Spotify's Non-IPO Wasn't Much of an IPO

(Bloomberg View) -- Spotify.

My weird worry about Spotify Technology SA's not-exactly-an-initial-public-offering, which happened on Tuesday, was that no one would sell. And I think I was right?

Fewer Spotify Technology SA holders sold shares in the company’s direct listing Tuesday than expected by advisers, potentially contributing to an initial shortage that drove the price up, people familiar with the matter said.

Spotify’s stock opened at $165.90 at 12:43 p.m. in New York and climbed as high as $169 a few minutes later. Just 5.6 million shares changed hands at the opening price, or 5 percent of the total number potentially available to trade, according to data compiled by Bloomberg. About 30.5 million shares were traded before the stock closed 10 percent below its opening price at $149.01.

As my Bloomberg Gadfly colleague Shira Ovide wrote on Tuesday about those 5.6 million shares:

That is an incredibly small 3.1 percent of Spotify's 178 million total outstanding shares. This is an irresponsibly small slice of Spotify to trade out of the gate.

There are two dangers with a small float: Share price bumpiness and legitimate questions about the valuation's validity.

Now. You can't take that 5.6 million number too seriously. After all, a key feature of Spotify's direct listing was that insiders who wanted to sell didn't have to do so in the first trade. Sure Spotify and its bankers encouraged them to do so, but if you were a private-market investor in Spotify, you'd be perfectly entitled to wait 10 minutes after that opening trade at 12:43 to sell your shares. That opening trade was very close to the highest price of the day (and of the week so far), so if you waited longer you did worse, but there is nothing improbable about that. 

But my worry was that, while not enough people would want to sell, a lot of people would want to buy Spotify. All of their attention would be focused on the opening of trading, while the people who want to sell can do so any time. If all the buyers were lined up to buy at 12:43 on Tuesday, and all of the sellers are slowly selling off their stock over the course of the week or month or year or whatever, then you would expect a pricing dynamic in which that first trade would go off at a very high price, and then Spotify's stock price would then fall as the supply comes in, with a lot of volatility along the way. I don't think you can reject that description yet.

But I may have overestimated how many people wanted to buy:

Because the number of Spotify shares eligible for sale is so much higher than in a normal IPO, buyers have been hesitant to jump in for fear of doing so just before a large block of shares comes onto the market, people familiar with Spotify trading said. ...

So far, Spotify’s trading activity has lacked the influx of retail investors that would normally be expected to jump into a well-known, newly public company, which has hurt the stock price, people familiar with the listing said.

One of the people familiar with the listing said some financial advisers had been wary to push their clients to buy immediately for fear of complications around the direct listing.

If the story of Spotify's direct listing is that, on the first day, there weren't that many sellers, but there also weren't that many buyers, and then over time, as people get comfortable with the listing process and as the stock price settles down, more insiders will show up to sell, and more outsiders will show up to buy, then that is ... fine? Like, what are you looking for in this direct listing? There is a temptation to say that the direct listing is a failure if it doesn't end up looking like an IPO, if it results in less trading than an IPO or if that trading is more volatile or if large stable blocks of shares don't immediately move into the hands of long-term committed institutional investors. 

But why should Spotify care? Being listed, for Spotify, replaces not being listed, and seems like a distinct improvement. In the first two and a half months of 2018, 7.9 million shares of Spotify traded in private markets, at prices ranging from $48.93 to $132.50. In the first two days of being public, 42.2 million shares traded, at prices ranging from $135.51 to $169. Spotify seems pretty clearly to have accomplished the goals of increasing liquidity and reducing volatility for its shareholders. It seems pretty clearly not to have accomplished the goal of replicating an IPO exactly, but that was never actually its goal. Still, if you were worried that Spotify's listing meant the beginning of the end for Wall Street equity underwriting, this might reassure you. If a company wants to do an IPO, Spotify's direct listing does not look like a perfect substitute.

Elsewhere, the New York Stock Exchange celebrated Spotify's listing by raising a Swiss flag, possibly because it was confused (Spotify is Swedish), or possibly because it wanted to signal that it is as indifferent to Spotify's listing as Spotify is.

Are banks tech companies?

What is this Bloomberg Markets story about? The headline is "Wall Street's Big Banks Are Waging an All-Out Technological Arms Race," and part of the thesis is that, especially in equities, banks are no longer in the business of using their balance sheets to profitably intermediate trades for clients, but are instead in the business of providing technology platforms to those clients to do the trades automatically:

Constraints brought about by the financial crisis ended the leverage that had fueled the boom. Fixed-income traders felt the brunt of the changes, and in the years since, equities traders —especially those with a technology background—have enjoyed a renaissance. Their rise has touched off a battle for supremacy that’s come down to only three companies: Goldman Sachs, Morgan Stanley, and JPMorgan Chase. These rivals are now locked in a technological arms race to control a $58 billion-a-year industry. 

