A Post-Expiration Loss
Last month shares of SolarCity Corp (NASDAQ:SCTY) surpassed $52 after Tesla Motors Inc (NASDAQ:TSLA)‘s exceptional quarterly report. SolarCity is a supplier for Tesla Motors Inc (NASDAQ:TSLA) and its Chairman is the CEO of Tesla (Elon Musk). Therefore, the two companies are deeply connected.
SolarCity Corp (NASDAQ:SCTY) has rallied from its IPO of $8 — but saw its shares decline 21% last week. The reason for this decline is both its large run higher in 2013 (as investors take profits) and also a substantial lockup expiration that investors believe will cripple the stock.
A share lockup occurs when a company decides to go public. The company establishes lockup periods wherein existing shareholders are not allowed to sell their holdings. The purpose is to create support for the stock, seeing as how on many occasions the largest holders are insiders and those who owned prior to the company becoming public.
A lockup protects the retail investor — there is a distant warning (when the IPO is filed) as to when these shares “could” hit the market — and these investors often sell or short the stock prior to the lockup expiration. In theory, if a large number of additional shares come to market, it throws off the balance of supply and demand, thus, pushing the stock lower as insiders and original investors sell in the open market.
A Look Back at a Past Expiration
SolarCity Corp (NASDAQ:SCTY) declined 5% on Tuesday when more than 61 million shares came to the market. Currently, SolarCity has 75.35 million shares outstanding. Thus, the company’s current expiration is more than 80% of its shares outstanding; meaning a great amount of selling pressure was expected to hit the market.
Now, after the large expiration has occurred, it will be interesting to see how the stock will trade. To better explain, let take a look at a previous high-profile lockup expiration. Back on Nov 14, 2012 Facebook Inc (NASDAQ:FB) had a lockup expiration that people referred to as “the big one.”
Facebook Inc (NASDAQ:FB) had many lockup expirations prior to November 14, but all were small and all caused the stock to trade significantly lower. Therefore, when more than 700 million shares could’ve come available with an expiring lockup, it made sense that investors would be scared about a decline in the price of the stock.
However, the contrary occurred, as Facebook Inc (NASDAQ:FB) rose nearly 9% on the day of its lockup — this after the stock had fallen from $40 to under $20. You might ask, “Why did this occur?”
Well, there are a number of reasons that a stock might trade higher when all logic suggests it will fall. To me, the most reasonable explanation is a short squeeze.
In the case of Facebook Inc (NASDAQ:FB), investors sold shares short in advance of the large lockup expiration. When the stock did not fall to the expected level, shorts then bought back shares to limit loss (short covering).
When Facebook Inc (NASDAQ:FB) rose 9% on the day of its lockup expiration, it had three things in its favor. First, the stock had been cut in half from $40 to under $20. Second, the stock traded higher on the day prior to the expiration, thus making it more difficult for short targets to be reached. Lastly, the CEO owned the majority of shares in the lockup expiration.
A “Possible” Scenario Moving Forward
Like I said, SolarCity Corp (NASDAQ:SCTY) did trade lower on Tuesday, but with such a large expiration many were expecting 15-25% losses. SolarCity currently has 15.5% of its float short, and what led to a better-than-expected Tuesday performance might very well be short covering from those who were expecting the stock to fall below $30.