Insiders Are Primary in Next Wave of Secondary Offerings

Investors, who may not have gotten their fill of last year's hot IPOs, can feast on a buffet of follow-on offerings courtesy of insider shareholders eager to cash in at least a portion of their bounty.

Such investors, however, should be careful their appetite for these offerings doesn't lead them to indigestion.

IPO insiders -- company executives and venture capitalists -- are driving their charges back to market at an increasing rate, often before the 180-day ban on selling shares, known as the lockup period, ends, says one investment banker.

A company that went public in 1999 would consider returning to the market "if it can, primarily because selling shareholders want to put some of the cash in their pockets," says Frank Maturo, an investment banker at Merrill Lynch (MER). On average, shares to be sold by insiders make up about 25% to 35% of recent follow-on offerings.

Red Hat Not Red Hot About 30% of Red Hat's recent secondary offering came from selling shareholders such as company insiders and venture capitalists.

The number of these offerings is increasing. There have been 33 follow-on stock offerings that had selling shareholders so far this year, compared with 20 at this point in 1999. And the continuing bull market, which sent many an IPO into the stratosphere, attracts investors to these offerings.

It is unclear if the offerings are a bad thing for the average individual investor who holds some of these stocks. The common belief is that follow-on offerings tramp down the price of the shares outstanding because of dilution, and that such offerings imply a lack of confidence in the company when insiders sell their stock so soon after an IPO.

Indeed, a look at the performance of these offerings proves one sure thing: There is a wide disparity among these stocks' reactions to the announcement of a follow-on offering. In 10 of the most recent follow-on stock offerings that had selling shareholders, the average stock involved actually climbed 25% between the time the company filed to sell shares and the time it actually sold them, usually a period of less than one month.

That average is somewhat skewed by the top three stocks in the sample, all of which returned better than 50%. Without them, the average return of the remaining seven stocks -- four of which were up, three were down -- was only 8%.

And Red Hat (RHAT) is a prime example of the negative turn after a secondary. The company priced its follow-on offering on Feb. 3. Red Hat, which has been public only since Aug. 11, sold 4 million shares, increasing its outstanding shares by one-third, to 16 million. Of the shares in the offering about 30% were sold by a group of insiders that included its two co-founders.

Red Hat shares, which started to fall after the filing and have continued downward, have dropped more than 40% to the mid-70s since the company filed the offering on Jan. 14, when the stock closed at 132 1/4. Not helping matters was that in addition to the follow-on, Red Hat's lockup expired Feb. 11. A Red Hat spokeswoman declined to comment on the stock price.

Wade Woodsen, of the venture capital firm Sigma Partners, says the follow-on offerings let shareholders sell stock in a more orderly manner than if everyone headed for the exits en masse when the lockup expires.

"That locked-up stock is going to come out sooner or later," Woodsen says. "It just depends how you want it to come, in a managed process or in a haphazard one." Sigma has not sold shares in any follow-on stock offering in the past six months.

The latest company to take a hit on a follow-on offering is smart-search site Ask Jeeves (ASKJ), which saw its stock plunge almost 15% in the two days since filing Wednesday to hold a follow-on offering of $150 million worth of stock. About one-third of that total is being sold by insiders.

Merrill's Maturo is uncertain how the market is going to react in the long run to this continuing flow of selling-shareholder offerings. "The companies want to push this more than the bankers do," he says. "I think investors will be discriminating on these things."

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