(Bloomberg View) -- Spotify.
What makes Spotify Ltd.'s direct listing different from a regular initial public offering? One difference is that, unlike in a typical IPO, Spotify will not be raising any money: It is listing its stock publicly so that its current shareholders can sell, but Spotify itself won't sell any stock on the first day. This is a difference from most IPOs, but it is not an essential one. There are plenty of IPOs where the company doesn't really need the money and insiders sell more shares than the company does. There is a lot of money in private markets, and big tech companies are staying private longer, and the result is that the pressure on companies to go public is increasingly likely to come from private investors who want to cash out rather than from the company's own need to raise money.
Another difference is that, unlike in an IPO, Spotify won't have bankers who build a book of demand and then set the initial price of the shares at a level that clears that demand. Instead, it will have a designated market maker on the New York Stock Exchange that will build a book of orders to buy and sell the stock, and then set the initial price of the shares at a level that clears that market. For aficionados of market structure, that is kind of a big difference, and I have argued that it is novel and kind of exciting. But from a less nerdy perspective the difference might not look that big. These are really just two ways to handle a basically similar auction process. It's not like in regular IPOs the price is set "by the banks" and in a direct listing it's set "by the market." It's set by the market either way, though there's more judgment and subjectivity in the way the IPO pricing initially reflects the market.
There are other differences. Spotify won't do an investor roadshow, but yesterday it did "a live-streamed hours-long event designed to introduce the company to public market investors," which is not un-roadshow-like. Spotify won't pay banks for underwriting its deal, but it will pay them something like $30 million in advisory fees, which would not be a terrible IPO paycheck. Spotify won't have banks "stabilizing" the deal by buying the stock if it goes down, but then the banks don't end up stabilizing most IPOs anyway just because most IPO stocks go up.
[Chief Executive Officer Daniel] Ek also doesn’t want to impose the post-IPO lock-up period on existing investors, during which they aren’t allowed to sell shares for, typically, three to six months after the shares start trading.
If you do an IPO, you will meet with your bankers and they will tell you that you need a lockup. No one will buy stock in an IPO, they'll tell you, if they know that a ton more supply might come on the market at any time. So the company itself, and all of its big investors, need to agree not to sell more stock for three to six months after the IPO. The investors grudgingly accept this condition, because the tradeoff is that they get to sell stock in the IPO. And it makes sense that the lockup would make the IPO go more smoothly. You have one big coordinated trade: Everyone who wants to sell sells at the same time, and everyone who wants to buy has one big opportunity to get in at the IPO price. By focusing everyone on one moment in time, you maximize the chances of the deal going well.
But Spotify, whose direct listing is now scheduled for April 3, seems to be doing a perfectly fine job of focusing attention on itself. And it won't have a lockup. If you're a Spotify private investor, you can sell a bunch of your shares on the first day, much like you would in an IPO, but you can also sell a bunch more on the second day, which would not be allowed in an IPO. The tradeoff that selling shareholders in an IPO have to take -- you get to sell in the initial offering, but in exchange you're locked up from selling afterwards -- just goes away.
If Spotify's deal goes well -- if a lot of stock trades on the first day, smoothly and at a high and sustained valuation -- then a lot of other companies that are thinking about going public will draw lessons from it. One obvious lesson you could draw is "we should do a direct listing too," but this won't be for everyone. "For us, going public has never been about the pomp or circumstance of it all,” said Ek, and "you won’t see us ringing any bells or throwing any parties" on the day of the listing. But plenty of private companies still do want to ring the bell at the New York Stock Exchange and have a big party to celebrate the milestone of going public. Others just need to raise money. Others will want a bit more say over who buys their shares, or will want to do a roadshow to be introduced to all their new investors. Even if Spotify's deal goes perfectly, it won't be the end, or the beginning of the end, of the IPO.
But other companies could incorporate pieces of Spotify's direct listing into their own IPOs. If you want to raise money in an IPO but don't want to do a roadshow, you can just tell your bankers that you'll do a one-day live-streamed presentation. They'll tell you that that is a bad idea, and you'll say "well it worked fine for Spotify." They'll argue that you're not Spotify and that you are unnecessarily introducing risk into your deal, but at the end of the day it is your deal, and Spotify's example may give you enough courage to stand your ground.
