Spotify May Replace Its Shareholders Quickly

(Bloomberg View) -- Happy Spotify Week!

My weird worry about Spotify Technology SA's not-exactly-an-initial-public-offering, which is scheduled to occur tomorrow, was that no one would sell. In a normal IPO, the pre-IPO shareholders -- founders, employees, venture capitalists -- typically agree to sell a pre-set, pre-disclosed number of shares in the IPO itself. But any shares that they don't sell right then are normally locked up for three to six months; they can only sell them after the company has been trading for a while and issued a quarterly report and generally settled into being a public company. Given that restriction, it makes sense for investors to take some risk off the table by selling at least a portion of their stock in the IPO.

But if you are a current Spotify investor, what's the rush? There is no IPO: You can sell tomorrow in the opening auction on the New York Stock Exchange, but there's been no roadshow or book-building process to drum up interest and come to an opening price. And there's no lockup: If you don't sell in tomorrow's opening auction, you can sell 10 minutes later, or on Wednesday, or in a week, or whenever. Why not wait to see what the price will do? (And if you sell right at the opening, doesn't that suggest that you expect the price only to go down?) 

This, it seemed to me, could have wild results. A lot of people want to buy Spotify as soon as possible: There are plenty of public investors who want it in their portfolio, for fundamental or hype-related or quasi-index-y reasons. But if the supply doesn't come to meet them immediately -- if a lot of current Spotify investors wait 10 minutes or 10 days to sell -- then Spotify could have a ton of demand and a very limited float, and a stock price that is high and volatile, until the supply finally comes out and things settle down.

Apparently I was wrong:

It is unclear how many shares could trade on the first day. As much as 91% of Spotify’s 178 million shares will be eligible for trading, but people close to the deal said they expect the actual float to be closer to two-thirds of the shares, and for co-founders Mr. Ek and Martin Lorentzon to hold on to their stakes in the company, at least initially.

Still, Spotify’s anticipated float is dramatically higher than the average IPO. Since 1995, U.S.-listed companies have sold roughly 35% of their shares on average in IPOs and U.S.-listed technology companies have sold 27%, according to Dealogic.

I mean, I still have no idea; "eligible for trading" doesn't mean "actually sold." But if two-thirds of the shares actually come loose on the first day then my concerns will obviously have been misplaced, and whatever weird stuff happens with Spotify will have nothing to do with a lot of sudden demand meeting a small trickle of supply.

But if 60 or 70 or 91 percent of Spotify's shares change hands on the first day, that's a little weird too. People sometimes say that the shareholders are the owners of a corporation. Spotify might, tomorrow, all at once, change out most of its owners. (Keeping around only a few -- like the founder-executives who run the company on behalf of the other owners.) Unlike in a typical IPO, Spotify's managers won't get to know the big new investors during a long series of roadshow meetings, and they won't pick which new investors to allocate shares to. There'll be no fanfare; indeed, there'll be a pointed absence of fanfare. ("Its executives declined to come to the NYSE Tuesday to participate in the usual rituals of an IPO, such as ringing the opening bell.") Spotify's managers seem totally indifferent -- let's anthropomorphize a bit and say "Spotify seems totally indifferent" -- to who its owners are.

We talk sometimes about the balance of power between entrepreneurs and suppliers of capital. One way -- one quite traditional way -- to think about the public corporation is that it is a thing owned by shareholders, who hire managers to manage it for them. Another perfectly plausible way to think about it is that it is a thing created and essentially owned by founder-managers, who hire shareholders to supply some money to them. Spotify's founder-managers have extra voting rights and can't be bothered to pretend to get excited to go public. They are treating the whole concept of having shareholders with indifference. On the traditional theory of shareholder primacy, that is a little surprising. But it may more accurately reflect how companies -- at least, how hot tech unicorns -- actually work now.

Happy April Fools' Day!

If you are the chief executive officer of a public company, can you make false statements about your company's financial position in public written comments? Sure, I guess is the answer? At least on April 1? I dunno, why not. This is not legal advice. I guess Elon Musk does not concern himself unduly with legal advice:

After the worst month for Tesla Inc. shares in more than seven years, punctuated by company blog posts about the death of a Model X driver, Elon Musk is joking about his electric-car maker going bankrupt.

“Despite intense efforts to raise money, including a last-ditch mass sale of Easter Eggs, we are sad to report that Tesla has gone completely and totally bankrupt,” the chief executive officer wrote in an April Fools’ Day tweet on Sunday. Another post included a photo of Musk and a message that he “was found passed out against a Tesla Model 3, surrounded by ‘Teslaquilla’ bottles, the tracks of dried tears still visible on his cheeks.”

In his defense, April Fools' Day fell on a Sunday this year so no one traded on his tweets. But I guess you still can today. I have not seen Musk tweeting -- or Tesla putting out an 8-K saying -- that it was just a joke. That would sort of spoil the joke. 

The real defense is of course that if you are a sensible person you know to ignore Musk's tweets because (1) it is April Fools' Day, (2) it is Elon Musk, and (3) it reads like a joke. (Also: Tesla has done stock-moving April Fools' jokes before, and on weekdays.) This is more or less a materiality defense: No reasonable person could consider Musk's tweets relevant to her decision to invest in Tesla securities.

