One of the hottest tech start-ups on the planet is preparing to go public.
This company has 140 million users and more than $3 billion in sales.
Everyone’s going to be clamoring for shares once it starts trading on the NYSE…
But not me!
Today I’ll show you why I’m steering clear of this public offering…
And I’ll show you why you should steer clear, too.
Listen Up
The start-up I’m referring to is Spotify, the music-streaming service.
Available in 60 countries, it offers more than 30 million songs that can be played instantly from your computer or mobile phone.
Spotify is massive. In fact, it’s become the dominant player in online music:
Its revenues reached $3.3 billion last year, up more than 50% from the year before.
With numbers and growth like that, you might think investing in Spotify’s upcoming stock market debut would be a “no brainer.”
But actually, it’s better suited for investors who have “no brain.”
Let me explain…
Not Your Usual Public Offering
Rather than going public using a traditional IPO process, Spotify is planning to use an unconventional tactic known as a “direct listing.”
As Fortune recently described it, “If an IPO is like a wedding, a direct listing is running off to elope. A faster, easier, cheaper route to the same result.”
You see, with a direct listing, there’s no lengthy process where an investment bank markets and sells the start-up’s new shares.
Instead, a start-up simply makes its existing shares available on the stock market.
This method of going public offers several benefits. For example:
It lets the start-up’s early private investors and employees cash out…
It gives stock market investors the opportunity to get involved…
And it enables the start-up to become a public company — without paying a fortune to investment banks like JP Morgan or Goldman Sachs (NYSE:GS).
Going Direct Becomes a Realistic Option
To be clear, direct listings aren’t new…
But thanks in part to a new set of laws known as the JOBS Act, they’ve recently become a more realistic option.
If you’re a longtime Crowdability reader, you might already be familiar with the JOBS Act. This is the law that enables everyone, regardless of income or net worth, to invest in private start-ups.
But as it turns out, this law also makes it easier for a start-up to conduct a direct listing.
As you’ve just learned, direct listings can be beneficial for a start-up, its early private investors, and its employees.
But there’s one group of people they could be terrible for:
Individual investors like you!
Don’t Touch This Stock!
First of all, since there’s no investment bank involved in a direct listing, there’s no third party to help set a fair price for the company’s shares.
That means you’d have no idea if the company’s stock is overpriced!
Secondly, without a bank, no one’s there to orchestrate a “first-day pop” in the company’s share price, or to help stabilize shares if the going gets rough.
Furthermore, with a direct listing, there’s no "lock-up" period…
That means company insiders can start dumping their shares immediately. This could lead to heavy selling — and major losses for new stock market investors!
Even More Reasons to Steer Clear
You shouldn’t necessarily avoid every direct listing…
But in Spotify’s case, we believe the risks outweigh the potential upside.
For example:
The music Spotify streams is owned by big record labels like Universal and Sony. These labels charge Spotify a fortune to license their music — and there’s not much Spotify can do about it.
These licensing costs help explain why Spotify’s losses are growing even faster than its revenues. For example, even though the company grew its revenue by more than 50% last year, its losses grew by 133%!
And don’t minimize the threat of future competition...
Spotify’s competitors include battle-ready giants like Apple (NASDAQ:AAPL) Music and Pandora.
Keep Your Eyes Peeled
Here’s the bottom line:
A direct listing might be good for Spotify and its early start-up investors…
But for investors like you, we believe it’s too risky of an opportunity.
The thing is, if other start-ups decide to copy Spotify’s strategy, expect to see a lot more direct listings in the near future.
So keep your eyes peeled:
Either stay away from these deals entirely…
Or be prepared to do a ton of extra research before you invest.