THE CUTTING EDGE: FOCUS ON TECHNOLOGY : California Dealin’ : ‘Lockup’ Fears May Hit IPOs Harder Than Actual Sales

As if shareholders of such beaten-down California Internet stocks as EToys and Autoweb.com haven’t suffered enough, they may soon face another headache: the potential for large stock sales by top executives and other corporate insiders.

In the next few months, a number of dot-com companies that had their initial public offerings early this year are scheduled to remove self-imposed prohibitions--known as “lockup” agreements--that have kept insiders from selling their shares.

Lockups are promises by company insiders, such as managers, directors, employees and large investors, to refrain from selling shares in the first few months after the company’s IPO.

They’re usually required by Wall Street underwriters, which want them in place to preempt IPO investors’ fears that insiders could depress a stock’s price by dumping their sizable holdings immediately.

But most lockups expire six months after an IPO. That gives insiders--some of whom have worked at modest salaries to secure lucrative stock and options--their first chance to cash in.

“We know shares do come out at that time, and in some deals it’s a race to see who can get out first before there’s an effect on the stock,” said William Smith, manager of Renaissance Capital’s IPO fund in Greenwich, Conn.

Internet companies from California and elsewhere whose lockups expire this month include AutoWeb.com, Priceline.com, IVillage, Cheap Tickets, About.com, Salon.com and Autobytel.com, according to Renaissance.

October’s lockup expirations will include Ariba and Razorfish. November will see a slew of lockups ending, including Internet “backbone” companies Copper Mountain Networks and Redback Networks, as well as TheStreet.com, EToys and Barnesandnoble.com.

The central problem with lockup expirations, of course, is that they can place a huge amount of new stock on the market. In some cases, a stock’s float--the number of shares in public hands and available to be traded--can jump by 50% to 100% or more.

In general, Internet companies sell only a few million shares in their IPOs. Cheap Tickets, for example, sold a mere 3.5 million shares last March, while Auto-Web.com sold 5 million.

The small floats initially act as booster rockets for the stocks because there aren’t enough shares to go around, especially for coveted issues. But the removal of lockups can swing that demand-supply balance in the other direction.

More frustrating for many IPO investors is that it’s tough even to get a handle on how many shares might be unlocked. In their Securities and Exchange Commission filings, companies spell out their lockup terms. But the complex language can be murder to decipher.

Yet some experts say the widespread fears about lockups are overdone. So far, there have been few cases of significant insider dumping of Net shares whose lockups expired earlier this year, IPO analysts say. And in most cases in which insiders have lightened their positions, there’s scant proof that the sales did much damage to the stocks, they say.

“There’s a huge misconception about lockups,” said Robert Gabele, president of First Call/Thomson Financial, a Rockville, Md., service that tracks insider activity. “There is more stock available for sale [after a lockup expires], but that doesn’t mean it’s going to be dumped on the market all at once.”

In some cases, stocks have been hurt more by investors fretting about a lockup ending than by any actual selling once the shares are released, Gabele said.

For example, fear over insider sales may have contributed to a 35% drop in EBay shares, to about $61, in the two weeks leading up to its Jan. 21 lockup expiration. Indeed, some insiders did sell shortly after the expiration, parting with almost 2.6 million shares in February, and about 1.2 million since then, according to First Call/Thomson Financial.

But if the selling held the shares back, it did so only momentarily. EBay launched into a powerful rally in late February that carried the stock to a high of $234 in late April, when it peaked along with many other Internet plays.

“There was a lot of selling of EBay shares by people worried about the lockup expiration,” Gabele said. “It was pretty well sold out by the time the lockout period expired--and then it rallied.”

But IPO stock owners can face selling by more than just top managers as lockups expire.

Healtheon, an Internet health-care company, saw its stock tumble from $38.94 on Aug. 9 to $31.75 on Aug. 10, as an expiring lockup freed up 20 million shares. Volume surged as 7 million shares changed hands on Aug. 10.

None of Healtheon’s top managers unloaded shares, a spokeswoman said. The selling came from insiders at a smaller company Healtheon acquired last year.

By the end of this month, a lockup of about 40 million more Healtheon shares is expected to expire when transactions involving deals with other companies are completed, the spokeswoman said.

The stock has languished, closing Friday at $33.94.

Another threat to Net stocks can come in the form of secondary offerings. These are packaged stock offerings in which the company, and/or insiders and major investors sell shares to prearranged investors.

As with insiders selling on the open market, the deals increase the supply of shares. However, the detrimental effect on the stock price can be mitigated because investors are already lined up to buy the new shares.

A red-hot Net issue, Juniper Networks, said last week that it and certain shareholders are planning a secondary offering of up to 5.75 million shares.

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Ultimately, the general market environment can have a lot to do with stocks’ trends around lockup-expiration time or when secondary offerings are made.

If a stock is already depressed--as many Net shares are, at least compared with their spring peaks--many insiders may be reluctant to let go of much stock, preferring to wait for a rebound.

On the flip side, if investors are hungry enough for a stock, that demand can offset insiders’ sales.

In general, a larger share float can make a stock less volatile, which may please some investors but disappoint others.

Part of the reason Internet stocks zoomed late last year and early this year was because of so-called short covering, Gabele said. Some traders who expected Net stocks to fall had sold the stocks short, meaning they borrowed shares and sold them, betting they could repay the loans with cheaper-priced shares later.

But when Net stocks surged anew in spring instead of falling, short sellers had to scramble to buy replacement shares to close out their loans. And because many Net stocks had relatively few shares available to trade, the buying by short sellers pushed prices up.

With a larger float as lockups expire such short-covering rallies in Net shares may be more contained, Gabele said.