Aug. 2, 2000 -- Nothing can help your stock more than having a bunch of big shareholders prohibited from selling their shares. But guess what can happen when that restriction is lifted?
In the months following an initial public offering, company employees, directors and venture capitalists are usually banned from selling their shares in the newly public company. These folks got stock before thecompany went public, typically much cheaper than the IPO price. This so-called lockup period typically lasts for 180 days but can be as short as 90 days and as long as 1,000 days or more.
A lockup doesn’t mean a stock doesn’t trade. It just means that certain holders aren’t allowed to sell during a specified period. The idea behind a lockup is to prevent a flood of new shares from entering the market right after the IPO. Limiting the supply or the number of shares trading can help keep the price of a new stock up.
That Magic MomentWhen a lockup period ends, which is referred to as the lockup expiration, insiders are free to sell their stock. The fear: They will unload their shares, inundate the market and drive the stock price down.
The conventional thinking says a stock’s price will flatten or fall in the days and weeks before that date arrives — just on the perception that insiders will dump their stock when the selling restrictions are lifted. The stock will then come back in the days after the lockup expiration. Or, maybe it won’t.
Predicting when and how a lockup expiration will hurt a particular issue is just not that easy.
One 10-year study by two assistant professors at Penn State University found that the average stock fell about 2 percent in the week the lockup agreement expired. Another study by Thomson Financial, Investor Relations which looked at IPOs from the first half of 1999, found that these expirations had almost no effect.
It’s All About TimingThere’s no exact formula for playing IPO lockup expirations. The effect depends on the company, the market climate and how many shares might hit the market.
When the market was more than robust last year and at the beginning of this year, stocks blew through lockup expirations and no one cared, says Brad Alford, CEO of IPO Lockup.com, a Web site that trackslockup expiration dates. “There was always someone on the other side of the trade.”
Infant tech stocks like Juniper Networks breezed through lockup expirations unscathed. Investors are more wary this year and intensely focused on the potential effect of more supply coming into the market. In March and April, new IPOs dried up but new shares kept hitting the market from lockup expirations in May.
“Lockup expirations can add to the additional supply out there,” says Steven DeSanctis, director of small-cap research at Prudential Securities. “They put additional pressure on some of these stocks.”
Take VA Linux for example. This provider of servers and workstations designed for the Linux operating system went public in December and soared 698 percent on its first day of trading. But the company’s stock has faltered this year and its lockup expiration at the beginning of June didn’t exactly help the price. It fell in the days leading up to that expiration and continued to fall. The stock is down 82.4 percent this year and 8.7 percent since the end of May.
Of course, a lockup expiration doesn’t mean that employees and insiders have to sell. It only means some of them can. But jittery investors in a wobbly market will unload shares at the first whiff of a glut.
Time’s Up, Now What?When a company goes public, it will typically issue, or float, as many as 20 percent of its shares outstanding. The rest remain in the hands of private investors. At the first lockup expiration, you could potentially see a deluge of new shares entering the market — more than half a company’s shares outstanding — which could put pressure on a stock’s price.
You’ll want to know how much supply could possibly come into the market. A lockup expiration that includes five to 10 times the number of shares trading from the IPO isn’t alarming, but if you see 20 times the number of shares or more hitting the market, you should take note.
Some investors try to gauge how much stock will actually be sold once the expiration day hits.
Of course, a fund manager running several billion dollars can call a company’s investment bankers directly to handicap the situation. If the stock is trading at 400 percent above its IPO price, that middle manager within the firm is probably going to sell. If his shares are under water, he probably won’t.
Individuals sitting at home don’t have that luxury. They, instead, have to assess any coming lockup expiration from their home offices.
If you’ve got shares in a new company, you’ll want to know when any lockups expire. You can use UnlockDates.com or IPO Lockup.com to track these dates. Nevertheless, information on lockup expirations can still be hard to find or confusing. The lockup schedule may not spelled out in a company’s prospectus or there may be additional selling restrictions on the stock that you aren’t aware of.
You will want to have a plan. If the market starts to get rough for your stock ahead of a lockup expiration, what are you going to do?
Take profits? Buy more? Sell it and buy it back? No matter what, you should brace yourself for some rocky trading.