After soaring in the months following FireEye's (NASDAQ:FEYE) IPO, the stock is more than 70% off its March highs, including a 26% loss on Wednesday. Looking ahead, the stock may be attractively priced given both growth and its fundamentals. But actions on May 21 could send shares crashing lower, and to explain we can think back to similar events with Facebook (NASDAQ:FB) and Twitter (NYSE:TWTR).
Pricey, but growing fast
At one time, FireEye shares traded at a whopping 87 times trailing 12 month sales, which were clearly overvalued. Now, shares are still expensive at 28 times sales, but somewhat understandable given its 100% plus growth.
Hence, many might feel compelled to take a leap of faith and invest in FireEye, especially those investors who feel Internet security companies are poised for many years of explosive growth. But you may want to wait, because on May 21, 68% of its shares will be available for sale.
Here comes the lock-up expiration
For those of you unfamiliar with lock-up expirations, following an IPO there is almost always a period of time where insiders and other early investors are unable to sell their shares. For FireEye, the big date where these shares can be sold is May 21, when 95 million of its 145 million total shares could potentially be dumped on the market.
Clearly, a surplus of shares, or supply, with limited demand will equal a lower share price. In some cases, this can create a formula for disaster. With that said, there are two examples of how this could turn out for FireEye.
The expected scenario
The first, and worst, case scenario is a Twitterlike event. A couple days ago Twitter had an even larger lock-up expiration than what's planned for FireEye, approximately 480 million of its near 570 million shares were available to sell, which translates to 84% of its total.
On this day, May 6, shares fell 18% on significantly higher than normal volume, implying that a large number of shares were in fact sold. But this selling didn't end in just one day, but rather carried on to the following day, as shares fell below $30 for a near 5% loss. Hence, nearly a quarter of Twitter's valuation was wiped out.
An unlikely scenario
With that said, Facebook represents a different and unlikely reaction, as its shares rose 13% back in November 2012 when 804 million shares were available to sell, about 40% of total shares outstanding. Back then, Facebook's 13% rally gave it a stock price of just $22.36; shares are up more than 150% since.
Looking back, there were several reasons that Facebook shares didn't collapse. First, short interest had been rising in preparation of a collapse, and when it didn't occur, short-covering caused the stock to rise. In terms of fundamentals, Facebook's lock-up expiration followed its third-quarter earnings, a period where the company was showing some signs of life in mobile. Lastly, insiders did not sell: CEO Mark Zuckerberg owns the majority of Facebook and clearly saw the long-term value in shares of his company.
Where will FireEye fall?
So, what will happen to FireEye? Clearly, its 68% of shares on lock-up is much larger than Facebook's expiration, and given its very rapid stock collapse, like Twitter, it seems reasonable that insiders might elect to sell shares with the company still pricey relative to fundamentals.
With that said, Facebook shares too traded more than 50% off its highs prior to its lock-up expiration, like Twitter and FireEye. The difference might be that so many of Facebook's shares were owned by one person, and also that Facebook's stock decline was longer lasting, more balanced, unlike Twitter and FireEye, which have both fallen off a cliff.
Therefore, don't be surprised to see a large drop for FireEye on, and perhaps before, May 21.
Interestingly, it wasn't long after Facebook's lock-up expiration that shares began their uptrend. Prior to the lock-up expiration, Facebook consistently traded lower by the day, but in looking back, it almost seems that the expiration served as a weight being lifted off the shoulders of retail investors, thus pushing people to invest with confidence.
Now, will this happen with FireEye and also Twitter? Unfortunately, no one knows. But given the enormous losses in both stocks, combined with very impressive growth rates, investors should feel confident that lock-up expirations for both companies should signal that the road of losses are at least nearing an end. And for long-term investors, this nearing of an end might be all that's needed for long and large gains.
Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Facebook and Twitter. The Motley Fool owns shares of Facebook. 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 Motley Fool has a disclosure policy.