Streaming music company Spotify has filed a confidential registration with the U.S. Securities and Exchange Commission (SEC) and is seeking to go public during the first half of 2018, according to a report by Reuters. While this move was expected by much of the investing community, it confirms a long-rumored detail that the company will bypass the traditional initial public offering (IPO) and use an unconventional and far less familiar listing process called the direct public offering (DPO) to list its shares on the New York Stock Exchange (NYSE), a division of Intercontinental Exchange, Inc. (ICE -0.25%)

While most investors are at least passingly familiar with the process for an IPO, very few will have heard of a DPO, or direct listing. How does this approach differ from the traditional filling process, and why would Spotify take this alternative approach to going public?

A computer monitor, notebook, and smartphones displaying the Spotify app.

Why is Spotify using a direct public offering to list its stock? Image source: Spotify.

This approach is all about the money

A direct listing eliminates much of the pomp and circumstance associated with a traditional IPO. The biggest benefit afforded by this type of filing is the cost savings for the company. Investment banks that handle a standard IPO typically charge millions to orchestrate the filing and withhold shares at the listing price to be sold later.

The other important distinction is that the offering doesn't result in the issuing of any new shares, so it doesn't raise capital for the listed company. A DPO also prevents the dilution of existing shares that occurs with a traditional IPO, allowing for insiders, employees, and early investors to obtain the most benefit from the filing. This type of listing also allows insiders to sell shares immediately, foregoing the usual waiting period.

In order to bypass the traditionally expensive and drawn-out process, the SEC allows companies to submit a confidential draft of their IPO registration statement and work out any issues prior to releasing their financial statements to public scrutiny. Once approved, the company would transfer its shares directly to the relevant exchange. This process already exists for companies with valuations under $1 billion, but the NYSE submitted a request to the SEC in 2017 to amend the rules to include larger companies.

It is important to note that the SEC has not formally approved Spotify's request.

How will this affect the stock price?

Investors don't yet know how the public will value the streaming music giant, but recent equity shares swap with China's social media titan Tencent Holdings Limited (TCEHY 0.09%) would value the company at nearly $20 billion. A valuation of that magnitude would make this the biggest tech listing on U.S. markets since Facebook debuted in 2012. 

There are no guarantees, though. Flooding the market with the shares of insiders could result in the price falling because of the lack of underwriters to set the price and also prevent too steep of a fall if there is insufficient demand by the investing public for the newly available stock.

Spotify logo.

Will Spotify prosper? Image source: Spotify.

A new paradigm

Spotify's listing comes at a time when the streaming music industry is booming. While album sales from both digital and physical sources in the U.S. fell 17% in 2017, on-demand streaming jumped 58% over the prior year, according to Nielsen's 2017 Year-End Music Report. The advent of streaming is widely credited with reversing a longtime decline in music industry sales.

Spotify is the clear leader in streaming music with over 140 million active users. In a post on Twitter, Spotify revealed it had over 70 million paying subscribers for its platform. This far eclipses second-place Apple (AAPL -0.08%) Music with 30 million and the growing rivalry between the two has been contentious.

Should I buy shares when they debut?

Revenue from streaming music services is expected to exceed $9.7 billion by 2022. In the first half of 2017, the number of global streaming music subscribers grew 23% over the prior-year period to 162.6 million. This provides a rich playing field for Spotify.

It is important to note that the company has not yet publicly disclosed its financials. Media reports from last year indicate that while Spotify's revenue for the first half of 2017 grew by 40% year over year, and its gross margins improved, the company is still operating at a loss. Spotify's future success will ultimately depend on its ability to achieve profitability. 

As with any new listing, let the buyer beware.