Why Direct Listings Are Suddenly All the Rage
During my days on the trading desk in San Francisco, the afternoon before a company went public was always fairly exciting; the institutional players (Fidelity, TRowe Price, SAC Capital, et al.) were jockeying for the largest allocations and the underwriting syndicate was examining those institution’s indications of interest in order to sell the most shares at the highest price.
A lot has changed in the 11 years since I was on the desk and the process by which companies are going public is among those mechanisms that are evolving. As opposed to the traditional IPO process, Special Acquisition Companies (SPACs) and the subject of this brief piece, Direct Listings, are rapidly gaining in popularity.
Using the traditional IPO process, a syndicate of investment banks is solicited to buy the entire supply of shares from the company at a predetermined price, also known as the underwriting process. This group of banks will then conduct a roadshow, whereby the management team of the soon-to-be-listed company goes on the road and attempts to drum up support for their IPO from the big institutional mutual fund and hedge fund managers. After the IPO, the investment banks have the expectation to defend the stock once it starts to trade by buying back shares at the IPO price (if the stock starts to falter and trades down instead of up) that they had oversold during the IPO (called the greenshoe).1 In addition, if the IPO is well received, there is usually a first day spike in price that the those who had participated in the IPO are able to monetize. Yet the company is locked in at the lower (sometimes considerably so) IPO price, leaving considerable amounts of much needed capital on the table.
Consider DoorDash (DASH). In December of 2020, the food delivery company was priced at $102/share and closed at $189.50/share on its first day of trading, potentially costing the company as much as $87.50/share on its 33 million shares offered. Or take for example, Airbnb (ABNB), which went public the following week at $68/share. It closed out its first day of trading at $144/share, potentially costing the company $76/share on its 51.5 million shares offered. In addition to the billions of dollars left on the table by both companies, early investors and insiders are subject to a lockup period of 90 – 180 days before they can make sales of the stock that they have held as they helped to build the company over time.
The investment banks don’t do this from the bottom of their hearts of course. All of this support, risk taking, and logistics has a price. Airbnb reportedly paid their syndicate $74 million to arrange their IPO and Snowflake (SNOW) reportedly paid $122 million to their banks.2
However, in August of 2020, the game changed substantially. The SEC approved direct listings with companies now able to raise fresh capital. This will now allow companies to not only sidestep the very expensive underwriting process of traditional IPOs but will also allow them better price discovery so that they are not leaving as much money on the table as did DASH and ABNB. Further, angel investors, venture capitalists, and company insiders are not subject to lockups and as such, are permitted to make sales on day one of trading.
What about costs? Spotify, which went public in 2019, paid their direct listing advisor, Goldman Sachs, $35 million,3 a fraction of what Airbnb and Snowflake paid their bankers. The latest direct listing, Roblox (RBLX), a children’s mobile gaming platform, went public via direct listing on March 10. And while information regarding what they paid Goldman Sachs, Morgan Stanley and Bank of America could not be found at the time of this writing, the company and their early investors did capture the upside movement in the stock when it popped on the open. The New York Stock Exchange issued a $45 reference price which could be thought of as the IPO price and the stock opened at $65 which is where the company and early investors made a sale. This potentially put an additional $20/share of capital back into the company and the hands of the early adopters of Roblox.
The market will be acutely focused on the next big direct listing, the San Francisco based crypto exchange Coinbase (will trade under symbol COIN). The firm has stated that they will not be raising additional capital and thus the only supply will be from existing shareholders. Coinbase is expected to go public on the Nasdaq as soon as this month with a market cap estimated to be as large as $100 billion.4
Only time will tell if a sea change is about to take place in the IPO market as a result of the new rules issued by the SEC last fall. However, two of the biggest and most anticipated IPOs of the year have thus far chosen to go public via direct listing which must have the capital markets teams of investment banks across Wall Street crying into their beers.