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Should Snap Investors Be Worried About Looming Lock-Up Expirations?

By Evan Niu, CFA – Jun 10, 2017 at 10:00AM

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Shares are overvalued and fundamentals are deteriorating. What would you do once your shares were free to sell?

Conventional wisdom suggests that when a freshly public company's lock-up expiration arrives, the stock will plunge, as early investors and employees are then free to unload shares. In some cases, those individuals and funds may have waited years for the opportunity to do so, particularly if they were recruited with hefty equity compensation in the company's private days. That's not always the case (Yelp being the most prominent example of a stock jumping after the lock-up expiration in recent memory), but more often than not, it is.

In a matter of months, Snap's (SNAP 3.21%) IPO lock-ups will expire, and there is a distinct possibility that sellers could flood the market, pushing shares down in the process.

Dice with "buy" and "sell"

Image source: Getty Images.

A tale of two lock-up agreement expirations

Snap has two separate lock-up agreements that are set to expire soon. The first is the standard IPO lock-up, which covers 150 days after the IPO. That means July 29 is the date that investors should mark on their calendar as the day that all 1.16 billion shares that were outstanding as of the end of last year will be free to be sold. In contrast, Snap's float is currently about 404 million, out of 682.1 million Class A shares outstanding. Keep in mind that the 1.16 billion figure above also includes 281.1 million Class B shares and 215.9 million Class C shares, which are only held by insiders and convert to non-voting Class A when the holder opts to sell them. Of those total shares outstanding, 625 million will still be subject to volume limitations under Rule 144, which governs selling restricted and control securities.

There's another batch of shares (already included in the above share counts) that will be freed after 180 days following the IPO (August 29), per the prospectus:

In addition to the restrictions contained in the lock-up agreements described above, we have entered into agreements with certain security holders, including our [investor rights agreement], our standard form of option agreement, and our standard form of restricted stock unit agreement, that contain market stand-off provisions imposing restrictions on the ability of such security holders to offer, sell, or transfer our equity securities for a period of 180 days following the date of this prospectus. 

This is why it was so peculiar when Snap asked some investors to voluntarily commit to a separate lock-up agreement that would prohibit them from selling for a year. At the time, Snap expected that investors collectively holding 50 million shares would agree to it, but it seems that Snap was unsuccessful in extracting these commitments since there's no mention of this agreement in the most recent 10-Q. It doesn't inspire a lot of confidence when Snap is asking new investors, who already get no voting rights whatsoever, to hold on for a year while earlier investors and insiders would be free to cash out within the standard time frame of a few months. Newly public stocks are notoriously volatile and Snap's overvaluation (trading near 45 times sales) will only contribute to that volatility, so a one-year holding period would be incredibly risky.

It's also worth acknowledging that Snap's overvaluation may also tempt investors to sell, particularly the venture capitalists. If shareholders don't see a lot of continued upside, since shares are already overvalued while the fundamentals are simultaneously deteriorating, the optimal decision is to sell. Full disclosure: I'm short via long puts (see disclosure below), so I'm certainly hoping for some selling pressure from the lock-up expirations on the horizon.

Evan Niu, CFA has the following options: long January 2019 $20 puts on Snap Inc. The Motley Fool recommends YELP. The Motley Fool has a disclosure policy.

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