From research to market making, Wall Street has been feeling the heat from investors, regulators, and technology. As middlemen go, Wall Street has-at least the biggest firms among them-held up reasonably well under the pressure to cut costs and validate services. Yet recent reports that music streaming giant Spotify would go public with a direct listing, cutting out much of the usual Wall Street hand-holding that comes with hefty underwriting fees, show that even firms flush with cash are reluctant to pay for floaties if they can swim on their own in the listings market.
Spotify is being frugal with its owners cash, but its still not exactly going Dutch-as in the Dutch auction initial public offering (IPO) that Google used when it made its exchange debut back in 2004. Instead, it will pay its three advisers-Goldman Sachs, Morgan Stanley, and Allen & Co.-roughly $30 million to coordinate the selling of existing owners shares to new owners in order to reduce the risk of a wild debut when the stock opens on the exchanges. But this raises the question of why they are going half way.
Firms without a major public profile have reason to pay up so that Wall Street will spread the gospel on their business model and prospects. This typically ensures that the stock comes to market modestly under-priced, producing enough of a quick bounce to reward risk-taking first buyers-those that didnt have a solid basis for pricing it. But household names like Google dont need preachers to spread the good news. They can save tens of millions of dollars by just letting a computer set the opening price on the simple basis of revealed supply and demand. This is the Dutch auction model.
This model is already being used for trading in the secondary market, after stocks are listed. Auctions bring buyers and sellers together-without costly middlemen, and without leaking information-in an environment that prevents manipulation or gaming by one party or another. The benefit is transactions dozens or hundreds of times larger than those on the exchanges, saving investors money. Auctions are particularly useful for small- and mid-cap stocks, which tend to be illiquid and volatile on the exchanges. So why cant they improve performance in the primary markets, for IPOs, as well?
The Google experience was, by any reasonable standard, a success. The IPO price quickly rose 18 percent on its first day of trading, a pop that rewarded the new owners for their risk without robbing the original ones. It was a moment of exhilaration, reflected Lise Buyer, Googles director of business optimization at the time. To be sure, Google hadnt gone full Dutch. It had underwriters who used the discretion given them to lower the auction clearing price of $100 to an actual IPO price of $85. That judgment call, widely considered a sound one after the fact, helped justify their 2.8 percent fee-a fee still way below the traditional 7 percent.
Spotify, at a roughly $19 billion market capitalization, is about 20 percent smaller than Google when it went public. There are plenty of other differences between the tech stars. Still, the Google experience is fourteen years old, and investors have since become much more comfortable with financial technology. They now trade almost everything electronically. They are as likely to trust a robot to manage their portfolios as a human adviser. There is every reason to believe that Spotifys owners would therefore benefit by employing at least as much of a pure auction process as Google did.
There is always a reputation risk to executives in cutting out middlemen whose hefty fees are widely considered part of the natural order of things. But Spotify didnt get to this point by accepting the music world as it found it. It can do better.
Don Ross is the CEO of PDQ Enterprises, owner of CODA Markets, Inc., which operates the CODA Markets ATS.
