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Stock Lock-Ups at Facebook Cause Falling Share Prices

This article was written by in Investing. 5 comments.

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Early investors in Facebook’s stock — mostly venture capital investors, in this case, not employees — were finally allowed to sell their shares yesterday. Many did; trading volume for Facebook on Thursday was significantly higher than it has been any day since the day following the company’s initial public offering. The stock opened much lower on Thursday and even lower today. The stock value has shrunk almost 50 percent since the IPO.

The precipitous decline positioned Facebook as the second worst-performing IPO ever, behind only the company’s partner in crime (so to speak), Zynga.

FacebookFacebook’s employees are effectively (or rather, ineffectively) staring at the frenzied market activity from behind a glass window. They have been and are witnessing the precipitous decline of the value of the trusted company that not only drives their wealth through ownership of shares or stock options but also drives their income. A large market devaluation of their company could result in management decisions that affect their salaries in an effort to save money, cutting costs in response to analysts’ criticisms. Tying up wealth and income into one stock while being restricted from selling is a risky situation. Yes, early employees with stock benefits could become very wealthy, but the farther any employee is away from Mark Zuckerberg’s closest circle of confidence, the less likely that is.

Perhaps a good rule of thumb is not to invest too much of your wealth in the company that you also rely on for your salary. Rules like these are often bent when one is part of an exciting start-up. The risk of losing everything is ignored when there is a potential of getting stinking rich. That’s why venture capitalists are eager to get into promising companies early in their development stages. With Facebook, the air of early investment carried into what was actually late investment. Even long-time Facebook employees are for the most part not included in this special class of privileged investors.

The pain for employees is sure to continue. Several more stock release days are scheduled through the end of the year, and they continue to next May. On Thursday, 13 percent of Facebook’s shares, a total of 271 million, suddenly became eligible to be sold. This flooded the market, increasing supply while demand stagnated. That will likely be the pattern repeated at each following release day. This 271 million potential share dump is dwarfed by the potential remaining in 2012. By the end of December, an additional 1.4 billion shares will no longer be locked up, including the CEO’s own investment.

November 14 is the big day. Out of the additional 1.4 billion shares potentially re-entering the market, 1.2 billion will be released on that day. If you think Facebook is a company worthy of your investment, and you don’t think the next three months will be that important to Facebook’s growth, you might want to wait until after that day to invest in the company. Timing the market is always a dangerous proposition, but this looks like a simple question of supply and demand. Is it possible for Facebook to do anything that might increase demand for its stock before a massive potential sell-off in November?

Investors might naturally draw comparisons between Facebook, as a large technology-focused company, with Google, a company that arguably influenced technology. The comparison may not be apt because Google went public in what have been an earlier point in its development, while Facebook was relatively mature when the company offered shares to the public. Google, for the most part, grew consistently. There may have been times where the stock price had been flat, but the company never lost a significant amount of value when investors had the opportunity to sell en masse.

When it comes to choosing stocks, investing in what you know makes sense. With millions of Facebook users able to buy the company’s shares, it seems like a natural investment. I use gasoline when I commute, and I know lots of other people rely on gasoline to live their lives and conduct their businesses. Based on this, oil companies make good investments. I’m not sure if the same theory applies to Facebook, however.

  • Facebook has almost 1 billion active users. That’s only slightly less than the total population of developed nations throughout the world. Add in developing nations, also candidates for relying at least somewhat on gasoline, and the market for fuel is significantly higher.
  • While people rely on gasoline to live their lives, most would be able to survive without Facebook. While for many people, the extent of social interaction has deteriorated from talking face to face, through increasing levels of technology like telephones and email, on its way to instant messages tied to Facebook, life would continue without too much inconvenience if Facebook were to suddenly disappear.
  • Fads can be fickle. The favorite search engines changed over time. In the earlier days of the World Wide Web, Webcrawler was the best search engine. AltaVista eventually became the reigning champion in terms of search quality. Google penetrated this market, and stayed. With social connecting and networking, Friendster was an innovator. MySpace supplanted Friendster, which quickly disappeared. MySpace put up more of a fight, but Facebook quickly became favored among those making the social media decisions. Facebook could be ousted at some point in the same way Friendster and MySpace were, but the user base may have passed a critical level that makes such an overthrow unlikely.

If Facebook is here to stay, its long term value can’t be denied. The problems with its revenue structure can only be temporary. With its advertising failing, Facebook is turning to other strategies for earning money for its users, like making itself a payment processor. If Visa and MasterCard and the banks they partner with can skim a few percentage points off every financial transaction, there’s a potential there for Facebook, as well. If, however, the focus on revenue drives Facebook users away, the company will eventually fail.

Regardless of Facebook’s ultimate destiny, the next few months, at times when the supply of shares will be inflated, the company’s performance will be rocky. Maybe these blips, the dates around the various lock-up releases, will be buying opportunities for those who believe Facebook has reached a point of complete world domination in the social media business.

Bloomberg, Wall Street Journal

Published or updated August 17, 2012.

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About the author

Luke Landes is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about Luke Landes and follow him on Twitter. View all articles by .

{ 5 comments… read them below or add one }

avatar 1 Anonymous

Good point about drawing from the same well when it comes to salary and investments… especially in the tech sector, where fortunes can be (and have been) fleeting. The smart investors sold a chuck of their stock early to lock in some gain, so even if the stock tanks, they’re a few million to the good. Nice problem to have, if you can find it, to paraphrase that old song.

I’ve always avoided faddy IPOs. MOst of the time I lost out on good things like Priceline and Amazon, but other times I dodged a bullet. It’s like Warren Buffett says: rule #1 = don’t lose it. :)

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avatar 2 Anonymous

Facebook management has virtually no experience dealing with stockholders, analyst, public watchdogs, hedge funds or short sellers. Both Enron and WorldCom went down because they were focused so much on their stock value that they did stupid, illegal, and ultimately destructive things to their business. I would approach any Facebook investment strategy very very carefully and watch for signs of any over-reliance on stock value or acquisitions in support of growth.

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avatar 3 qixx

Is there anything you know of from the Zynga IPO to help determine if mid-November would be a good time to actually invest in Facebook? Seems like that would be the point when the supply will reach it’s highest and demand seems to be next to nothing. Should make the cost almost nothing. I’d actually think Facebook would be a good stock for future reverse splits.

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avatar 4 wylerassociate

I thought the facebook IPO was just ridiculous hype to begin with especially having CNBC create this silly weeklong hype machine to that friday IPO. I won’t invest in facebook because it isn’t a good investment. The only social networking stock that I would buy is LinkedIn because they serve a purpose in networking, tips for professionals, & looking for new jobs.

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avatar 5 Anonymous

I don’t plan on buying shares of Facebook. I agree with wylerassociate that LinkedIn would be a better investment because it serves a purpose, much like your gasoline analysis.

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