Ignore the IPO date -- find the CPO date
What is the optimal time to take a position in a technology company IPO?
In my own investing I’ve often avoided buying shares in IPO’s during the first six months due to high prices relative to fundamentals. A common criticism of traditional IPO’s is that prices are too high. Some investors argue that companies leave money on the table by doing a traditional IPO instead of a direct listing. My base reason against buying during this period is that for most of its history the Renaissance IPO ETF has failed to beat the S & P 500. However, some of these companies will turn into great long term investments. Some will be zombies or duds. When is the time to take a position? How can IPO investments be good long-term but bad short-term? In this article I'll model when common locked-up shares become overvalued. When that disappears the common public offering date takes place (CPO date).
A pre-IPO company has different types of regular shares, preferred shares and options. Pre-IPO reported valuations falsely use preferred share values multiplied by common share volume as outlined in Squaring VC Valuations:
Reported valuations assume that all shares are as valuable as the most recently issued preferred shares. We calculate values for each share class, which yields lower valuations because most unicorns gave recent investors major protections such as initial public offering (IPO) return guarantees (15%), vetoes over down-IPOs (24%), or seniority to all other investors (30%). Common shares lack all such protections and are 56% overvalued.
Common shares sellable during lockup are not the same as other shares as there is a class below them. Common shares that are under lockup. This makes them (temporarily) more like preferred shares as they have extra rights. All companies phase out lockup provisions on most shares over time.
The main benefactor of lock-ups is options market makers. Because they can sell options and hedge the transaction using the non-locked up shares. As I’ll show later on they are able to charge a premium on options contracts for locked up IPO companies. (NOTE: whether they are making more money or merely passing on a higher cost is a subject of research for a later article)
As a long term investor I want to buy a company and hold it for an extended period. I don’t want to pay a preferred premium as the option to sell is not something I’m planning to use. For some companies, I’d take a discount to have my shares locked up after purchase if that were possible.
Recently I had the idea that it might lead to a “good enough” estimate of the current preferred premium value of the non locked up common shares if I was to use the option markets themselves to estimate the relative premium of shares allowed to be sold after IPO but before significant lockup’s expire. Basically the skeleton of the idea is to
develop a similarity model of locked up companies to out of lockup companies,
compare similar options breakeven points (both 6+months out and in the money) on the out of lockup companies to similar ones from companies that are still in lockup.
Convert the breakeven difference into a standard unit. Example: shares of xyz have a -3% month breakeven for out of lockup share options on group 10 compared to -5% a month breakeven on in-lockup share options (the difference being the estimated preferred value of the shares).
NOTE: other analysts have approached IPO timing analysis in a different way. I consider this analysis more related to the usage of common shares by the options market and how it temporarily inflates prices.
I used the following factors to model company similarity (data from finbox) and created a k-means model in BigQuery.
rule_of_40_next_year (projected next year revenue growth + projected unlevered free cash flow margin + buyback yield — which is negative for companies net issuing shares)
gross_margin
overpriced_underpriced_by
company age
industry
sector
operating_country
This generated comparable clusters of companies.
Comparables Generated for IPO’s Currently in Lockup
GDRX - TDOC, VEEV
AMWL - TDOC, VEEV
ABNB - ETSY, CHWY, PTON, SFIX, W
BIGC - CLDR, DBX, NET, PSTG, PLAN, ZEN, ZS
ASAN - CLDR, DBX, NET, PSTG, PLAN, ZEN, ZS
FROG - CLDR, DBX, NET, PSTG, PLAN, ZEN, ZS
SNOW - FSLY, MDB, OKTA, SHOP, SQ, TWLO
PLTR - AVLR, DOCU, NOW, SMAR, PANW, SPLK, WDAY
JAMF - AVLR, DOCU, NOW, SMAR, PANW, SPLK, WDAY
U - AVLR, DOCU, NOW, SMAR, PANW, SPLK, WDAY
ZI - ANGI, EB, IAC, MTCH, PINS, SNAP, TWTR
Options Pricing
Using the above groups I gathered data comparing option breakeven points (both around 6 months out on just in the money puts) on the out of lockup growth companies compared to similar ones from companies that are still in lockup. Lastly I convert the breakeven percentage difference into a standard unit (percent breakeven cost per 30 days).
Options Pricing Sheet (in-progress and open for viewing)
Ticker - Option premium (~ 6 months out)
GDRX 13.26%
One of my most closely watched stocks in the group as I really like the company and business model, but it still appears their options are trading at a small premium. Lockup expiration 3/22/2021
AMWL 42.33%
Lockup expiration 3/16/2021
ABNB 44.22%
Originally used July and premium was 2% but market is pricing in early lockup (then found the following: https://www.theinformation.com/articles/airbnbs-ipo-signals-that-rigid-lockup-rules-are-on-the-way-out).
What the above article describes is that Airbnb is adopting a more flexible lockup — rather than the typical 180 day rule — employees will be allowed to sell following march earnings, assuming that certain targets are met. This leads me to believe that the lockup premium on common shares will disappear sometime between April 15-July 15 — at least the market seems to be pricing that in at the moment.
BIGC 48.6%
Lockup expiration 2/1/2021
ASAN 18.64%
Lockup expiration is listed on some sites as 3/29/2021. But as they did a direct listing there may not be many lockup’s at all (https://public.com/learn/what-to-know-about-asanas-ipo).
FROG 38.04%
Lockup expiration 3/15/2021
SNOW 33.83%
Lockup expiration 3/15/2021. The expiry of the lockup could weigh on share price accretion from here, as early holders sell and SNOW's free float rises from 32.2 million to 345.8 million shares in March 2021.
PLTR 118.68%
Another of the “direct-listing” stocks. This is the largest discrepancy by far, and is going to require some follow up research. I’m sort of suspicious that given Peter Thiel involvement in Palantir that some of this premium is likely to due to usage of the options markets by him or associates or unusual lockup provisions. Lockup expiration 3/29/2021
JAMF 5.04%
Lockup expires on 1/18/2021. The market is already pricing in the lockup to some extent and the premium is approaching the value of common shares in its group.
U 65.91%
Lockup expiration 3/17/2021
ZI -15.81%
Lockup already expired. CPO date has passed.
The cheapest premiums come from companies at or near their option expiration (JAMF, ZI). The most expensive premiums seem to be related to lockup provisions, general interest in the the company as well as how many shares were initially sold relative to total supply of shares. I’ll have to get better data in terms of the float relative to market cap to model initial supply as a factor. From this initial set it does seem unlikely that that the 30%+ premiums will last once the lockup approaches and passes. I’ll continue to update the model weekly to see how these premiums change over time and how well they are at finding special situations (as it seems to have done with airbnb — I did the model first and found the article second).
Due to the relatively high interest in options markets over the past year, this may be atypical results, but the basic thesis to wait for the CPO date is simple. It is really unlikely that companies prospects (by fundamentals) are going to appreciate 50% in 6 months or 30% in 3 months. As a long-term investor focused on buying growth at a reasonable price the current IPO and lockup pattern is unlikely (though not impossible ) to present any bargains or reasonable prices. Options hedgers are essentially renters in the long term that are a temporary factor inflating the price.
Once the majority of the lockups expire, the option premium is likely to collapse. The CPO date is a dynamic concept. It depends on the situation of the company, but by watching the relative values of the options markets, the above code and system can assist in gauging when the option markets are inflating the price and when the participants have found a new shiny toy and decided to move on to different pastures.
Related:
Options Pricing Sheet (in-progress and open for viewing)
https://www.dropbox.com/s/gmkx6rql9c8lcnt/Green_Bananas.pdf?dl=0