Slack, the workplace messaging platform, is taking an unusual path to the public markets.
On Thursday, shares of the company will open for trading on the New York Stock Exchange under the ticker “WORK,” making it the latest in a parade of highly-valued tech companies to go public this year. But unlike the vast majority of its peers, Slack won’t be doing so by way of an initial public offering.
Instead, it’s doing a direct listing.
This go-public method reduces the number of banks involved in the process (and by extension, the fees the company pays out to them) and designates them as deal advisers rather than underwriters. And direct listings nix the capital raise and new equity issuance that take place in a regular-way IPO. Instead, shares that have been converted to publicly tradeable stock by existing investors are sold to the public.
Slack, valued privately last year at more than $7 billion, in its prospectus called its go-public playbook “a novel method for commencing public trading” of its stock. But it isn’t the first company to embrace a direct listing.
Last year, Spotify (SPOT) was the first major company to list and offer public shares without a capital raise or the help of underwriters. Despite the chaos some investors predicted ahead of the non-traditional listing, Spotify’s first day of public trading was by and large a success. Spotify ranked as the 5th largest opening trade in the U.S. on record, according to data from the NYSE.
Here’s a look at what a direct listing means for Slack – and why a public listing with this profile could only work for a select group of companies.
Why do a direct listing in the first place?
For starters, by reducing the number of banks involved in their public listings, companies can significantly reduce the costs in fees related to regular-way IPOs.
Slack has brought on Goldman Sachs (GS), Morgan Stanley (MS) and Allen & Co. as primary financial advisors for the deal – the same consortium that advised Spotify’s direct listing. In contrast, IPOs can have more than a dozen investment banks involved as underwriters. A direct listing pares down the underwriting fees incurred, which on average total 4-7% of gross proceeds, along with additional offering costs directly related to the IPO.
Plus, a direct listing does away with the brouhaha of a lengthy roadshow – the mainstay of a typical IPO wherein underwriters and company executives gather investors in hotels and conference rooms to try and garner support for the soon-to-be public company.
With a firm like Slack, which already has more than 10 million daily active users and a known brand, some analysts say turning over the marketing reins to banks could actually do more harm than good.
“If you enlist a bunch of bankers to help you got to market, the bankers are going to be very involved in crafting what your pitch deck looks like, how you tell your story to investors, what you’re saying on the road,” Paul Condra, emerging-tech analyst for PitchBook, told Yahoo Finance. “Some companies need that.”
“A company like Slack, I think, has a very honed message,” he added. “They’re very focused on what they’re trying to do. I think their CEO has a really clear vision and probably doesn’t really want or need their advisers mixing up the message.”
And as a major benefit for existing investors, a direct listing removes the lock-up period required in a typical IPO. With a lock-up, company insiders and certain other stakeholders are barred from selling their shares, typically for between 90 to 180 days after the IPO. The requirement is meant to keep these investors from liquidating their assets too quickly – but it also keeps them sidelined from cashing in paper gains in the event of early share price appreciation.
In a direct listing, existing investors’ converted stock comprises all of the shares offered to the public. And since new shares aren’t being issued, a direct listing is much less dilutive for a company.
Company filings from the past month show that Slack’s shareholders have been actively converting Class B shares into publicly tradeable Class A shares in anticipation of the listing. As of June 18, Slack reported that about 194 million Class A shares would be available for trading Thursday.
Whether by direct listing or IPO, going public can have many benefits for a company and its shareholders. Early investors can choose to cash out, companies get public shares that can be used as currency for future mergers and acquisitions, and new equity can be issued for follow-on raises down the line.
So what are the downsides?
For most companies, the hallmark of a direct listing – the lack of a capital raise – is reason enough to favor an IPO.
“There are very few companies that want to go through all of this trouble to become a public company and not raise capital at the time of debut,” David Ethridge, PwC Deals managing director, told Yahoo Finance.
But the absence of a capital raise is less of a concern for Slack, given its current cash position. While Slack is not yet profitable, it reported cash and cash equivalents of $841 million in its most recent fiscal year. That would be enough to keep the company afloat for another 8.6 years, based on its current pace of free cash outflow.
The Slack messaging application is seen on a phone screen August 3, 2017. REUTERS/Thomas White
Companies that opt for a direct listing also potentially miss out on the benefit of an oft-used safety net for newly public companies: the over-allotment option.
Also called a “greenshoe,” the over-allotment option will have an underwriter include a provision to offer up to a 15% bonus allotment of new shares sold by the company. These could then be repurchased if prices start sinking to help push the stock price back up.
However, even this method has its limits, as bankers have only 30 days to exercise the green shoe option.
How is a direct-listed stock going to trade?
The NYSE, in consultation with Slack’s financial advisors, set a reference price for Slack’s shares at $26.00 on Wednesday.
The reference price is not a share offering price. It’s also not the opening public price for shares.
Slack’s opening share price will be determined in a price discovery process not unlike that of a regular-way IPO. Buy and sell orders will be collected from broker-dealers starting at 9:30 a.m. ET Thursday, John Tuttle, vice chairman of the NYSE, told Yahoo Finance. Throughout the process, a designated market maker will put out indications on the floor of the stock exchange showing a range in which the stock could hypothetically open at a given time.
“That attracts more order flow, which allows them to iterate on that and narrow, or adjust, that indication until the designated market maker, in consultation with the financial advisor, feels like the price discovery process has really played itself out,” Tuttle said.
At that point, new orders will be halted, the first cross will be executed, and trading will continue for the newly public stock.
Slack’s share price in recent private market transactions served as one determinant in coming to a reference price for the stock, Tuttle said. Last year, the New York Stock Exchange set Spotify’s reference price at $132. Shares opened the next day 25.7% higher, at $165.90 apiece, but pared gains by market close. The stock now trades about 13% above its reference price.
In private transactions, Slack’s stock traded in a range between $8.37 and $23.41 each for the year ended January 2019. Its volume-weighted average share price between February and the end of May this year was $26.38, according to Slack’s prospectus.
Will direct listings replace the IPO?
Other major private tech companies, including Airbnb, have reportedly mulled direct listings. But don’t expect it to overtake the traditional IPO.
“I think we will see more direct listings going forward. Do I think it’s going to replace the IPO? No,” Tuttle said. “Because we have to remember that many companies come to market to raise capital. And so there’s a certain profile of companies that the direct listing would be a fit for ... but yes I think we’ll continue to see direct listings in the future.”
Ethridge, for his part, agreed.
“This is not really what I would call a trend,” Ethridge said. “I think it’s a unique structure that’s beneficial and is going to suit the fact pattern of a very select group of companies who may want to pursue it.”
Note: Updates with Slack’s share reference price. This article was originally published June 19, 2019.
