Facebook's Plunge Is Only the Beginning
Aug 22nd 2012 10:03AM
Updated Aug 22nd 2012 10:10AM
The Facebook (NAS: FB) saga continues to get worse and worse. Just when investors probably thought that their huge losses in the wake of the bungled IPO couldn't get any bigger, Facebook director and longtime insider Peter Thiel became the latest shareholder to give up on the company. By selling the vast majority of his stock, Thiel signaled that even after falling 50% from its IPO price, Facebook may have far more room to run lower.
But undergoing a lock-up period isn't unique to Facebook. For just about every company that goes public, there's a time at which a flood of shares can potentially come onto the market. Later in this article, I'll point to some stocks to look at for potential lock-up-related moves. But first, let's look at why the lock-up phenomenon exists in the first place.
Lock-ups and you
The ironic thing about lock-up periods is that they're designed in part to protect individual investors from employees and other insiders trying to dump all of their shares of a stock that has recently gone public on the market at the same time. As a result, a company's IPO usually limits the number of shares that insiders can offer as part of the IPO, and then imposes restrictions on selling additional shares during the first few months that the stock trades.
The problem recently, though, is that companies have increasing issued very small numbers of shares in their IPOs, pushing up demand and getting investors used to a relatively high price. For instance, although Molycorp (NYS: MCP) issued about a quarter of its outstanding shares in its IPO when it went public back in 2010, Caesars Entertainment still has about 80% of its shares unavailable to the public, according to figures from Yahoo! Finance. Pandora (NYS: P) and LinkedIn also issued very small amounts of stock to the public, with both sales representing less than 10% of outstanding shares.
As a result, when insiders get a chance to sell, it can greatly increase the supply of shares available, putting pressure on prices. So in effect, the lock-up period doesn't prevent large insider-selling and the adverse impact it can have on a stock's price; it merely delays it.
So where's the next shoe to drop?
Throughout the social-media space, newly public companies are among the first ones that analysts talk about, given their sharing the industry with Facebook. For instance, many people are pointing to the coming expirations of lock-up periods at Yelp (NYS: YELP) and Splunk (NAS: SPLK) , which came public in March and April and have their six-month lock-up expirations coming in the near future.
Just because a lock-up date is coming doesn't mean that the stock has to fall. But that's the general trend, with countless stocks showing the same pattern that Facebook has had in dropping either on a lock-up day or in anticipation of one.
In addition, companies that have heavy ownership interest from venture capital firms are more likely to suffer losses on lock-up dates. A study cited in The Wall Street Journal that looked at nearly 4,000 companies found that venture-capital-backed companies traded more than 2% below their non-venture-capital-backed peers during the five days surrounding a lock-up expiration.
With all the hype surrounding initial public offerings, it's easy to get wrapped up in the immediacy of getting into a stock right now. But because of the way the IPO process is structured, it can actually make a lot more sense to wait until the dust has cleared and all the maneuvering from insiders and other stakeholders has run its course. That way, you'll be sure that everyone who wants to sell has already had an opportunity to do so, and you'll be more likely to get a price that reflects both buying and selling interest evenly.
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The article Facebook's Plunge Is Only the Beginning originally appeared on Fool.com.Fool contributor Dan Caplinger doesn't like being locked up, out, or in. He doesn't own shares of the companies mentioned in this article. You can follow him on Twitter @DanCaplinger. The Motley Fool owns shares of LinkedIn and Facebook. Motley Fool newsletter services have recommended buying shares of Facebook and LinkedIn. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy unlocks the knowledge you need.
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