But this is a defense that is not limited to things that are, strictly speaking, jokes. We have talked a lot about Jesse Litvak, the former Jefferies LLC mortgage-bond trader who was sent to prison for lying to customers about the prices he paid for bonds. Part of his defense was that everyone knows that bond traders and salespeople lie about the prices they paid for bonds, and that "such statements from sell‐side sales representatives or traders are generally biased, often misleading, and unworthy of consideration in trading decisions." I once wrote: "This is the sense in which 'everybody's doing it' really is a defense against fraud charges. To be fraud, lies have to be material, and if lies are so common that they are ignored, then they can't really be material." The extent to which that applies to bond trading is unclear; Litvak is in prison, after all. But it obviously applies on April Fools' Day. If everyone is saying nonsense about their companies, then there's no excuse for taking any of it seriously.

Oh elsewhere there's a lot of actual bad Tesla news! "Tesla Inc. confirmed the Model X driver who died in a gruesome crash a week ago was using Autopilot and defended the safety record of its driver-assistance system that’s back under scrutiny following a fatality." And: "With pressure escalating during one of the worst weeks in its almost 15-year-history, Tesla Inc. raced to manufacture and deliver as many Model 3 sedans as it could to report to rattled investors. The carmaker still probably came up short." Maybe they'd be less rattled without the bankruptcy jokes?

Defunct Chinese bonds.

On the other hand, do you expect your pastor to lie to you? Well: Do you expect your pastor to lie to you about a securities offering? Probably not, no, is my guess, which means that if "the pastor of one of the largest Protestant churches in the country" allegedly runs "a scheme to defraud elderly investors by selling them interests in defunct, pre-Revolutionary Chinese bonds," then the Securities and Exchange Commission is going to take an interest:

The SEC's complaint alleges that, in 2013 and 2014, Kirbyjon Caldwell, Senior Pastor at Windsor Village United Methodist Church in Houston, and Gregory Alan Smith, a self-described financial planner who the Financial Industry Regulatory Authority has barred from the broker-dealer business since 2010,targeted vulnerable and elderly investors with false assurances that the bonds—collectible memorabilia with no meaningful investment value—were worth millions of dollars.  Caldwell and Smith raised at least $3.4 million from 29 mostly elderly investors, some of whom liquidated their annuities to invest in this scheme.

I don't think we've talked about pre-Revolutionary Chinese bonds around here but they're a classic, right up there with "prime bank" schemes in the annals of great and endlessly recurring financial frauds. ("These bonds have been in default since 1939 and the current Chinese government refuses to recognize the debt," notes the SEC complaint.) Why do these schemes keep coming up, if they are widely known to be frauds? I tend to think the answer is that they have a certain magico-religious appeal, that they add to the enchantment of the world, that humans have a deep desire to believe in something bigger than themselves, to find some scheme that makes sense of an indifferent-seeming universe and that, ideally, gives them a central place in that scheme. Believing that there is some secret financial system where "prime banks" pay huge risk-free returns, or where defaulted Chinese bonds will finally pay off -- and that you are among the chosen few who can take advantage of this opportunity -- is emotionally and spiritually satisfying, until you lose all your money. It probably helps if a pastor pitches it.

I also appreciated this, from the SEC complaint:

Throughout 2014, Caldwell and Smith continued to send emails and texts promising investors that they would be paid. These lulling emails usually provided elaborate explanations for why Caldwell had been unable to sell the bonds. Excuses ranged from issues pertaining to international currency exchanges to failures of international organizations like the International Monetary Fund or the World Bank to approve the redemptions. Although these excuses sounded plausible to some investors, they had no basis in fact.

I don't know if "lulling emails" is a technical securities-law term but it ought to be.

Congrats, Barclays.

It has now been more than 10 years since the collapse of Bear Stearns, and I think we are now going to move on from worrying about the mis-selling of mortgage bonds before 2008. Everyone is tired of it: "Barclays Plc agreed to pay $2 billion to settle a probe into how it sold the sort of mortgage bonds that fueled the financial crisis, securing a penalty less than half of what U.S. authorities originally demanded." Sure, fine, blah, enough. People keep worrying that no one has learned any lessons from 2008, and that we're rapidly heading back to the same regulatory environment that led to the crisis, but I have to say that 10 years ago it would have been essentially unheard-of for a big bank to pay a $2 billion fine, and it would have been even weirder for everyone to agree that that was good for the bank:

“The settlement came at the bottom end of expectations and much sooner than expected,” said Ian Gordon, an analyst at Investec Plc, who called it a “clear positive” and a “very happy Easter” for the bank. 

Salad blockchain.

There was a time -- a simpler time, a happier time -- when Money Stuff was almost never about cryptocurrency and blockchain. How did we occupy ourselves? Well, we talked a lot about bowls. The Rise of the Bowl was pretty much the theme of Money Stuff back in 2016. Just, literal bowls. Like the kind you eat salad out of. "Plates inhibit you because food slides off," someone told the Wall Street Journal. "Even if I had the option to eat off a plate, I would eat out of a bowl," someone told the New York Post. Bowls had a moment, in 2016, and we observed it. 

