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Beware the Lockup Expiration

There are plenty of lessons to be learned from the debacle that is Facebook (FB) since it became public in the middle of May. The share price has been cut in half and the company is now on the verge of dissipating more wealth than Bernie Madoff -- at least on paper.

We could spend this whole article on the missteps the company, underwriters and investors have contributed to the shares' collapse. The one I would like to highlight is how lockup expirations can hit these highly valued equities hard. FB plunged another 6% on Friday as another key lockup period expired.

This seems to be the norm in the social media space, as similar occurrences have hit Groupon (GRPN) and Zynga (ZNGA) as well. Given that Facebook still has a massive amount of shares under lockup, I believe investors should stay away until at least the rest of lockups expire by the end of year. More importantly, investors should avoid or short these two highly-valued equities, which also have significant amounts of shares that will become available when their lockups expire over the next few months.

Splunk (SPLK) came public in April and provides cloud based solutions that provide real-time operational intelligence.

Four reasons Splunk has downside from $31 a share:

  • Insiders and early investors have been consistent and frequent sellers of the shares since the company came public. Tens of millions of shares have been dumped on the open market over the last few months.

  • Another lockup expiration hits in October. Given insider activity to date, there is no reason to believe that this event will not generate significant selling when it occurs.

  • The company is not making any money. It is projected to lose a few cents a share in both fiscal 2012 and fiscal 2013.

  • The stock is selling at an incredible 21x revenues and 13x book value. For a company that only projects to have 35% sales growth in fiscal 2013 with no profit forecast, that is very rich. In its one earnings report so far as a public company, Splunk easily beat estimates and the stock then plunged about 15% because management did not guide future quarters forward. This highlights the hazards of investing in such high-flying shares: Even good is usually not good enough to move the stock upward.

Yelp (YELP) is an online urban city guide that helps people find places to eat, shop, drink, relax, and play based on the informed opinions of a community of locals in the know. The company went public in March.

Four reasons YELP still is significantly overvalued at $21 a share:

  • Let's start with valuation. YELP is valued at more than 12x trailing annual revenues and 9x book value.

  • The company is projected to lose $0.30 this fiscal year and then breakeven in fiscal 2013. Consensus earnings estimates for both fiscal 2012 and fiscal 2013 have been reduced in the last three months.

  • The barriers to entry to Yelp's primary business are not large and the company faces several competitors such as UrbanSpoon, which is owned by deep-pocketed IAC/InterActiveCorp (IACI).

  • Very much like Facebook, the company must find a way to monetize and manage the migration to mobile. Although insiders have mostly held on to their shares so far, another lockup expiration hits in September.

At the time of publication, Jensen was long IACI and short SPLK.

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