Or more substantively, if you want to do an IPO but don't want to lock up your existing shareholders from selling stock for three to six months afterwards, maybe you could say no to that too? Or if you want to do an IPO but don't want to give the banks a "greenshoe" option to help them stabilize the shares? The banks will freak out about this and tell you that these are essential elements of the IPO process, and that eliminating them is risky and almost unprecedented. But if Spotify eliminated them and did fine, then why can't you?
Spotify's direct listing jettisons almost as much of the IPO apparatus as it is possible to get rid of while still going public. (Though you could imagine going further: cutting out the advisory role and fees of the banks, say, or not even bothering with a big investor presentation.) If it goes well, it will give other companies ideas, but there is no need to follow Spotify's example exactly. If Spotify demonstrates that all of the IPO apparatus is unnecessary, then it's a lot easier for future companies to pick and choose what parts of the IPO apparatus they want.
We talked yesterday about what I called "insider guessing": The Securities and Exchange Commission and federal prosecutors brought charges against an Equifax Inc. executive who was allegedly able to figure out that his company had been hacked, and who sold a bunch of Equifax stock, but who had never explicitly been told about the hack. The SEC and Justice Department think that this would be insider trading, and I think I more or less agree; in any case, I said that "it's not gonna look great to a jury."
But perhaps that was wrong? A reader pointed me to this amazing 2010 case, in which the Securities and Exchange Commission accused a couple of railroad workers and their family members of insider trading on merger news. No one had told the railroad workers about the merger, but they made a good guess: "as part of the due diligence process, there were an unusual number of daytime tours of FECR’s Hialeah Yard involving a tour bus and people dressed in business attire," and they figured that if that many people in suits were touring their rail yard it was probably for sale. So they bought call options, and the SEC accused them of insider trading.
But the SEC lost at trial: In 2014, a federal jury sided with the railroad workers (though some defendants had settled before that). Juries don't issue written decisions so it's a hard to know what their reasoning was, but you can sort of guess at it. If you are confronted with workers in a rail yard who saw tourists in suits and concluded from that that they should buy call options on their parent company's stock, it is hard not to admire them a little. That's clever! I would be inclined to attribute their profits mostly to cleverness, and only secondarily to inside information. You could imagine a spectrum of insider trading, where if your boss just tells you "we are being acquired" and you trade, then that is cheating and illegal, while if you pick up only subtle clues about an acquisition and use bold leaps of deductive logic to decide to trade, then that is just good old capitalism and perfectly legal. That is certainly not legal advice, and I don't think it exactly captures how the law thinks about materiality and inside information -- though arguably it is reflected in the "mosaic theory" of insider trading -- but perhaps it is how juries feel about insider trading.
After Broadcom Ltd.'s bid to acquire Qualcomm Inc. was blocked because the Committee on Foreign Investment in the U.S. concluded that the acquisition by Singapore-incorporated Broadcom would take Qualcomm in a "'private-equity'-style direction" and undermine U.S. national security by reducing investment in wireless technology, the former chairman of Qualcomm, Paul Jacobs, is planning a ... private equity buyout ... backed by a foreign company?
SoftBank, the Japanese conglomerate that controls the $100bn tech-focused Vision Fund, is one of the potential partners approached by Mr Jacobs, according to one of the people with knowledge about his take-private plan. ...
Moreover, a bid with foreign backing could attract fresh scrutiny from the Committee on Foreign Investment in the United States which vetoed the Singaporean-domiciled Broadcom’s bid over concerns about its links to Chinese entities. However, people close to the matter believed those concerns were surmountable.
Ah. Meanwhile, President Trump's executive order blocking the deal also declared that Broadcom's candidate for Qualcomm's board of directors "are hereby disqualified from standing for election." But they've already printed the proxy cards, so if you want to vote for them you can go ahead. Maybe you should?
Institutional Shareholder Services Inc., an influential proxy-advisory firm, recommended that Qualcomm Inc. shareholders make a symbolic vote in protest against the chip giant’s moves to block Broadcom Ltd.’s $117 billion bid for the company.
ISS, in a note to investors late Wednesday, stood by its original recommendation that shareholders vote for four Broadcom nominees for Qualcomm’s 11-person board, even though the votes won’t count.
