How Lockups Can Leave You Out In The Cold
Akamai Technologies went public last October and became an immediate sensation. Demand for shares in the Internet-infrastructure company was nearly insatiable. Just 9 million shares were offered at $26 apiece, and buyers pushed the price to $145 on the first day. The stock even touched $345 a share in late December, but like most Net stocks, it got crushed in the spring, falling to $60 in late May. Then Akamai started to recover, but in late July, its stock quickly plunged from above $100 a share to below $80, where it has been stuck since.
When stock prices plunge, it's difficult to pinpoint exactly why. But if the business is, like Akamai, in its infancy as a public company, there is often a suspect: the expiration of a "lockup."
The lockup is an agreement between investment bankers and the companies they bring public. What's locked up are the shares owned by the founders, employees, their friends and family, and the venture capitalists who staked the deal. These shares, which can account for as much as 90% of all of the issued stock, are kept off the market to allow the company to build a track record and attract investors. A typical lockup lasts 180 days, but it can be as short as 90 days or as long as three years. Shares may also be unlocked in stages, with a varying amount free to trade every three or six months. And with the O.K. of its investment bankers, a company can also shorten or lengthen a lockup period.
The ins and outs of lockups are essential facts for investors in newly public companies. Fortunately the Web is making the information easier to get (table). Buying a stock without first checking the lockup, says Brooks Nelson, an investment manager at Nelson Capital Management in Palo Alto, Calif., "would be like buying without knowing what the company does. It's as important as knowing the fundamentals of the company."
Indeed, the last thing an investor wants to do is buy a stock right before the lockup expires. And if you own the stock and are considering selling it, do so well before the expiration. Why? Stocks prices often drop beforehand as investors anticipate a flood of new shares on the market.
In Akamai's case, the stock slid from $84.69 on July 26 to $71.25 on Aug. 1. What's unusual is that only 2.8 million shares--a mere 5% of the total public shares--were unlocked and freed for trading on Aug. 1. The stock rebounded to the mid-70s in a few days, but it has not been above $78 despite the recent strength in technology stocks. Perhaps that's because the market is anticipating Sept. 13, when 58.8 million shares--more than half of Akamai's total--are unlocked.
LOADED GUN. "It's all about fear," says Brad Alford, CEO and founder of IPO Lockup.com, a Web site that tracks lockups. "It's like a gun that's loaded--you don't know if they're going to use it." In the past few months, Alford has observed "alarming dips in value" after lockups expire--as much as 15%. That's something to consider between now and yearend when, according to Carson Group, a New York-based financial data firm, lockup agreements covering 4.8 billion shares of 157 companies are set to expire. No doubt, expirations contributed to last spring's Nasdaq rout, which came six months--the typical lockup period--after last fall's IPO boom.
While it's expected that restricted shareholders will want to sell some of their stock, these investors know that swamping the market would backfire on them by driving the prices down. Founders, executives, and employees are the least likely to sell in large numbers. They're usually in it for the long haul. Their friends and families are more likely to sell, but they're not the biggest shareholders.
The insiders to watch are the venture capitalists--the folks who backed the company as a startup. The greater the proportion of the stock held by venture capitalists, the more likely there will be sales when the lockups expire. "Venture capitalists don't get paid until they liquidate," says Richard Gadbois, a financial adviser at Merrill Lynch.
They can leave plenty of damage behind in their scramble for the exits. Laura Field and Gordon Hanka of Pennsylvania State University studied 1,948 lockup expirations between 1988 to 1997. They found that companies with venture-capital backing suffered an average drop in share value of 2.3% after expiring lockups, vs. just 0.8% for those without venture money. In 1999, the loss was steeper: 6% for venture-backed companies and 1% for others.
Where can you get the skinny on lockups? The company's prospectus--a legal document that must be filed with the Securities & Exchange Commission--spells out the terms. Companies must also file if they change the lockup's terms. With most IPOs, the insiders' shares are restricted and governed by SEC Rule 144. Holders of "144 stock" must file their intentions to sell shares, and have three months from the filing date to do so. They may change their mind and not sell, but then they have to amend their filing. With unrestricted stock, insider shareholders only need to file with the SEC after they've sold.
It's easier to keep abreast of this information by visiting Web sites that track it. And most of these sites provide their research for free. IPO Lockup.com, one of the most comprehensive sites, has a handy calendar marked with ticker symbols on the day a company's lockup ends. Click on a ticker symbol, and the "lockup zone" pops up. That shows the company's share price from four days before the expiration through four days after. The site includes names of the IPO underwriters and insiders, including venture capitalists. The percentage of shares they own is listed, along with the number of shares unlocked, the total outstanding shares, and the number of days they estimate that it would take to absorb the new supply of shares. Carson Group's UnlockDates.com provides much of the same information, and has a free service that will e-mail you alerts on lockups for up to 10 stocks. Alert-IPO.com will send alerts for $34.95 per year.
It really pays to keep an eye on lockup data. After all, investing in newly-public companies in emerging industries is risky enough. The last thing you want is to see your stock swamped because the floodgates were opened.