But you could read against the grain of that story. "With the upgraded electronic system and revamped prime brokerage," begins one paragraph, and ... prime brokerage isn't a tech thing? Prime brokerage is, basically, we will lend you money so you can buy stocks, and we will lend you stocks so you can short them. And then:

Morgan Stanley hugged its quant clients close. Instead of merely offering to execute trades, prime brokerage provides all-important leverage and custody of assets. “Prime brokerage is really the lifeblood,” says ETL co-founder Michael Botlo. “This is the oxygen. This is what you’re immersed in. If all of a sudden prime brokerage becomes terrible, then you’re toast. If you can’t short anymore, you’re dead. If you can’t access your swaps, you’re dead.”

If you focus on the technological arms race, it might seem a bit odd that the only contestants are Goldman, Morgan Stanley and JPMorgan. Sure they all talk a good game about being tech companies, but, you know, there are actual tech companies in the world. Google or Amazon could presumably build trading algorithms, if they put their minds to it. Plenty of smart technologists, from banks and not, have gone off on their own to build trading platforms that will disrupt the banks and align with clients' interests and revolutionize trading and so forth. U.S. equities are about as electronic and open and all-to-all as financial products get; if you are going to disrupt the banks, this is the place to do it, and in fact the history of high-frequency trading is pretty much one of scrappy high-tech upstarts disrupting the big slow banks in stock trading.

If you focus on the prime brokerage, though, of course the race is among the three big banks. Quant funds want tech-y things, sure; they want low latency and fancy execution algorithms and so forth. Lots of tech-y companies can do that sort of thing. But they also want money, balance sheet, leverage and stock-borrow access. That's not a tech business at all. That's a banking business. 

This is a frequent lesson in fintech. A tech person looks at a thing that banks do and says: "I could do that better. I am smarter and faster than a bank, and more trustworthy, and I do not have the legacy issues that the bank has." And then she builds an amazing product, and goes out and pitches it to clients, and learns that an amazing product is not what the clients want. The clients want access to the banks' network of customers, or to the banks' corporate clients and new issues, or just to the banks' money. Banks may be working to get an edge over each other through technology, but their edge over technology companies comes from something else.

Bureaucracy.

I left investment banking almost seven years ago now, and while I rarely miss it, this passage occasioned a certain nostalgia:

Someone recently told Jamie Dimon during a JPMorgan Chase & Co. leadership gathering that bureaucracy is a necessity in a complex company.

“This is hogwash,” Dimon told shareholders in a letter on Thursday, recalling the exchange. “Bureaucracy is a disease. Bureaucracy drives out good people, slows down decision making, kills innovation and is often the petri dish of bad politics.”

The head of the largest U.S. bank said he’s going to war on bureaucracy across the firm. There are even “war rooms,” set up by its operating committee last year to find ways to streamline certain tasks, such as signing up new clients and managing vendors.

Oh man. Imagine that operating committee meeting:

Committee Member 1: We need to reduce bureaucracy. But how?
Committee Member 2: We could set up a series of committees on reducing bureaucracy.
Committee Member 1: You do see the irony there right?
Committee Member 2: Well we could call them "war rooms."
Committee Member 1: Oh "war rooms" that's totally different, war rooms are good.

Is bureaucracy necessary in a complex company? Yes, probably, but at least at a bank you can default to swaggery names for your bureaucracy. Never make a list when you can make a dashboard. Never have a Committee to Reduce Committees when you can have a War Room to Reduce Committees.

Or there is this, from Dimon's shareholder letter in the annual report

Internal meetings can be a giant waste of time and money. I am a vocal proponent of having fewer of them. If a meeting is absolutely necessary, the organizer needs to have a well-planned, focused agenda with pre-read materials sent in advance. The right people have to be in the room, and follow-up actions must be well-documented. 

So, one: Sure. But, two: If you are opposed to bureaucracy and red tape, sending around reading materials before every meeting, and follow-up checklists after, is ... kind of a mixed bag? In a truly informal fast-moving company, the person who wants the thing would just go chat with the person who does the thing, and they'd agree on how to do the thing, and then do it. There wouldn't be the flurry of calendar invites and pre-reading materials and room scheduling and post-meeting checklists that you get in, you know, a bureaucracy. The pre-reading absolutely is useful in a big company with a lot of meetings where efficient informal communication is difficult. But that's ... that's just another way of saying that bureaucracy is a necessity in a complex company.

Also the necessity-of-bureaucracy comment that someone made to Dimon? That was at a "senior leadership offsite." I hope it was an offsite about having fewer meetings!  

Elsewhere in that letter: "Dimon Sees Growth Opportunities All Over, 'Even in Fixed Income.'"

The crypto.

