Slack, a US messaging company, last week became the second big tech firm to use a direct listing as its route to the public markets.
And so came the excited chatter, just as it did with Spotify in April 2018: banks cut out of deals, the intermediators disintermediated! A bit like Google’s 2004 auction, but done right! The future of IPOs!
Not so fast. First off, the number of companies that could pull off such a method of coming to market is vanishingly small. Second, the idea that this is some brave new world of direct corporate access to markets that cuts out the pesky Wall Street middleman is nonsense.
In fact, some of what happens in a direct listing looks quite a lot like a typical IPO, but with much of it squeezed frantically into the listing day itself. And while the listing venue plays an important role, it’s fair to say there’s still something for the bankers to do. And for traders, there’s an awful lot.
The process for Slack started months before its debut, with the company’s advisers working through the long task of cajoling potential sellers into selling and potential buyers into buying – as well as explaining to both sides just how a direct listing is supposed to work.
We shouldn’t downplay the importance of that explanation. Venture capital sellers such as those that hold most of Slack are lovers of the limit-order for the certainty it gives.
The problem is, it tends to make for lumpy trading. So a lot of the sell-side education is about making them think a bit less like VCs and a bit more like equity traders: “Yes, I know you have five million to sell at this level, but what about instead doing four million here and another million here, etc.”
For potential new buyers in the public market, there are arguably more challenges to get over. In a typical IPO they would have the wonderful comfort of an allocation, better known to the long-only community as a starter position at an artificially low price.
In a direct listing there is no such thing. Gone is the quick flip to take advantage of the IPO underpricing. A direct listing requires the portfolio manager to take a fundamental view on their entry price from the very first share they buy.
What they don’t get – in the absence of a bookbuilding price range – is much advance indication of what that price is likely to be.
The day before its listing, the NYSE announced Slack’s reference price of $26, an indicator of sorts that is based on the volume-weighted market price (VWAP) of previous private market transactions.
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While the reference price doesn’t constrain the listing, it is intended to be meaningful, hence the requirements that the VWAP be referenced to trades deemed big enough to be representative.
For Slack, that meant going back further than for Spotify, where private market activity had been more intense in the run-up to its listing.
Ready, set, go!
And so we get to the most fraught part of the whole business, the listing day itself. Citadel Securities, which was the designated market maker (DMM) for the Spotify listing, repeated that role for Slack.
Starting early in the morning, the DMM, Morgan Stanley and other advisers worked through the buy and sell orders received from across the Street to establish a price at which a sufficient number of shares could be sold for an orderly open.
At this point, there are a lot of judgement calls being made, not least on trading volume – perhaps the most critical determinant of whether the stock will gap out either to the upside or downside on the open: something guaranteed to spook retail.
That’s not easy: it means looking at how much is technically free to trade, and then how much of that is actually free to trade. In other words, how much is held by accounts that are not only able but willing to release their stock on day one. That’s where those months of conversations come in.
The issuer wants to know that it is selling x shares at y price to raise z proceeds, and that’s a pretty tall order with a direct listing
For Slack to avoid leaping around, the feeling was that it needed to open with a minimum of 20 million shares trading, and ideally about a third of the expected first-day volume. The high-end expectation for day one was for 100 million or more.
In the end it opened at about 11:30am, with about 46 million shares trading at $38.50. It might have been possible to open with 30 million, but the feeling was that probably wouldn’t capture enough buyers and sellers to ensure a steady start to listed life.
Unlike an IPO, there is no greenshoe option available and no formal stabilization, but the DMM is obviously working throughout the debut to minimize trading volatility.
And unlike in an IPO, even a fairly moderate first-day pop is not really what is wanted. In the absence of a bookbuild and allocation process, the last thing you want is for a swathe of new investors to have a reason to cash out.
Slack’s start worked out pretty well: it closed the day at $38.62 on volume of more than 137 million.
Not for everyone
There are some obvious efficiencies in a direct listing, with its compact price-discovery timeframe and its lower costs. Slack traded within a tight range on debut – exactly what was wanted. Why not always shoot for it?
First, the biggest reason: if you need primary capital, it’s impossible. The issuer wants to know that it is selling x shares at y price to raise z proceeds, and that’s a pretty tall order with a direct listing.
But you also need a pre-existing investor base that is at least diverse enough to ensure flow on the first day: it won’t work if most of the stock is in the hands of one seller, for instance. There were four big holders of Slack, and enough other investors willing to trade.
Away from the logistics of the market open, however, there is a big element missing compared with a traditional IPO. There is no marketing of the company to speak of, no formal roadshow and investor education. This is only possible for a company whose product is already well known, or one that is easily understandable if not.
That made Slack a touch more challenging than Spotify, but still doable. Of the recent crop of other tech IPOs, teleconferencing firm Zoom Video is probably the kind of name that could have pulled it off, despite being, like Slack, largely an enterprise story rather than a retail one. Airbnb, which plans to come to market next year, is an obvious candidate.
Slack’s business is intended to make it easier for employees and colleagues to interact. In that respect, it’s in the intermediation business. Its route to the public markets has been a prime example of much the same thing.