Stocks: The 'Lockup' Effect
By JOE LIGHT
http://online.wsj.com/article/SB20000872396390444233104577591343830753460.html?ru=yahoo?mod=yahoo_itp
Three months after its initial public offering, Facebook FB -4.13% already is down almost 50% from its $38 offering price. The worst might be yet to come.
Over the next nine months, company insiders and early investors will be allowed to sell millions of their shares for the first time, which could put the social network's price under increased downward pressure. The company's first lockup expired on Thursday, sending shares down more than 6.2% to a record low of $19.87. The stock closed Friday at $19.05.
Facebook isn't alone. Between now and the end of the year, at least 63 other companies will undergo the same test, according to the financial-report provider Edgar Online.
If history is any guide, the coming stock gluts could make it advisable for investors to lighten their stakes in recent IPOs, especially those of companies in the technology sector and those that already have seen institutional selling, experts say.
"We're talking about billions of shares that will go out on the market over the following months," says Rich Greenfield, a media analyst at research firm BTIG, speaking of Facebook. "We know insiders can sell. The question is, 'Will they?'"
When companies go public, company insiders and early investors can typically sell only a fraction of their shares, which are then traded freely on the stock market. The rest of their holdings are restricted from sale during a "lockup" period, which usually expires six months after the IPO.
After the lockup ends, the number of shares in the market can multiply several times over, often causing prices to fall.
Facebook, which went public May 18, chose to spread its lockup periods over a year. The first expiration caused the number of the company's publicly traded shares to balloon by 64% to 692 million.
A Facebook spokeswoman declined to comment.
Other much-ballyhooed IPOs with imminent lockup expirations include consumer-reviews site Yelp, YELP -1.19% software company Splunk and private-equity firm Carlyle Group CG +0.24% . Facebook will face its second lockup release in mid-October.
In theory, the number of shares shouldn't matter to valuation. Fundamentals such as earnings per share and book value per share don't change simply because more of the company can be traded.
But in practice, lockup expirations can significantly depress share prices.
When deals site Groupon's GRPN -5.00% lockup expired in June, shares dropped 9%. On Tuesday, review site Angie's List plummeted 16% as its lockup expired. (For a list of future expiration dates, go to ipoportal.edgar-online.com.)
Behind the trend: supply and demand. Until Thursday, for example, only about 421 million shares of Facebook were freely traded. When the last Facebook lockup expires next May, there will be 2.14 billion shares floating in the market.
Most of the new crop of highly-touted tech companies, which are backed by prominent venture-capital firms, could face even stronger headwinds.
In the five-day window surrounding their lockup expiration, shares of newly traded companies backed by venture-capital firms tend to trade 2.1% below companies without venture-capital backing, according to a study of 3,981 firms by researchers at the University of South Florida and Babson College.
Insiders and early investors are unlikely to sell all those shares at once, but many who have waited years to realize their gains will be quick to cash out at least some of their stake, says Daniel Bradley, a finance professor at the University of South Florida who has studied IPOs.
"If you have a significant amount of insider selling, it says something about what they believe the fundamental value [of the company] is," he says, while noting that some sellers simply might be diversifying.
It also is a bad sign if institutional investors, such as mutual funds and market makers, sell large blocks of shares before the lockup expiration, says Nikhil Varaiya, a finance professor at San Diego State University. That's because such investors are usually more knowledgeable than small investors about companies they sell, he says.
Prof. Varaiya found that the more big trades a company sees in its first days of trading, the worse the shares perform after the lockup expires.
The effect hurts performance for up to three years after the IPO, and isn't diminished even if other investors make big purchases to offset the sales, he says.
That could spell more trouble for Facebook. In June, mutual funds run by Fidelity Investments sold 1.9 million shares of the company, according to monthly portfolio disclosures.
Big investors, including Fidelity, have also already unloaded thousands of shares of Splunk, whose lockup expires in October.
"That kind of trading does not bode well," Prof. Varaiya says.
A version of this article appeared August 17, 2012, on page B9 in the U.S. edition of The Wall Street Journal, with the headline: Stocks: The 'Lockup' Effect.
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