Initial Public Offerings have lock-ups. In a lock-up, existing holders of the IPO stock, people who own stock at the time of the new issue, agree not to sell for a certain period of time.
This allows the underwriter to support the stock without having to worry about the existing holders dumping on his efforts.
To give you an example of what happens when there is no lock-up, I recall one deal about 1984 that was a roll-up of existing oil and gas partnerships. The promoters offered a large number of owners of interests in oil and gas limited partnerships the chance to swap them for stock at a valuation of $5 per share. This stock was the subject of a registration statement, giving these investors stock in a soon to be public company.
When the issue hit the market, it may have had a print, a trade at $5 but the efforts to support the stock soon collapsed as all the holders of the stock sought to dump it for cash. The stock was soon at $1.50, never to see $5 ever again.
Underwriters soon learn that their performance largely is graded on the short term price of the stock. After six months or so, they are off the hook. The question for the underwriter is will the stock go to a premium in the immediate aftermarket.
True., the underwriter has warrants lasting usually two years, allowing him to buy often one share for every ten he sold at the issue price, but most of these are worthless two years later. The ones that are exercised often have huge rewards. In other works, underwriter warrants are a something like a lottery ticket -- more likely worthless but a big payoff if they are not.
As a trader, you can be certain that when the lock-ups expire, the supply of stock will increase. As most new issues are issued at a relatively high price because of promotion by the underwriters, and that promotion is long since over by the time of the lock-up expiration, you can be sure that a lock-up expiration is going to find a soft market.
This is not to say that the stock will collapse, but as a trader, you do not want to be long into a lock-up expiration.
If you are looking for a good short, one with a huge drop in price, you probably would not be looking at lock-ups for IPOs, as they do not mean huge drops in price, but they do mean a soft market.
As an IPO market maker, you can be sure I would know the dates of all lockups, and would never enter a lock-up expiration make sure I had a nice short position.
We now have a chance to test these ideas, as Facebook, a stock that has had a disastrous aftermarket, now faces expiring lock-ups.
Chart courtesy of Stockcharts.com
I read that 230 million employee shares will soon be free. -- 11% of the company's existing 2.1 billion shares outstanding.
Another tidal wave of stock, hits November 14, when 777 million shares are freed up. In a period of a few weeks, shares equal to almost half of Facebook's current shares outstanding can hit the market.
The only reason not to make a knee-jerk decision to short this stock is that it is down into "fallen angel" territory already.
You have to wonder what the underwriters and the company were thinking when they structured all this, including soaking up all available demand to begin with.
It is not a question of how loyal or how enthusiastic about the future these shareholders are. People love money and many of these shareholders have huge fortunes awaiting them they will want to enjoy now.
Just the amount of money needed to soak up all this stock almost guarantees another soft market. How many buyers are left for this stock?
Another form of lock-up that you should not overlook is the availability of stock to be sold pursuant to Rule 144. You may recall that that holding period for 144 is six months. Also recall that the insiders ("affiliates"), those who are key officers and directors and 10% shareholders, can sell 1% per quarter of the outstanding stock of that class, or if the class is listed on a stock exchange or quoted on Nasdaq, the greater of 1% or the average reported weekly trading volume during the four weeks preceding the filing a notice of sale on Form 144.
Always look for new supply and new demand in trading IPOs. Your job is prediction.
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