Earlier this month, Spotify (NYSE: SPOT) made Cardi B-type money moves by making its debut on the New York Stock Exchange by way of a Direct Public Offering. What does that really mean though? It means that its users (and even non-users) can now own a piece of the music streaming platform they’ve grown to love and can’t live without. But let’s take it back to the music and break this major event down.
What is a direct public offering?
According to Investopedia, “A direct public offering (DPO) is a type of offering where the company offers its securities directly to the public to raise capital.” Simply put, a company is looking for more cash from investors (that’s us) to put towards research and development, expansion, etc. in exchange for ownership in the company.
Think of it like your favorite indie artist (cough Chance the Rapper) releasing an album on a music streaming platform with digital copies available for download. The company is the artist, the album is the stock, the capability to listen to songs from the album would be like owning shares of the stock, and the money used to buy the album or pay for the streaming service is the investment capital.
Why didn’t Spotify do an initial public offering instead?
If a DPO is like an indie artist dropping an album, then an initial public offering (IPO) is like a major label artist dropping an album. And since DPOs don’t require a major label, the companies doing them can set their own terms.
Some of the terms Spotify set were not issuing new shares, no lock-up period, and its own share price.
Spotify channeled its inner Drake by taking a “Nice For What” approach towards investment bankers; it doesn’t need to be cordial with them. Typical IPOs require these bankers to facilitate the event for bags on bags of cash. To do this, more shares must be created, thus decreasing the value of current shares. This process is known as dilution and Spotify is Team ‘No New Shares.’
Another term of their DPO is no lock-up period. When companies have IPOs, those who invested before the company went public are subject to a lock-up period. Simply put, they can’t sell their shares for a designated period of time (e.g. 6 months from IPO date). But Spotify went Rosa Parks on Wall Street and said, “Nah.” Since there is no lock-up period, investors and employees were able to sell their shares the moment the company went public on the NYSE.
This term has been especially beneficial to record companies as many of them were given equity stakes in Spotify as a peace offering. Sony specifically sold over $250 million of its stake in Spotify the same day it went public. But why? There are many reasons, but the main two being that either Sony simply wants to cash-in because they can improve their balance sheet or they want to pay royalties to artists. It could even be a mix of both but that’s up for Sony to decide.
The last major term is setting its own price. When investment banks dilute shares in IPOs, it forces the share price to drop considerably. Most IPOs price anywhere between $10 to $50 per share. Since DPOs don’t dilute shares, Spotify was able to list its shares well over $100 each.
What does Spotify going public mean for the industry?
As far as private tech companies are concerned, it will highly encourage them to look at performing DPOs instead of IPOs. Large startups like Uber and Airbnb may be more inclined to look at this route instead of traditional IPOs if and when they decide to go public.
With regards to music streaming, the only comparable business model in the stock market is Pandora (NYSE: P) and if it’s the benchmark for the industry in terms of the stock market, then Spotify is in for a tough road. Over the past five years, Pandora’s stock has dropped almost 90% and that’s highly associated with the financial success of the music streaming business, or lack thereof.
Pandora has yet to turn a profit and Spotify is no different. The costs of acquiring access rights to music and customers is highly expensive, which has had a direct result on the low compensation that artists receive from the platform. Other services like Apple and Tidal offering a similar revenue share model, but Spotify has received the most scrutiny for its low compensation rates.
Music streaming services as a business model have yet to prove they can be lucrative and many investors are keeping their ears to the streets to see if Spotify can prove this theory wrong.