Anyway in 2018 Money Stuff is about blockchain, but sometimes the blockchain is also about bowls:

A bowl of Chicken Pesto Parm represents more than just a new dish on the Sweetgreen menu. That warm salad of roasted chicken, organic spinach, quinoa, spicy broccoli, and Middle Eastern spiced za’atar bread crumbs, with pesto vinaigrette and hot sauce, represents 3,000 hours of research and work with more than 150 farmers across the country to explore new ingredients. ...

Adds co-founder and Chief Executive Officer Neman: “We were the first to use blockchain as an application for food. We were one of the first in the category to release an app [in 2013]. We designed this new menu for flavor, and the analytics from our app allows us to find out what people are craving.” 

Look I don't know how the blockchain for salad works either, that is not the point here, the point here is that there is a blockchain for salad.

Elsewhere the blockchain might be illegal in Europe:

Under the European Union’s General Data Protection Regulation, companies will be required to completely erase the personal data of any citizen who requests that they do so. For businesses that use blockchain, specifically applications with publicly available data trails such as Bitcoin and Ethereum, truly purging that information could be impossible. “Some blockchains, as currently designed, are incompatible with the GDPR,” says Michèle Finck, a lecturer in EU law at the University of Oxford. EU regulators, she says, will need to decide whether the technology must be barred from the region or reconfigure the new rules to permit an uneasy coexistence.

I take no position on whether EU regulators should ban the blockchain but they should definitely consider a ban on talking about the blockchain.

The crypto.

There is a species of economic reasoning that thinks that a currency managed by a central bank is too unpredictable and discretionary, and should be replaced by some sort of mechanical rule for the money supply, like a Taylor Rule or the gold standard. This sort of thing is a particular specialty of the Wall Street Journal opinion pages, and last week they published this version by Max Raskin, arguing for the replacement of central banks not by a rules-based approach or the gold standard but by Bitcoin: 

Countries interested in adopting a passive monetary policy could use bitcoin as a model. Such a policy would have some of the benefits of passive investing. Index funds save investors from the significant management fees active funds charge. The Fed and other central banks have their own fees, known as budgets. More significant is the macroeconomic cost of uncertainty. Businesses delay investment, and long-term planning becomes more difficult, with unknowns from the government.

Ah yes the notorious uncertainty of central banking could be replaced by the smooth stability of Bitcoin. What could possibly ... hmm ... wait ... it says here that Bitcoin has had more than 100 percent inflation so far in 2018? Sort of a rough performance but I guess steady predictable inflation is ... oh wait last year Bitcoin had more than 90 percent deflation? If your view of Bitcoin is that it shows how a currency could be administered by mechanical rules without a central bank, you really ought to reckon with the fact that Bitcoin is a terrible currency. I mean, it has other appeals -- as a store of value, an international transfer mechanism, etc. -- but as a way to buy a sandwich it is notably useless. I am not sure why you'd want to use it as a model for your monetary policy.

Meanwhile there is that proverb about selling shovels at a gold rush, but the modern version is probably that you should sell Lamborghinis at a crypto rush:

The luxury automobile maker delivered a record 3,815 vehicles to customers in 2017. It was the seventh consecutive year of sales growth, according to Lamborghini.

A general manager at Lamborghini Newport Beach in Costa Mesa, California, told CNBC that the dealership had "over 10 transactions" involving cryptocurrency in December, when bitcoin reached $19,000 per coin.

Hedge funds.

I don't know, I'm not all that impressed by this:

Italian financier Leonardo Marroni runs a $115 million hedge fund from the spare room downstairs in a house in the leafy London suburb of Wimbledon.

The space is Devet Capital’s trading floor, conference room and occasional bedroom for six former stray dogs, where the firm operates on an annual budget of up to about £66,000 ($98,000). That amount would barely cover the costs of most hedge funds’ software systems.

The "hedge fund" category is broad, and there's a lot of money in the world, and I'm sure someone somewhere is running $100 million with no expenses other than a subscription to a tabloid that prints horoscopes. If you run a billion dollars out of your house with no budget, then that is noteworthy. But $100 million, meh. Still I like the sound of some of Devet's initiatives, like having its trader-analysts also do investor relations and trade reconciliation ("so many activities are overrated," says its co-founder), and the thing about the dogs. Really every hedge-fund trading floor should double as a bedroom for stray dogs.

Things happen.

Saks, Lord & Taylor Hit With Data Breach. Einhorn's Main Hedge Fund Down 14% This Year After March Drop. Wall Street experiments with marijuana investments. The Danger Lurking in a Safe Corner of the Bond Market. The endless SMR. Dealpolitik: Zuckerberg’s Grip on Facebook Could Put Directors in a Tricky Position. How to Think About Corporate Tax Cuts. Over 1,300 robots dance together to break Guinness World Record.

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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.

To contact the editor responsible for this story: James Greiff at jgreiff@bloomberg.net.

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