11.14.12

Early Investor Lockup Expires, But Facebook Gains Anyway

More than 800 million shares of Facebook came on the market today. Matthew Zeitlin explains why the stock had one of its strongest days.

Facebook is one of the most widely observed and discussed stocks in the world, even though it just went public in May. Since falling by more than 40 percent from its IPO price of $38, Facebook today closed at $22.36, up $2.50, or just more than 12 percent, on the day.

But why does this one day of trading matter for the long-term success of the company—and, perhaps more importantly, the market’s perception of its future profitability? That’s because today, some 804 million shares held by early investors were freed up for sale.

These limits on when initial shareholders and employees are allowed to sell are designed to reassure later investors that there won’t be a stampede of early sellers that will drive down the stock price. Even if these initial investors and employees are not particularly pessimistic about the company’s future prospects, they may just want the money immediately and bring down the price too low. One major Facebook shareholder who is not affected by any lockup expirations is CEO and founder Mark Zuckerberg, who promised in September not to sell any of his Facebook stock for at least a year.

Past lockup expirations, even though they were considerably smaller than today’s release of more than 800 million shares, resulted in sizable declines in  Facebook’s stock price. When insiders were first able to sell nearly 271 million shares on Aug. 16, the stock hit a low of $19.69 that morning before closing at $19.87, a 6.3 percent decline for the day. One of the most notable sellers was Peter Thiel, the company’s first major investor. He offloaded 20.1 million shares after the first lockup expired, netting him just under $400 million. The second lockup expiration, when 234 million shares were made available, came just before Hurricane Sandy closed down the stock market, but the stock still dropped when markets opened again on Oct. 31.

Just this Monday, Facebook stock declined to $18.87 in intraday trading on concerns about the lockup expiring. But today, instead of seeing the 5 or 6 percent drop one might expect from previous expirations, investors held steady. And even though the volume of trading this morning was very high, the stock still gained value, outperforming the Dow, the NASDAQ, and an index of technology stocks.

The other reason why this lockup expiration didn’t result in a sell-off could be genuine optimism about Facebook’s profitability.

Some market analysts attributed the buying to pent up demand for Facebook, which some traders think has reached a bottom in terms of its stock price. If that were the case, more stock available at the current price would lead to more buying. When the market (and early investors) were more pessimistic about Facebook’s stock price, more stock just meant more opportunities to sell, which lead to those large one-day dips.

The other reason why this lockup expiration didn’t result in a sell-off could be genuine optimism about Facebook’s profitability. Its third-quarter earnings, released late last month, beat expectations and showed steady revenue growth and a user base quickly shifting to mobile phones. If stock markets really were efficient, the effects of these lockup expirations could be “priced in.” And as a result, there wouldn’t be so much volatility on the actual days the shares became available. If investors really think Facebook’s future earnings will be higher, they should have bought accordingly, regardless of the lockup. Same with those Facebook bears who sold on the first two expirations.

But here’s an alternate explanation. Maybe the stock went up because Facebook’s prospects look pretty good. If there’s one company whose very real success (being by far the largest social network in the world) is constantly overlooked in favor of an obsession over the day-to-day moves of its stock, it’s Facebook. (The behavior of its stock is catnip for journalists and CNBC bookers because it moves so sharply in response to any news—even a lockup expiration that has been known about for months.) Now if only Facebok could figure out a way to get people to pay attention to mobile ads. That would be a real story.