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Facebook's Plunge Is Only the Beginning

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The Facebook (Nasdaq: 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 (NYSE: 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 (NYSE: 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 (NYSE: YELP  ) and Splunk (Nasdaq: 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.

Be patient
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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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.


Read/Post Comments (3) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 22, 2012, at 9:06 PM, hheiserman wrote:

    Dan - Excellent advice. Thanks for sharing. Hewitt

  • Report this Comment On August 23, 2012, at 9:56 AM, FoolishLonghorn wrote:

    This endless fascination with Facebook stock is amusing.

    Motley Fool encourages investors to take a step back when evaluating investments. Ignore the media and the experts. Evaluate a stock based on fundamentals, not the talking heads.

    Facebook is an interesting company. There is a good chance it will continue to grow and a lot of opportunities for increased earnings.

    On the other hand, there is so much froth and hype, initially positive but now very negative, that the stock price has little to do with company fundamentals.

    Until stories on Facebook stock fail to show up daily at this website as well as other financial websites, I have no interest at all in Facebook as an investment, either short or long.

    However, the entertainment value in all of these articles should not be under estimated.

  • Report this Comment On August 23, 2012, at 10:08 AM, Winfield31 wrote:

    I think they sensed disaster and perpetrated it. First almost doubling the float right before they went public and the staggered vesting for initial investors, plus do they even make money? Some are more experienced then others http://twitter.com/lefkofsky

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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