Here is a delightful story about how Ripple is trying to get its cryptocurrency, XRP, listed on the big U.S. cryptocurrency exchanges, and is getting turned down, even though it has offered money for a listing:

Last year, a Ripple executive asked whether a $1 million cash payment could persuade Gemini to list XRP in the third quarter, according to people familiar with the matter. That followed other attempts by Ripple to get Gemini to add XRP, exploring strategies like paying out rebates and covering related costs, the people said.

During preliminary talks with Coinbase last fall, Ripple said it would be willing to lend the exchange more than $100 million worth of XRP to start letting users trade the asset, according to a person privy to that discussion. Ripple, without putting the proposal in writing, told Coinbase it could pay back the loan in XRP or dollars, the person said. If the exchange had chosen the latter, it could have profited had the tokens become more valuable upon being listed, the person said.

The exchanges' objection appears to be that, if an exchange lists a cryptocurrency that the Securities and Exchange Commission decides is a security, then they will be in big trouble.

Is Ripple's token a security? Who knows! It seems likely that the SEC is not going to treat Bitcoin or Ether as securities, whether or not that analysis is correct, so the U.S. exchanges are comfortable listing those. (Coinbase also lists Litecoin and Bitcoin Cash, which I guess are close enough to Bitcoin to be fine.) Otherwise ... who knows, but the current SEC seems to start from the assumption that every cryptocurrency is a security until proven otherwise, so you can see why the exchanges would be nervous.

But Ripple is kind of an odd situation. Usually, when a company issues a token, it is pretty clear to everyone that the token is a speculative investment in the company's business project: If the company's product or network or whatever takes off, then the token you use in it will be worth a lot of money, and so the token is a bet on the company's success. That sounds like the definition of a security.

But the fortunes of XRP are curiously unconnected to the fortunes of Ripple the company. I mean, not quite: Ripple owns a ton of XRP and will be very rich to the extent that XRP is worth a lot, and it has sold XRP to fund its work. But Ripple's actual business -- of building blockchain-y payment infrastructure for banks -- so far doesn't seem to involve much XRP:

The problem is that banks say they have no interest in using XRP. Current and former executives at seven global banks—some of whom have partnered with Ripple—say there was scant chance they would ever entrust their corporate clients’ payments to a cryptocurrency. ...

Chief Executive Officer Brad Garlinghouse says Ripple is working with more than 100 banks to overhaul the way they handle payments for their clients. “Ripple is trying to be a catalyst to mature a whole industry,” he says. “The current system is fraught with friction and is measured by a lack of transparency and speed.” There’s a difference, however, between Ripple, the company, and XRP, the token. XRP is “absolutely at the core of what Ripple is doing,” says Garlinghouse, but at the moment the company’s main product, RippleNet, doesn’t rely on it.

So if you think that Ripple's business of building payment infrastructure for banks will be a success, and that its network will become dominant, then it's still not clear that you should buy XRP to express that view.But if XRP is just sort of its own weird thing, and not an investment in the enterprise of Ripple that can expect profits from the efforts of Ripple's management, then perhaps it is not a security?

Elsewhere, here is another delightful story about over-the-counter cryptocurrency trading markets. A big selling point of cryptocurrency is that I can just transfer Bitcoins or whatever to you "on the blockchain," with no third-party intermediary: The blockchain registers the transfer the coins, and we don't need to rely on a bank any more than we would if I were handing you a $10 bill. But in practice that doesn't happen too much: Sure I might want to sell Bitcoins, and you might want to buy them, but how will we find each other? And even if we do find each other, how can I trust that you'll send me dollars for my Bitcoins, and how can you trust that I'll send you Bitcoins for your dollars?

And so Bitcoin exchanges have sprung up, where people use a central trusted third-party intermediary to hold on to their dollars and Bitcoins for them, and the exchanges keep getting hacked or stealing all the Bitcoins. But the OTC market is a competitor to that: Instead of trusting exchanges to hold your Bitcoins, you can hold them yourself, and when you want to sell them, you can call up an OTC trading desk which will go out and find (and vouch for) someone who will buy them. Once again, crypto-finance is discovering that some of what regular finance does is actually useful.

The SEC warns of SEC impersonators.

The Securities and Exchange Commission today issued an Investor Alert warning investors of fraudsters claiming to be SEC employees in an attempt to trick investors into sending money or revealing sensitive account information.  The alert makes clear that the SEC does not contact investors to confirm trades, set up trading accounts, or record the details of trades. The alert also notes that federal government agencies, including the SEC, do not endorse or sponsor any particular securities, issuers, products, services, professional credentials, firms, or individuals.

I don't know. If I were a scammer I'd mock up some SEC-looking letterhead and put out my own Investor Alert saying "the SEC regularly contacts investors to confirm trades, and anyone who tells you otherwise is an impostor." If you're the sort of person who was going to fall for this stuff in the first place, what are the odds you are also the sort of person who carefully reads and checks the validity of SEC Investor Alerts?

Things happen.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.

To contact the author of this story: Matt Levine at mlevine51@bloomberg.net.

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