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Investors wary of expiring stock lock-up periods

In sizing up the prospects for today's hot IPOs, many investors are asking, "Where will they be in 180 days?"

In sizing up the prospects for today's hot IPOs, many investors are asking, "Where will they be in 180 days?"

That's because at many companies, a large portion of shares has been doled out to company insiders. These shares typically can't be sold until 180 days after a company's prospectus is issued.

In recent months, the expiration of this lock-up period has sent high-flying shares into a tailspin.

For example, one day in August, Healtheon shares fell more than 21 percent when the company's inside shareholders got their first chance to take profits after the February IPO. The company's shares reached 126 in May but are now at about 33.

Stock in Perot Systems, which quickly jumped to more than 80 a share after it went public in February, today is trading around 16. One reason cited by analysts: In August millions of shares owned by employees and executives became tradable.

Lockups prohibit holders of restricted stock to begin selling their shares until a specified time. The holders of the restricted stock tend to be company executives, early investors such as venture capital firms, and companies that received the restricted stock in lieu of payment for services.

Companies that have issued a large number of shares to insiders, compared with the total number on the market, have a greater risk of plunging when the lock-up period expires. Issues that are thinly traded also are at greater risk.

"If the ratio is 10-to-1, compared with 2-to-1 or 3-to-1, you have increased risk when the lockup expires," said Bob Gabele, editor of Insiders Chronicle. "I don't expect a higher ratio to be a death knell to a stock, but it may underperform with ratios of 8-, 9-, or 10-to-1."

Priceline, for example, has a ratio far higher than 10-to-1. The company floated 10 million shares when it hit the public markets in March. Another 132 million shares are eligible for sale by insiders.

Meanwhile, Sycamore Networks, which had a successful IPO earlier this month, floated 6.5 million shares and has 52.8 million eligible for sale after its lockup expires, Gabele said.

Compare that with Martha Stewart Living Omnimedia's IPO. The "queen of how-to tips" floated 7.2 million shares recently but will have only 7.1 million eligible for sale once the lockup expires.

Although it's highly unlikely that all shares will be dumped once a company's lockup expires, investors can typically expect 10 percent to 15 percent of shares to be sold, Gabele said. In Priceline's case such a scenario could translate into more than double the number of shares on the market. Some analysts say that concern is partly to blame for the pressure on Priceline's stock.

"The market has been going up, so a lot of these companies won't see a large number of these shares come out. But if market goes down, the perception is that more of the restricted stock will be sold," Gabele said.

In addition to weighing the ratios, investors also should consider the liquidity of the stock, said Craig Columbus, an analyst with Disclosure, a research firm that specializes in insider sales. He noted that thinly traded stocks get hurt the most when the restricted shares are set free to hit the markets.

During the past year, investors have been keying into the lock-up expiration dates in determining when to unload their stock, analysts say.

"It started to become much more in vogue in the last year," Columbus said. "It's because many new issues have been coming onto the market. A lot of them had early run-ups, so profit-taking was to be had."

And the practice does not appear to be on the wane.

"Once something becomes ingrained in the mind of the investor, it's hard to create a sea of change," he said.