Carol Anne Huff, who previously wrote a series on the changes to Nasdaq’s listing standards, is back with another article.  This time, on Direct Listings.
Below, Carol Anne dives into the NYSE’s proposal to allow companies to raise capital through a direct listing and whether the expansion of this IPO alternative will have an impact on the SPAC market. She also explores the idea of a SPAC eventually attempting a direct listing too.  As the SPAC product continues to evolve, it’s certainly food for thought, so read on for her take on this IPO alternative.

Additionally, congratulations to Carol Anne on her move to Arnold & Porter, where she intends to continue to grow her SPAC practice.

If you’d like to read up on Carol Anne’s previous articles on the Nasdaq rule changes, you can go HERE, HERE and HERE.)  

Direct Listings: SPAC Friend or Foe?

By: Carol Anne Huff, Arnold and Porter*

Direct listings are the latest attempt to improve upon the traditional IPO model, providing an alternative route to listing without an underwritten offering.   In this respect, they have something in common with SPAC business combinations, which are often presented to target companies as a means of going public without the time and expense of an IPO.  This raises the question of whether direct listings should be viewed as a competitor to the SPAC model or whether they might be a tool that SPAC practitioners can put to use.

Direct Listing Basics

The term “direct listing” refers to the listing of a private company on a national exchange without an underwritten public offering or any issuance of new shares.  Spotify and Slack are the examples that come to mind.  Those companies issued no new shares in connection with going public.  All of the sales were resales by existing stockholders.  For this reason, until recently, it was assumed that the only candidates for a direct listing were companies that did not need to raise capital in the IPO.

This notion was recently turned on its head by NYSE’s filing of a proposed rule change to allow issuers to raise capital in connection with a direct listing and to issue shares as part of the opening trade on the first day of listing.  NYSE is referring to this as a “primary direct floor listing.”  Although the proposal was rejected by the SEC, NYSE is reportedly still in discussions with the SEC regarding the proposal and NYSE filed an amended proposal on December 13, 2019.

Reasonable minds can disagree as to whether the advantages of a direct listing outweigh the disadvantages in comparison to a traditional underwritten IPO.  The most often cited advantages being that that a direct listing is potentially less expensive because there are no underwriting fees (although the company still retains an investment bank as a financial advisor) and the company’s insiders are not subject to the standard 180-day underwriters’ lockup.

The other advantage is that the price at which the stock opens is determined by the market.  The stock exchange’s designated market maker, in consultation with the issuer’s financial advisor, sets an opening reference price based upon information available regarding buy and sell orders and historical private trades. In contrast, in an IPO, the price is set by the company and the underwriters after conducting price discovery through a road show and book-building process.  Issuers have argued this leaves money on the table, with stocks priced to leave room for the “IPO pop.”  The tradeoff is that direct listings do not benefit from underwriters’ price discovery and, without stabilization by the underwriters, greater volatility in trading is a risk.

Given these pros and cons, one thing on which everyone seems to agree is that direct listing is not the right path for every issuer. For those companies looking to bypass an underwritten IPO, are SPACs in competition with direct listings as the IPO alternative of choice?

Which companies are likely to successfully execute a direct listing and are those the same companies SPACs are targeting?

Perhaps the biggest hurdle for companies considering a direct listing has been that the company does not raise capital in a direct listing, making it a non-starter for many companies.  If the NYSE is successful in expanding direct listings to permit a company to raise capital in the opening “auction”, it would be a game changer.  Companies looking for capital, in addition to liquidity for existing stockholders, will consider direct listing.

Given that SPACs are pools of capital, are these same companies likely to consider a SPAC transaction as an alternative?  Notwithstanding SPACs are pools of cash, they do not have a reputation for providing target companies with cash for de-leveraging or growth capital.  The SPAC’s cash generally goes to pay the cash purchase price and the SPAC often must raise capital through PIPE and debt financing to supplement the cash in the trust account.  In this respect, many SPAC transactions are alternatives to a sale transaction or, depending on the amount of rollover, an IPO with secondary sales and no primary proceeds.

SPACs are therefore more likely looking at targets with sellers who are willing to achieve partial liquidity in the business combination but not necessarily counting on the transaction putting cash on the target’s balance sheet (admittedly there are deals that are the exception).  In this respect, companies considering SPAC business combinations and direct listings (at least under the current regulatory framework) have something in common.

The subset of these companies looking at direct listings likely looks very different, though.  A company considering a direct listing has decided it is able to forgo a traditional road show, book building process and price stabilization in favor of company-led marketing efforts, such as an investor presentation accessible to the public.  Direct listings are therefore arguably harder to execute successfully than a traditional IPO and likely a viable option only for companies that are already known to investors and that have easy to understand business models.

In contrast, companies that choose to go public through a merger with a SPAC rather than an IPO have often concluded that the traditional IPO route is unavailable at present, whether due the size of the company, the industry, cyclicality or other reasons.  If a traditional IPO is not an option, those companies are not likely candidates for direct listing either.

Do Direct Listings Have a Role in the SPAC Market?

SPACs undertake their own IPO process, raising the question of whether a SPAC could directly list.  First and foremost, for direct listings to have a role in the SPAC market, the stock exchanges would need the SEC to approve rule changes to allow for  a primary direct floor listings–any issuance by the SPAC will be a primary offering to raise cash.  The exchanges would also need to allow SPACs to utilize the new rules.  The exchanges already have listing criteria specific to acquisition companies so it is not clear whether these new rules would apply to SPACs.  Further, if the NYSE’s proposal is approved, a company that wants to conduct a primary direct floor listing will need to sell at least $250 million of stock in the opening offering.

Assuming the SEC permits SPACs to utilize a direct listing, the question remains whether there is any benefit to a SPAC in doing so.  The benefit to an operating company of a direct listing is that it takes advantage of both the supply-side liquidity and buy-side market demand, to allow for a competitive, market driven pricing upon listing. Could an initial “auction” yield a higher price to the SPAC than the standard $10.00 per unit?

The answer is clearly yes.  One recent SPAC reached $10.30 in its first day of trading.  That said, to the extent an IPO price over $10.00 per unit were viewed by SPACs and investors as desirable, there is no reason SPACs listing through an underwritten IPO could not have already sought the same result but they have not done so.  Perhaps this is because the same question would remain–what percentage of those proceeds is placed into the trust account.

The SPAC model is constantly evolving and, should a primary direct listing become an option, it is likely that SPACs would consider using it. The limited number of SPAC IPO investors could make it easier for experienced SPAC sponsors to market without underwriter participation on the front end and instead retain an investment bank as a financial advisor, providing assistance primarily on the de-SPAC process. The question will be whether there is a real benefit to SPACs in doing so.

*Carol Anne Huff is a partner at Arnold & Porter and regularly advises clients on transactions involving special purpose acquisition companies.