US for their listing. It’s where the world trades.
What is so intriguing about it is that it’s a direct IPO. This means it’s not raising additional funds or having a bank underwrite the sale of the shares with a guaranteed price. Its taking its shares to market and saying “trade us, price us”. It’s pure market forces happening in front of our eyes. It’s epic – and in this day and and age, highly unusual.
To explain why this IPO is so unusual, it’s worth explaining what happens normally.
The Normal IPO
An IPO (Initial Public Offering) is where a company takes their shares to the public (on an exchange) to raise more capital while also allowing existing shareholders to sell down some of their holdings to take $ off the table. The process of “going public” is normally organised between the listing company, it’s lawyers and their investment bank(s).
The bank and lawyers arrange the IPO documents, while the bank underwrites the listing (committing to buying any any excess stock not bought before the IPO). The banks drum up interest in the company’s IPO via a roadshow and ensure that there is institutional demand for the raise. It also negotiates the price of the IPO and makes sure the supply (sellers + company) is met with demand (buyers’ pre-IPO). The banks get paid for this (normally handsomely) and also for the risk they take on buying any stock not allocated. Dropbox, in its recent listing, had Goldman Sachs & Co, JPMorgan and Deutsche Bank Securities as it’s underwriting banks.
There’s obviously a lot that goes on with this process, but that is the general gist.
What a normal IPO does for a listing company (think Dropbox) is:
- Sets a ball park price for the IPO. Since there is initial review, there is some guide to its trading price.
- Ensures the listing company will be able to complete it’s raise and shares will be sold (i.e. any shortfall is picked up by the investment banks)
- Puts stock in the hands of institutions, so there is liquidity (aka trading volume) when the shares start trading
For most companies, this process gives them comfort they will get the funds they need and provides some sanity to the share price for the first few days and weeks after the IPO. Having institutions on board also gives companies shareholders with deep pockets who can assist with additional raises and funding if need be.
Spotify is doing the complete opposite
Spotify is doing a direct IPO. This means no roadshow, no underwriting bank and no fundraising. Spotify is essentially giving the public the right to trade their stock and giving their existing shareholders a way to cash in on their holdings. There is no set price for the stock and no guidance on where it should or will trade.
Why would they do this?
- They are not raising money – they are just giving their employees and shareholders to sell stock.
- It saves money. Underwriting fees are expensive since Spotify isn’t raising money, they don’t need need that guarantee.
- They may not need institutions to own their stock. Maybe some already do own Spotify through the private market.
- They aren’t concerned with being able to grow without institutional support. They are generating cash from subscribers, so I assume they will use that to fund their business.
What does this really mean for trading Spotify?
I think it’s going to be a volatile stock first few days of trading. Without a confirmed raise price to anchor to and limited institutional holdings to provide needed volume – we have a cocktail of uncertainty over price combined with a uncertainty of volume.
Based on the Form F-1 that Spotify provided to SEC (US regulator) there are approximately 177m shares of Spotify on issue. In 2017, those shares traded in the private market (employees and other shareholders) between $37.50 and $125. This is a massive range.
However, in the first part of 2018 (1 January – 22 February) the trading range was $90 to $132.50. That’s a 47% wide in 2 months of trading! At the top of that range SPOT is worth $23.5bn or at the bottom, $16bn.
With that knowledge, I’m expecting very wide spreads of sporadic volume and an incredibly whippy stock. We’ll see the buyers try to feel out the interest of the sellers (employees and VC funds selling down). Buyers want to buy for less, sellers want to sell for more. It’s going to be a very interesting duel!
So what should you do?
As always, that’s up to you!
I don’t know what Spotify should be priced at and I am not the type to dig deep into the books. As indicated above, it traded between a valuation of $16bn and $23.5bn just this, both which may be low, high or both when it hits the public market. I honestly have no idea where it will land.
My take: whatever you think a share is worth, strongly consider using limit orders. When there is limited liquidity and lots of uncertainty as to price, market conditions can be volatile and whippy – making markets orders dangerous. If you do use market orders in these times, you could end up paying across a ridiculous spread until the market settles. And this could take days.
So while things are more radical than you’re used to, consider using limit orders and let someone else less prepared hit your order. Patience in these conditions can make a huge difference in your execution price. You can always use a limit order to trade through an offer (or bid), you just need to set your maximum price above the offer (or in the case of a sell, below the bid).
Here’s an example:
Assume Spotify is trading around $110 .
If you want to buy Spotify when the bid is $105 and the offer is $115, your market order buy will buy at $115. If you are prepared to pay more than $115, that’s probably ok. But what happens is there is no longer that volume or someone else gets to that $115 before you and the next best offer is $125. Then your market order gets executed further away from where you wanted to trade.
I you want to place a limit order for Spotify shares on day one (or after) we make it really easy on Stake. Use the advanced tab and just set your # ofshares and your level. Boom.
Even if you don’t trade the stock, it’s worth keeping an eye on the duel between buyers and sellers. You can follow what happens on Stake.com.au, as we’ll give Australians taccess from the moment it starts trading on April 3 (US time).
About the author – Matt Leibowitz
Formerly a Senior Partner and Head of Institutional Trading at fast trader Optiver, Matt launched Stake with co-founders Jon Abitz and Dan Silver after returning to Australia from the US, and finding it incredibly difficult to continue trading US shares. Having run global trading teams in the most sophisticated financial markets using the most advanced technologies, Matt was frustrated that investment opportunities for Australians were confusing, lengthy and expensive.