By Benjamin Pimentel /Dow Jones
Investors in once-hot social media stocks such as Facebook Inc, Zynga Inc and Groupon Inc have received some painful lessons on the effects of supply and demand, which analysts say may hurt other Web firms contemplating an initial public offering.
A man walks past a monitor displaying the Facebook website in Tokyo (file). Facebook fell to a record low, losing almost half its value since an initial public offering in May, after the lifting of restrictions on share sales by its biggest investors. Shares in the world’s largest social-networking service fell 4.1% to $19.05 at the close in New York on Friday
Facebook slumped more than 6% on Thursday, as about 271mn of the company’s shares emerged from what is known as a post-IPO lockup. The stock slipped below the $20 mark to set a record low by the close.
Worries about the expiration of lockups, which prevent certain shares from being sold on the open market until a fixed date following the debut, have been widely cited as one significant factor in Facebook’s sharp decline of more than 47% from its IPO price in mid-May. Groupon and Zynga also are trading at a fraction of their original valuations, with lockup concerns cited as a factor in those declines as well.
Some analysts say investors may be more wary of future social media deals that have relatively short lockup periods.
“I would caution investors in the future to look carefully at early lockups,” Scott Sweet of IPO Boutique said in an interview. “It reeks of danger. And I think we’ve seen this danger several-fold here.”
Morningstar analyst James Krapfel said, “I think investors will take a much closer eye to any future social networking IPOs in light of what has transpired at Groupon, Zynga and Facebook.”
Facebook could take more hits in the coming months. More than 1.3bn shares will come on the market before the end of the year, with a big wave, roughly 1.22bn, expected to hit November 14.
A Citigroup analysis found that with Thursday’s lockup expiration, the size of Facebook’s float, or the amount of shares available for trading, jumped 42%. By the time the big November lockup expires, the size of Facebook’s float will have surged by nearly 280%.
“It is a major concern,” Sweet of IPO Boutique said. “If the amount was a small percentage-which in this case it’s not-it wouldn’t matter... What’s considered an overhang is that investors know that more shares are coming, and the company needs a major catalyst to offset that negative influx that’s forthcoming.”
But finding such a catalyst has been aggravated by the fact that Facebook’s controversial public debut was followed by concerns about its ability to grow its business, particularly in mobile advertising.
Morningstar’s Krapfel said “there is a good chance lockup expirations in three and six months from now will lead to similar sell-offs, as most shareholders have a cost basis that is well below the current Facebook stock price, despite the nearly 50% sell-off since its IPO.”
However, Wedbush analyst Michael Pachter offered a different take.
“I have a hunch that this is not the lockup sellers selling, it’s holders succumbing to media hype,” Pachter said on Thursday about the drop on Facebook’s shares.
“The selling stockholders got $12bn in the IPO, so they don’t exactly need the money,” he added. “This is not them, this is spooked shareholders trying to figure out what to do. If the price holds at $20, it will go back up in the next few days.”
Pachter, who has an outperform rating on the stock with a price target of $35, has argued that $20 “is a psychological barrier” for Facebook’s stock.
Still, Facebook’s decline follows other examples of unlocking pain for social media firms, which highlight the strikingly downbeat investor sentiment on the social networking sector. Shares of Zynga shed 8% in late May when the lockup on more than 300mn shares expired. Groupon’s stock tumbled 9% on June 1 on the lockup expiration for more than 600mn shares.
Facebook’s stock has fallen by nearly half since its IPO in May, when it priced at $38. Groupon has plunged 75% from its IPO price of $20, while Zynga has plummeted 70% from a public debut price of $10.
Sweet of IPO Boutique was critical of what he said was a relatively short lockup period for Facebook. The first major wave of 271mn shares unlocked Thursday comes about three months after Facebook’s controversial public debut.
“Normally, I would say anything earlier than 180 days should be a red flag,” Sweet said. “It puts a very heavy overhang” on the stock.
Pachter of Wedbush also noted that “normally, all of the shares don’t unlock in the first 180 days,” adding, “This seems pretty compressed.”
Krapfel of Morningstar also said many companies “whose valuations have soared in recent years, lock-up expirations reliably lead to short-term selling pressure.”
“Future IPOs can be structured to have more staggered lock-up expirations, to prevent outsized selling pressure in any given period,” he said.
He also said the majority of IPOs have lockups of around 180 days after the trading debut. However, some underwriters have been known to waive the lock-up expirations, he added. He noted how some Zynga insiders, including chief executive Mark Pincus, “were allowed to sell early through a March secondary offering, before the stock sell-off took hold.”
“We think rules should change so that insiders must adhere to the original lockup expirations, and be allowed to sell no earlier than other investors and lower-level employees,” Krapfel said.
He added: “We find it quite despicable that Zynga executives were allowed to sell early, cashing out at a valuation they likely saw as fleeting given their insider knowledge of underlying trends.”
Representatives for Facebook and Groupon said their companies had no comment for this story. There was no immediate comment from Zynga.