I often think about how shareholder democracy is mostly pretty silly and symbolic. Shareholders can vote against board members or for shareholder proposals or whatever, but the board can generally ignore those votes. The only times when shareholders' views can be binding are in hostile takeovers or contested proxy fights. But sometimes not even then!
Active and passive activism.
We've talked a couple of times around here about the awkward fact that BlackRock Inc. Chief Executive Officer Larry Fink sent out a letter to corporate executives, with much fanfare, telling them to be better corporate citizens and to do more to make society better, but that BlackRock is the largest shareholder in the big publicly traded gun manufacturers and rather embarrassed about that. And because it is a big index-fund manager, it can't sell those shares: It's stuck tracking the index and uncomfortably owning the gun manufacturers.
But Bloomberg Intelligence analyst Eric Balchunas makes a great point: Active managers aren't stuck. Why aren't any of them noisily selling gun stocks, whether due to moral disapproval or savvy marketing or worries about those stocks' economic future?
Fink and his ilk may talk about high-minded ideals, but actively managed funds could take actions that might make a difference. They would have looked like heroes (at least to the news media and about half the country) and more importantly showcased the leverage they have over companies, helping them at a time when customers are leaving their funds for passive index products.
I suspect the boring explanation is that active mutual-fund managers are mostly making economic decisions and don't really think of themselves as having a big platform to take moral and political stances. (Social-responsibility funds are an exception, but then they probably didn't own gun stocks in the first place.) To be fair most passive fund managers certainly don't think they have such a platform either. ("We believe mutual funds are not optimal agents of social change," says Vanguard Group.)
BlackRock is unusual in that it does. "Somewhat accidentally," I wrote recently, "American corporate capitalism ended up in Larry Fink's hands." BlackRock is not just another fund manager; it's a central coordination point in financial capitalism, and it is wrestling with what sort of responsibility that entails. But if you're not that central, you can just buy and sell stocks.
Here is a glorious paper (and helpful Twitter thread of the highlights) about "The Surprising Creativity of Digital Evolution: A Collection of Anecdotes from the Evolutionary Computation and Artificial Life Research Communities." That's a mouthful of a title, but for our purposes, it's basically a list of times that artificial intelligence programs figured out ways to cheat on the tests their creators set for them. They're clever little devils!
In a graduate-level AI class at UT Austin in 1997 taught by Risto Miikkulainen, the capstone project was a five-in-a-row Tic Tac Toe competition played on an infinitely large board. The students were free to choose any technique they wanted, and most people submitted typical search-based solutions. One of the entries, however, was a player based on the SANE neuroevolution approach for playing Othello by Moriarty and Miikkulainen. As in previous work, the network received a board representation as its input and indicated the desired move as its output. However, it had a clever mechanism for encoding its desired move that allowed for a broad range of coordinate values (by using units with an exponential activation function). A byproduct of this encoding was that it enabled the system to request non-existent moves very, very far away in the tic-tac-toe board. Evolution discovered that making such a move right away lead to a lot of wins. The reason turned out to be that the other players dynamically expanded the board representation to include the location of the far-away move—and crashed because they ran out of memory, forfeiting the match!
In practice, evolution often uncovers clever loopholes in human-written tests, sometimes achieving optimal fitness in unforeseen ways. For example, when MIT Lincoln Labs evaluated GenProg on a buggy sorting program, researchers created tests that measured whether the numbers output by the sorting algorithm were in sorted order. However, rather than actually repairing the program (which sometimes failed to correctly sort), GenProg found an easier solution: it entirely short-circuited the buggy program, having it always return an empty list, exploiting the technicality that an empty list was scored as not being out of order.
"You get what you measure," I once wrote, "but only exactly what you measure." I was talking about measuring and compensating humans' job performance, but if you incentivize AI programs they'll also give you what you measure. One place to think about this is in artificial intelligence in banking compliance. Banks are constantly experimenting with AI in compliance, in part because they have tons of raw data to sift through to look for compliance problems, and in part because it is easier to convince regulators that you are serious about compliance if there is some actual algorithm that you can point to that is monitoring your behavior. The AI, if it is smart enough, will come up with all sorts of creative ways to spot misbehavior that the average compliance officer, and even the average cheating banker, would never come up with. But if it's even smarter, maybe it will find new ways to cheat.
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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.
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