Snap Inc (NYSE: SNAP) made its highly anticipated IPO debut on Thursday. Whenever such a large tech company goes public, it’s an important milestone in the company’s history and an occasion to celebrate for insiders and investors.
But a stock’s first trading day also serves as a transition point. Once that first public trading session is over, investors should turn their attention to the next big date that looms over any large IPO: lock-up expiration.
Most IPOs have a lock-up period ranging anywhere from 90 to 180 days after the IPO date. During that time, insiders, majority shareholders, and anybody else who had access to the stock before it traded on a public exchange are restricted from selling their shares of the stock on the public market. The purpose of the lock-up period is to reassure new public investors that they will not be buying into the stock at the same time a flood of company insiders are dumping their shares en masse. Once the stock has a period of time to stabilize on the public market, the lock-up expiration allows insiders to begin cashing out of their holdings, if they want.
The reason why IPO investors should be concerned about lock-up expiration is because stocks, like any other asset in a free market, are priced based on supply and demand. Once insider shares are no longer restricted, a stock’s float (public market supply) dramatically increases. Of course, this expiration only becomes an issue if insiders actually sell their shares, which they often do not. But the risk of insider dumping can be a bit higher at tech companies like Snap, where so many of the insiders are relatively young and may have a hard time resisting the temptation to become instant multi-millionaires.
Much like any other major market catalyst, lock-up expirations can be difficult to trade around. When Alibaba Group Holding Ltd (NYSE: BABA)’s largest lock-up expiration took place, the stock tumbled 2.7%. But the lock-ups are planned well ahead of time, so stocks also tend to be weak headed into expiration dates. Alibaba, for example, plummeted nearly 30% in the year ahead of its lock-up expiration. Once the expiration had passed, the subsequent “relief rally” drove Alibaba shares 65% higher in the year that followed.
Facebook Inc (NASDAQ: FB) demonstrated a similar trend. In the six months leading up to Facebook’s largest lock-up expiration, shares plummeted 48%. On the day of the expiration, the stock jumped 11%.
However, Facebook and Alibaba’s lock-up trading pattern doesn’t always hold true. Twitter Inc (NYSE: TWTR), for example, gained 24% in the six months heading into its largest lock-up expiration only to see shares immediately plummet 18% on expiration day.
Traders looking to trade the Snap lock-up should pay attention to how the stock trades headed into the expiration and whether or not there is a wide-scale exodus on the day of the expiration. If not, it could serve as an excellent buying opportunity.
The first key lock-up date for Snap will occur roughly 150 days following the IPO. At that point, pre-IPO investors, such as company insiders, will be allowed to sell their shares. The second major lock-up date applies to 25% of the shares that were offered in the IPO itself. Of the 200 million total IPO shares, 50 million of the shares will be restricted for one year.
Disclosure: the author is long BABA.
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