America’s stock market is shrinking. The number of public companies has been cut roughly in half over the past two decades, mostly by choice.
Some don’t want to deal with the pressure and reporting requirements. Others are avoiding the hassle and expense of an IPO. And a lucky few just don’t need the money.
Now, the New York Stock Exchange is trying to lure more companies back to the public market, even if it involves taking a less traveled route.
Last year, Spotify (SPOT) went public on the NYSE in a most unconventional way: through a direct listing. It didn’t hire underwriters from Wall Street investment banks, and no new shares were issued to raise money. Yet Spotify (SPOT) became a public company with a valuation at the time of nearly $30 billion.
Slack (WORK), the workplace communication tool, also decided to forgo the traditional initial public offering route. In June, it also pulled off a direct listing on the NYSE, achieving a valuation north of $20 billion. And it didn’t hire underwriters or raise any new capital, either.
The NYSE is now trying to persuade more unicorns to follow in the footsteps of those outliers, but with a twist The exchange filed paperwork earlier this week with the Securities and Exchange Commission proposing rule changes to allow direct listings to raise money by issuing new shares to the public.
“We think companies should go public. We want to create as many pathways as possible to help achieve that goal,” John Tuttle, NYSE’s vice chairman, told CNN Business.
Direct listings have their skeptics, butTuttle said “a lot” of companies from various industries are considering the same route as Spotify and Slack.
“In response to the demands of the marketplace, we are working to evolve our offering,” Tuttle said.
The SEC declined comment on the proposal, which the agency must approve before it can take effect. Tuttle expects the approval process to take at least 90 days.
Dwindling number of public companies
David Weild, the former vice chairman of the Nasdaq Stock Market, said the NYSE is smart in attempting to evolve.
“The New York Stock Exchange is catering to the companies. Frankly, it needs to,” said Weild. “I applaud them.”
At the same time, Weild, who now leads his own boutique investment bank, argued that these developments show that the current system isn’t working for US companies, who are the customers in this case.
“This is a shot across the bow of Wall Street. It’s an indictment of the market structure that we currently find ourselves in,” Weild said. “Obviously, the customer base is increasingly distrusting Wall Street — because Wall Street isn’t delivering the goods any longer.”
In 1996, the United States had more than 7,000 public companies. But that number tumbled to just 3,800 by the end of 2016, according to Vanguard, which cited the Center for Research in Security Prices.
Although that 1990s-era high-water mark was inflated by the dotcom bubble, it’s still stunning that the United States has fewer public companies today despite a much larger economy and population. In 1996, the United States had about 30 public companies per million people, according to the St. Louis Federal Reserve. But in 2017, the nation had just 17 public companies per million people.
‘They are trapped’
Countless billion-dollar unicorns in Silicon Valley would be prime candidates to go public, yet many of them see no need to face the accompanying hassles, expense and pressure.
“Once you’re public, scrutiny goes up,” said Jeffrey Pontiff, a finance professor at Boston College.
Also, there is so much money sloshing around Silicon Valley that some unicorns have achieved jaw-dropping valuations that would be hard to replicate on Wall Street. Just recently, investors balked at WeWork’s lofty price tag and questionable practices, forcing the company to abandon its IPO and eventually seek a bailout from SoftBank.
“Capital is locked up in the private market at inflated prices. It can’t get out at reasonable prices,” said Kathleen Smith, principal at Renaissance Capital, which runs the Renaissance IPO ETF (IPO). “They are trapped. They want another way to get out.”
No lock-up period
Yet that doesn’t mean a direct listing is necessarily the answer.
Slack is trading 13% below the reference price of $26 that was set on the eve of its unconventional IPO. The company has been hit by slower growth and competition from Microsoft (MSFT).
For its part, Spotify is trading 10% above its reference price of $132. However, the music streaming service is well below its opening price of $165.90 from its April IPO.
“The conclusion we had from the last two direct listings was: Why would anyone want to buy these things early on?” Smith said.
Of course, these two companies may eventually prove to be strong investments.
Direct listings can be tricky. Avoiding underwriters can save companies a lot of money when they list their shares. But the absence of underwriters can make it difficult to discover a fair price for the stock, which in turn can create volatility.
Another potential drawback is that direct listings allow early investors and employees to sell their shares immediately. There is no so-called lock-up period that prevents sales for several months. And that can rub investors the wrong way.
“Lockups make a whole lot of sense,” said Smith. “There is a lot the market doesn’t know about the company. Before insiders bail out, the marketplace wants to see management deliver results.”
