Lock ’em up: How share sell restrictions are coming back to haunt high flying IPOs
Beyond Meat Inc.’s stock shed more than 20 per cent of its value on Tuesday when the meat alternatives company became the latest in a series of 2019 IPOs to experience a deep sell-off after the expiration of a share lock-up.
Returns for the 2019 IPO market continue to suggest that investors are now exhausted by the number of so-called “unicorns” that hit the market this year to widespread fanfare. Companies such as Beyond Meat, Zoom Video Communications Inc. and Crowdstrike Holdings Inc. raced out to strong starts and easily doubled their IPO prices before falling back to earth. Others such as Lyft Inc., Uber Inc. and SmileDirectClub Inc. stumbled out the gate.
Regardless of how investors greeted them upon their arrival, the expiration of the share lock-up period — during which certain insiders and early investors are prohibited from selling shares following the IPO — has been an unusually severe momentum-draining obstacle for many of the companies.
After declining for weeks leading up to its lock-up expiration, Zoom Video has lost an additional seven per cent in the two weeks since, while Lyft has lost nearly 25 per cent since Aug. 14, when it surprised investors by announcing it had moved up its lock-up expiration date to Aug. 19 — one month earlier than expected.
Despite delivering its first quarterly profit — beating analyst expectations — and raising its revenue outlook when it posted its third-quarter earnings Monday, Beyond Meat wasn’t able to avoid the same downward pressure when its share lock-up expired Tuesday. The El Segundo, Calif.-based company has now lost 65 per cent of its share value since reaching its high of US$239 in July.
“With all of these companies, the issue is about valuation,” said Jay Ritter, a professor at the University of Florida who researches IPOs. “It was really difficult for me to justify (Beyond Meat’s) valuation at the peak given other long-established food companies were also developing meat substitutes.”
Companies such as Beyond Meat, Zoom Video and Crowdstrike all launched their initial public offering with tight floats, meaning that only a small percentage of each of their shares were placed on the market. The upward momentum, in part, could be attributed to high demand for low supply.
When lock-up periods expire and the remaining shares hit the market, the momentum reverses. The flood of supply begins to outweigh the demand and puts downward pressure on share prices.
According to Ritter, there has historically been a predictable drop associated with lock-up periods expiring. In the 1990s, IPOs that were not backed by venture capital declined an average of one per cent while those that did have VC ownership declined an average of three per cent. Between 2001 and 2011, those numbers decreased to average drops of zero and two per cent respectively.
Do you want to have (a sell-off) happen 180 days after the public debut or do you want it to happen all at once?
Triton Research co-founder Rett Wallace
Hedge funds and short sellers know that that drop is coming, Ritter said, and tend to contribute to it by increasing their short exposure to a name in anticipation of its lock-up expiration. On Monday, Beyond Meat was the most expensive U.S. stock to short, according to S3 Partners data, which attributed a hefty 92 per cent borrow fee to the company along with a total short interest of $560 million. After the drop on Tuesday, short sellers increased their positions by US$110 million.
In advance of its lock-up expiration in December, Crowdstrike has amassed US$353 million in short interest.
Matthew Kennedy, senior IPO market strategist at Renaissance Capital, said the downward move is fairly common after lock-up periods expire but suggested that most of the individual cases could simply be a “blip.”
“More often, the lock-up expiry doesn’t have such dramatic impact on the stock price,” said Kennedy, who referred to Beyond Meat’s single-day drop as being “more dramatic” than that of Lyft, Pinterest and Zoom Video. While each of the three is in the red since their share lock-ups expired, Lyft and Pinterest only fell 1.51 per cent and 1.35 per cent respectively on the day of expiration.
Much of the action, Kennedy insists, is being taken by private market investors who had their shares frozen and are looking to guarantee profits by cashing out. That exodus combined with the fears of retail investors surrounding lock-up expiration have led to names such as Beyond Meat trading closer to what he considers their fair value.
The lock-up may appear to have a negative effect on stocks, but Triton Research co-founder Rett Wallace said it’s crucial for an IPO to include one. It allows companies to put their focus on the launch itself and on establishing a long-term shareholder base without worrying about how many private market investors are going to dump the stock, he said.
“The nerdy academic thing to say is this is why we have lock-ups,” Wallace said. “Do you want to have (a sell-off) happen 180 days after the public debut or do you want it to happen all at once?”