Can Facebook Get Through Another Lock-up Expiration Quietly?

By Stephen D. Simpson, CFA | November 16, 2012 AAA

Nothing ever seems quite normal when it involves Facebook (NYSE:FB). So it's worth wondering what will happen to the stock as the company, the market and (it would seem) the world at large all deal with another sizable lock-up expiry that will add hundreds of millions of shares to the float. Considering that Facebook recently posted some encouraging financial results, it may be the case that putting this lock-up expiration in the rearview mirror marks the end of the "what's wrong with Facebook?" meme within the financial press.

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Another Avalanche of Shares Slide to Market
Experienced tech investors are already familiar with lock-up expirations, or at least they should be, as pretty much every IPO of any real size or significance has them. Tech companies typically issue millions of shares to employees and venture/mezzanine-stage investors as part of their start-up process, and those shareholders want their chance to cash out and monetize some of that wealth. Given that Facebook stayed private for longer than normal, it's not surprising that there's a larger number of early investors looking to cash out.

Way back in the day, Google (Nasdaq:GOOG) saw about 270 million shares freed up in the first six months (including an IPO that saw about 23 million shares sold to the public). Likewise, more recent entrants into the public markets like Groupon (Nasdaq:GRPN), Zynga (Nasdaq:ZNGA) and Yelp (NYSE:YELP) have all seen sizable lock-up expirations. At Groupon, a 600 million-share lock-up expiration back in June nearly doubled the public float.

Therefore, in some respects, there's not that much that's unusual about what's going on at Facebook. Certainly, the magnitude is different - Facebook has about 2.4 billion shares outstanding as of the last quarter, whereas Google has about 327 million outstanding. Likewise, this latest Facebook lock-up involves over 800 million shares (approximately 60% of the float) and that's a huge number no matter how you look at it. That said, and this is an important point, all of this has been known from the time of the IPO - it's not like the 800 million shares just materialized out of thin air.

Does It Change Anything?
Events like lock-up expirations can highlight some of the discrepancies of theoretical or academic finance and the realities of the actual world in which we all live, invest, and trade. Nothing about the lock-up expiration changes the value of Facebook - investors who weren't already including those shares in the denominator for their value analysis were making a big mistake.

On the other hand, it's ridiculous to think that increasing the float by roughly 60% isn't going to have a real-world impact on prices. The expiration of a lock-up doesn't mean that those shares automatically go to market (it means you *can* sell, not that you *must*), but let's assume that hundreds of millions will do so. With average daily volume of over 50 million shares, those extra shares are going to alter the supply-demand balance in the short-term. We can talk all day long about the long-term "value" of Facebook shares, but the stock market is always a day-to-day supply/demand machine.

Is This Where Things Get Better?
With this major lock-up expiration, things should quiet down significantly enough for Facebook in terms of large amounts of outstanding stock coming into the float. Therefore, it's worth asking if this will be the point where the stock can start building back some value.

The recent quarterly report was certainly encouraging. Not only did overall ad revenue grow 43% (up from 33% in the second quarter), but the percentage of that revenue coming from mobile devices leaped to 20% (from 5% in Q2). In response, the stock saw some upgrades from sell-side analysts, and average estimates have headed up a little bit. Facebook still has a lot to prove regarding its ability to monetize its user base (and head off competition from the likes of Google, Microsoft (Nasdaq:MSFT) and Yahoo! (Nasdaq:YHOO)), but at least the arrow is pointing in the right direction for now.

The Bottom Line
As I said in the intro, there's no such thing as "routine" when it involves Facebook. From a flawed IPO to early worries about the company's strategy to an overall sense that many investors never actually read the S-1 (or bothered to understand how Zuckerberg has run, and will continue to run, the business), this stock has been volatile and controversial from day one.

Although I suspect many of my financial writing peers and competitors have a vested interest in making sure that Facebook stays controversial and always in the news, I am curious to see what the company can actually do as an operating entity. After all, while events like lock-up expirations are not unimportant, what ultimately matters most is how well management can actually run this business for shareholders.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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