Think That IPO Was Great? Think Again.

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There's nothing in the investment world quite like the excitement around a hot company's initial public offering. High-profile IPOs fire the imagination and make some investors -- pros and amateurs alike -- desperate for shares at any price. That's never a good basis for an investment decision, but sometimes the stock does so well that it works out for all concerned.

Buying into IPOs can be a challenge. Actually participating in the offering (and getting shares at the offering price) means having a good relationship with your broker, and that may mean having a hefty account balance. And even then, with a popular IPO, whether you get shares may come down to luck.


Investors new to IPOs are sometimes taken by surprise by big moves in the weeks or months following the initial offering. Some of those moves, though, are driven by a couple of different kinds of predictable events -- events that every investor should know how to anticipate.

First the pop ...
Did you watch the Dunkin' Brands (NAS: DNKN) IPO last week? Were you surprised when the stock "popped" 47% on the first day? Or when LinkedIn (NYS: LNKD) closed up more than 80% on its first day of trading back in May, far beyond most sensible valuations? Heck, even damaged oldGeneral Motors (NYS: GM) managed to gain almost 4% on its first day back on the NYSE last year.

GM notwithstanding, investors tend to like (most) IPOs, but these "pops" are no accident. Nowadays, a big first-day rise is a carefully engineered event. The investment banks that manage the IPO process use a number of tactics to create that "pop" and give the stock every chance of appreciating significantly in the critical first few days and weeks of its life. One of those is the lockup period, during which major shareholders (such as a company's senior executives, founders, or early investors) are prohibited from selling any of their shares for a specific time, typically 90 to 180 days after the IPO.

The lockup keeps the supply of shares fixed during the initial buying rush, helping (at least in theory) to drive the price up. But investors in those brand-new shares need to be aware of the length of the company's lockup period, because its expiration can sometimes bring heavy selling pressure on a stock.

... then the unlock ...
This is true even when insiders aren't selling heavily -- the expectation can be enough to generate significant selling pressure. Shares of electric-car start-up Tesla Motors (NAS: TSLA) dropped from over $32 to near $25 in the days leading up to its lockout expiration in late December, a drop fueled more by anticipation than reality.

This may sound like no big deal -- and for some stocks, it isn't -- but sometimes the selling around a lockup expiration can puncture the bubble of hype that had been keeping a newly public stock at high levels. Despite making steady progress on its business plan, Tesla is still trading around $28 seven months later, and $32 seems a long way off.

... then they come back for seconds.
Similarly, a secondary offering, in which an additional batch of not-yet-public shares is introduced to the market, can create heavy selling pressure that endures for a while. Secondary offerings happen for a number of reasons: A big early investor may decide to cash out, or the company may decide to take advantage of a strong market to raise additional capital.

As with a lockup expiration, just the announcement of a coming secondary offering can drive share prices sharply downward. Shares of Bridgepoint Education (NYS: BPI) took a 12% hit last Monday after the company notified the SEC that its biggest investor was planning to sell.

That's a big hit, but Bridgepoint's offering is huge, and the proceeds won't benefit the company. A smaller secondary offering from Annaly Capital (NYS: NLY) , a real estate investment trust that trades mortgage-backed securities, helped drive share prices down about 4% over several days, but the company plans to invest much of the offering's proceeds, which should create more value for shareholders over time.

The upshot
As with so many things in investing, the extent to which these dips matter ultimately comes down to fundamentals. Annaly and Bridgepoint both look like fairly strong companies, and their shareholders should take these dips in stride -- or consider using them as a buying opportunity. But for investors in high-flying IPOs like LinkedIn's, Tesla's example should be food for serious thought.

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At the time this article was published Fool contributor John Rosevear owns shares of GM and Bridgepoint Education. The Motley Fool owns shares of Bridgepoint Education and Annaly Capital. Motley Fool newsletter services have recommended buying shares of GM. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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