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JFrog's Recent Stock Decline Is Just Short-Term Noise

By Leo Sun - Dec 1, 2020 at 8:15AM

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The company just freed up a quarter of its insider shares for public trading, but investors shouldn't assume all those shares will be sold.

JFrog's ( FROG 8.95% ) stock dropped on Nov. 23 after the software company granted an early lock-up release for 25% of its ordinary shares, but the stock subsequently rebounded over the following days.

Let's take a look at why JFrog freed up its locked-up shares ahead of schedule, why that decision caused its stock to drop, and whether or not it should influence our long-term view of this high-growth company.

What's an early lock-up release?

When a company goes public, its insiders and private investors are usually barred from immediately selling their shares. That "lock-up" period typically lasts for 90 to 180 days, and prevents big investors from flooding the market with shares and driving the price down for new retail investors.

Letter blocks spelling "panic" turned over to spell "calm".

Image source: Getty Images.

When JFrog went public in September, it stated that 88% of its ordinary shares would remain locked up for 180 days. However, it also struck an agreement with its underwriters in which 25% of its shares could be unlocked if "certain price and other conditions" were met.

Those exact conditions weren't publicly disclosed, but they likely required JFrog's stock to remain above a certain price and maintain adequate trading volumes before insiders could sell some of their shares.

The agreement initially required JFrog to meet those conditions "on or after" Dec. 14. But that day coincides with JFrog's blackout period -- during which insider sales are banned -- ahead of its next earnings report. As a result, the date was moved up to Nov. 20, and 25% of the locked-up shares were freed up for public trading on Nov. 25.

Does this early release affect current investors?

When JFrog's stock fell on Nov. 23, the decline wasn't caused by the actual lock-up release, which happened two days later. Instead, investors sold the stock on fears that insiders would dump their shares.

However, the stock rebounded and actually rallied 12% on Nov. 25, so insiders weren't eager to take profits, even after the stock rose over 50% from its IPO price of $44 per share.

That's a positive sign since many new stocks decline after their lock-up periods end. Facebook's ( FB 1.55% ) stock, for example, dropped to a record low of $19.87 in Aug. 2012 after its lock-up period ended -- compared to its IPO price of $38. But that drop also proved to be a rare buying opportunity for long-term investors, since Facebook's stock now trades at over $270 per share.

Therefore, JFrog's leap on Nov. 25 is an encouraging sign, and suggests both insiders and retail investors are bullish on the stock's prospects.

But is JFrog priced for perfection?

Many investors are bullish on JFrog because it's a high-growth silo-busting company that centralizes data for fragmented businesses.

Large companies often install a wide range of software across different computing platforms and services, and manually updating that software is tedious, time-consuming, and prone to human error. JFrog's core product, Artifactory, stores those updates in a universal repository that can be accessed by any computing platform. It then automates those updates with its continuous software release management (CSRM) system.

A laptop tethered to cloud services.

Image source: Getty Images.

JFrog's streamlined approach is disruptive, and about 75% of the Fortune 500 companies now use its services. Its revenue rose 65% to $104.7 million last year, and it narrowed its net loss from $26 million to $5.4 million.

In the first nine months of 2020, its revenue rose 46% year over year to $108.1 million, but its net loss widened from $5.2 million to $5.7 million. For the full year, it expects its revenue to rise 42%-43%.

JFrog's business still looks healthy, but it faces competition from bigger companies like IBM's Red Hat, Amazon Web Services (AWS), and Microsoft's Azure. Its trailing 12-month net retention rate, which measures the year-over-year spending growth in its existing customers, also dipped from 142% at the end of 2019 to 136% at the end of the third quarter.

Those challenges, along with its slowing revenue growth and lack of GAAP profits, make JFrog's stock look pricey at over 40 times this year's sales. In other words, JFrog's stock was priced for perfection and some investors were likely itching to take profits, so the early lock-up release triggered some panic selling.

But it's all just short-term noise

In the end, JFrog's early lock-up release is really just short-term noise. It didn't dilute its existing shares like a secondary offering would, and the company's insiders didn't seem eager to cash out. There are still plenty of reasons to sell JFrog's stock, but it's futile to fret over lock-up periods.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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