Lockups Become A Harder Game to Play

A total of 153 lockup periods encompassing roughly 3.7 billion shares are set to expire between Jan. 15 and the end of March, according to Thomson Financial/Carson. The bulk of those ? more than 1.92 billion ? will be released in the final 16 days of this month.

Leading the way are communications equipment maker Corvis Corp.

(NNM:CORV), whose Jan. 23 expiration will unlock more than 255 million shares and health-care products producer Bruker Daltonics (NNM:BDAL), whose Jan. 30 expiration will unlock another 455 million shares. The two companies will account for almost 37% of all shares to be unlocked during the remainder of the month.

Understandably, the notion of such an extraordinary number of shares being unlocked has some analysts worried that the law of supply and demand will take its toll on an already battered market. “You can expect a lot of downward pressure,” surmises Dan McCarthy, a market analyst with IPO.com.

But while it may seem logical that when fewer shares are hitting the markets, prices go up, and conversely prices go down when there is an influx of shares, the numbers do not always bear out this logic. For example, during the first three months of 2000, when the markets were pushing upward, there were 208 expirations unlocking in excess of 5.08 billion shares. During the final three months of the year, however, there were only 150 lockup expirations unlocking only slightly more than 2.92 billion shares. Given what happened to the markets during the final quarter of the year, the supply and demand theory seems far from full proof.

Holding On

Of course, just because insiders can sell their shares doesn?t mean that they will. The 16 expirations unlocking nearly 330 million shares have resulted in minimal selling. And with share prices of the many upcoming lockup shares struggling, the possibility that principal shareholders and insiders hold onto their shares is all the more likely. “When new shares are released, that sends a message that underwriters don?t want to send,” says Mark Littenberg, a partner and head of the Internet and New Media Group at Schulte Roth & Zabel, a New York-based law firm.

According to one study authored by professors Laura Casares Field and Gordon Hanka, of Pennsylvania State University?s Smeal Business School, which examined the lockup expirations of some 3,000 companies that went public from 1988 to 1997, the average firm’s stock price lost 2 percent in the week the lockup expired. The loss was 4 percent for companies that had several venture capital investors. “There is a statistically prominent cumulative average abnormal return of minus two percent in the week the lockup agreement expires, about half of which occurs on the unlock day. We find that the result holds over our entire ten-year period and that it is robust to various sample specifications…the average unlock day return is more negative for high-tech firms, but this result is not robust and seems to be related to venture financing. The unlock day abnormal return does not depend strongly on firm size, quality of the underwriter or exchange.”

Not everybody agrees, however, that lockup expirations automatically lead to price volatility. “The empirical data on the effects of lockup expiration on share price are mixed, especially outside of a very short-term horizon,” asserts Paul Elliot, an analyst with FirstCall.

The VC Impact

Elliot also reckons that when there is expiration-related volatility, it is driven by investors looking to “play” lockup expirations ? selling shares sometime before the lockup expires and before the price begins to drop, and then buying shares back immediately after the lockup expires, when prices dip. It may seem like an alluring maneuver, but, Elliot warns: “One effect of the increased preoccupation with lockup expirations is that they are increasingly difficult to game. It?s similar to buying ahead of a Fed rate cut ? if everybody knows its coming and everybody?s doing it, it gets real hard to make a buck.”

“The price drops associated with lockup expirations has gotten larger lately,” says Hanka. He attributed the trend to higher levels of sell-offs by venture capitalists who held shares in the respective companies they held shares in and who are now coming out of lockups. “When there?s not a VC, there?s pretty much no lockup shares being sold.”

The study went on to conclude that venture capital funding is a particularly strong predictor of abnormal returns, “as abnormal returns around the unlock date are three times larger (more negative) among venture-financed firms.”

It?s a sentiment that Elliot echoes: “(VCs) are in the business of cashing out and moving on to the next investment. My experience is that there is no price to low for a venture cap firm to sell.”

Omar Sacirbey can be contacted at Story Feedback.