The house always wins: how IPO banks are not threatened by direct listings
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A look at what fees Slack might have paid in a traditional flotation shows how talk of IPO banks losing out to direct listings looks misguided.
Would banks that have traditionally charged young companies hefty fees to arrange their IPOs lose out from a greater move towards direct listings with no primary capital raising?
The question has been raised a few times in recent weeks, not least during Goldman Sachs's third quarter earnings call at which CEO David Solomon brushed off such concerns. Was he right to do so?
We are of course deep in the realms of "what if…?", but speculation with all the rigour of the back of an envelope suggests he might be right. Or, at least, it's far from obvious that banks will suffer much.
If anything, returns are much higher on a direct listing.
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David Solomon, Goldman Sachs |
Slack, which did its direct listing in June this year, paid its financial advisers ‒ Morgan Stanley, Goldman Sachs and Allen & Company at the top level, with seven other firms below them ‒ $22.1 million.
Spotify paid its advisers ‒ also Morgan Stanley, Goldman Sachs and Allen & Company ‒ €29 million for its direct listing in April 2018. Slack's market cap at the close of day one was about $20 billion; Spotify's was about $26.5 billion.
So how do those fees stack up against a traditional IPO?
For the sake of argument ‒ and because it's good for our online search rankings if we mention the company as often as possible ‒ let's take Uber's deal this year as a comparable. Underwriting commissions on Uber's base IPO of $8.1 billion, which was 11% of the company, were $106 million, or 1.3%.
Now for Slack. It's obviously tricky to figure out a comparable deal size when there was no deal. A direct listing's reference price ($26 in the case of Slack) is largely meaningless for reasons that we have discussed before. So for want of anything else, let's take its opening price of $38.50, minus a 15% "traditional" IPO discount, so a market cap at that price of $16.75 billion.
Let's also assume a similar percentage sold as in Uber's deal, so 11%. At 15% below Slack's opening price, that gives a theoretical deal size of $1.84 billion for Slack. And these numbers are not utterly meaningless in this case ‒ after all, that opening trade of $38.50 was for about 46 million shares, 9% of the company.
Overstated
We can't know what Slack would have paid as an underwriting commission: there isn't a pure linear relationship between deal size and fees, although it certainly tends to be the smallest deals that would pay towards 7% in the US.
But using the same 1.3% fee as Uber, a $1.84 billion IPO for Slack might have paid $24 million to the banks.
On that basis, and with no commitment to underwriting, research and roadshows, the $22 million they actually got paid in the direct listing looks pretty attractive.
I think the noise around this really disrupting the IPO market or potentially disrupting the economic opportunity for the leading banks in the IPO market is overstated at this point- David Solomon, Goldman Sachs
There are always likely to be fewer banks on direct listings, of course, so the trick is to make sure you are there at the start and stay in the box seat. No surprise, therefore, that Goldman Sachs and Morgan Stanley have already cornered that market.
But back to Solomon. "I think the noise around this really disrupting the IPO market or potentially disrupting the economic opportunity for the leading banks in the IPO market is overstated at this point," he told analysts as he presented the firm's third quarter earnings.
Overstated indeed. We had assumed he meant the small number of direct listings would keep chunky IPO fees safe for some time. But it's clear that if you are in the direct listings tent, returns don't look too bad at all.
It’s little wonder he doesn't sound too bothered about it.