Slack, one of the many anticipate tech companies planning on going public in 2019, has decided to debut their shares to the public through a direct listing on the New York Stock Exchange. They will be the second major tech company behind Spotify (SPOT - Free Report) to do a direct public offering (DPO).
IPO vs. DPO
Choosing to go with a traditional IPO gives companies more stability and security. With the conventional IPO model companies use an investment bank like JP Morgan (JPM - Free Report) , Goldman Sachs(GS - Free Report) , Morgan Stanley(MS - Free Report) , or a syndicate of them, to underwrite their offering. The underwriter will gather interest from banks, institutional investors, mutual funds, etc. The offer price will be decided by the underwriter based on financial data and the amount of interest that the underwriter was able to collect. The goal of the investment bank is to set a price that will be oversubscribed, meaning there is more interest in the stock than shares to be offered. The shares can either be bought out entirely by the investment bank(s) or sold under Best Efforts Agreement where the bank sells the shares on behalf of the company but doesn’t guarantee the amount of capital that will be raised. Investment banks charge an underwriting fee anywhere from 3-8% of total offering and usually involves an option for the banks to buy shares at the offer price aka a greenshoe. During the initial sale, the investment bank(s) create a market for the stock, buying and selling shares to keep the price from becoming too volatile.
Going with a direct listing over an IPO comes with some significant risks. With a DPO the initial offer price is decided by the market on the day the shares become available. The exchange takes all the buy and sell orders to come to an opening price for the shares. With no investment bank making a market for the shares, if there isn’t enough interest in the stock than the price could plummet and the capital raised could be significantly less than expected.
The advantage of using the DPO format to list shares is that there is no investment bank taking control. There is no underwriting fee or greenshoe for Wall Street to profit off of. The price of the stock isn’t just set by the big banks and institution but by the market which includes smaller retail investors and traders. A DPO lets everyone get in on the “ground-floor” allowing for a much more natural and equitable public offering. A direct listing also permits existing shareholders to sell out of there shares immediately with no holding period. A problem that could arise is a lack of free-floating shares if not enough existing stockholders sell on the initial listing day, which could initially drive the stock above its fair value.
One year ago today Spotify launched its DPO on the New York Stock Exchange. SPOTs direct listing was a success, with barely a hitch. The shares opened over 25% higher than NYSE’s reference price of $132, and the company closed the day with a $26.5 billion valuation, making it one of the top ten biggest publicly traded tech stocks. The one small hiccup that this IPO saw was a lack of free-floating shares on SPOTs listing day (only 5.6% of shares traded) because of how few existing shareholders wanted to sell. The lack of free-float might have pushed the price beyond its fair value because demand outweighed supply.
Spotify’s DPO was successful because the company was already very well-known and distinguished in its category, giving them confidence that the DPO wouldn’t go unnoticed. SPOT already had access to almost unlimited capital being cash-flow positive, which means that the capital raised from this DPO wasn’t essential to the future success of the business.
The stock has traded up then down then back up again over the last 52 weeks ending up very close to its DPO price today. Below you can see how SPOT (blue) has performed against the S&P 500 over the last year of trading.
Slack is a cloud-based tool that helps communication and collaboration amongst groups, predominantly in the workplace. Slack currently has 10 million active daily users with a significant number being paying subscribers. There last round of funding in August valued the company at $7.1 billion and they are expected to be cash-flow positive by next year. Slack is still working with a few investment banks as advisers preparing for their DPO but saving a substantial amount of money with no underwriters.
When Slack goes public in the coming weeks make sure you do your due diligence before jumping into this stock. Keep an eye out for a lack of free-floating shares on Slack’s listing day, which could spike the price above fair value.
Direct listing for these large tech companies is still in the experimental stage, but if DPOs continue to be successful we could see a growing trend of companies using this method. Airbnb is another such tech company that is considering directly listing their stock on an exchange. This trend could have broader implications for Wall Street’s firms, that typically take a piece of out of every IPOs’ pie, hitting them where it hurts, their bottom line.
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