There's nothing in the investment world quite like the excitement around a hot company's initial public offering. High-profile IPOs fire the imagination and make some investors -- pros and amateurs alike -- desperate for shares at any price. That's never a good basis for an investment decision, but sometimes the stock does so well that it works out for all concerned.
Buying into IPOs can be a challenge. Actually participating in the offering (and getting shares at the offering price) means having a good relationship with your broker, and that may mean having a hefty account balance. And even then, with a popular IPO, whether you get shares may come down to luck.
Investors new to IPOs are sometimes taken by surprise by big moves in the weeks or months following the initial offering. Some of those moves, though, are driven by a couple of different kinds of predictable events -- events that every investor should know how to anticipate.
First the pop ...
Did you watch the Dunkin' Brands
GM notwithstanding, investors tend to like (most) IPOs, but these "pops" are no accident. Nowadays, a big first-day rise is a carefully engineered event. The investment banks that manage the IPO process use a number of tactics to create that "pop" and give the stock every chance of appreciating significantly in the critical first few days and weeks of its life. One of those is the lockup period, during which major shareholders (such as a company's senior executives, founders, or early investors) are prohibited from selling any of their shares for a specific time, typically 90 to 180 days after the IPO.
The lockup keeps the supply of shares fixed during the initial buying rush, helping (at least in theory) to drive the price up. But investors in those brand-new shares need to be aware of the length of the company's lockup period, because its expiration can sometimes bring heavy selling pressure on a stock.
... then the unlock ...
This is true even when insiders aren't selling heavily -- the expectation can be enough to generate significant selling pressure. Shares of electric-car start-up Tesla Motors
This may sound like no big deal -- and for some stocks, it isn't -- but sometimes the selling around a lockup expiration can puncture the bubble of hype that had been keeping a newly public stock at high levels. Despite making steady progress on its business plan, Tesla is still trading around $28 seven months later, and $32 seems a long way off.
... then they come back for seconds.
Similarly, a secondary offering, in which an additional batch of not-yet-public shares is introduced to the market, can create heavy selling pressure that endures for a while. Secondary offerings happen for a number of reasons: A big early investor may decide to cash out, or the company may decide to take advantage of a strong market to raise additional capital.
As with a lockup expiration, just the announcement of a coming secondary offering can drive share prices sharply downward. Shares of Bridgepoint Education
That's a big hit, but Bridgepoint's offering is huge, and the proceeds won't benefit the company. A smaller secondary offering from Annaly Capital
The upshot
As with so many things in investing, the extent to which these dips matter ultimately comes down to fundamentals. Annaly and Bridgepoint both look like fairly strong companies, and their shareholders should take these dips in stride -- or consider using them as a buying opportunity. But for investors in high-flying IPOs like LinkedIn's, Tesla's example should be food for serious thought.
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