Investment bankers predict a healthy flow of equity capital markets business this year as stock markets continue the run-up that began last spring. If the secondary markets' tone remains strong, investors may be tempted to buy new issues. But they should remain suspicious over whose interests the investment banks are serving: theirs as investors, or those of issuers' of stock who grant mandates and fees to the banks.
Lock-up agreements didn't appear to mean much this January as Goldman Sachs and Merrill Lynch, and then JPMorgan waived constraints preventing large shareholders in Yell and Telekom Austria from selling more stock before an agreed period had elapsed following initial disposals.
Lock-ups are typically agreed with the original vendor of a stock – perhaps a government in the midst of a series of privatizations, a private equity group which may regularly wish to exit positions to return cash to its investors, or a corporation pursuing a restructuring programme – when it first floats a portion of its holding in a company on the public market but still retains a large chunk of shares.
Sometimes vendors hold these blocks because they want to retain the chance to participate in the share's anticipated upside. More often they do so only because equity markets won't absorb their entire holding in one go. Public shareholders particularly dislike seeing private equity investors sell down their risk exposure to a portfolio company in one fell swoop.
Investors who do buy new shares in the primary market are often fearful that the imminent sale of a further block may depress the share price at any moment. And so they take comfort from an assurance that within a given period – say six months or a year after a new issue – no additional large chunk of stock will be sold.
But are these agreements worth the paper they're written on?
Bankers argue that breaking lock-up agreements can be good both for vendors and for the market. Getting rid of an overhang in a way that catches most people by surprise can in fact support the share price. This was the case for both Yell and Telekom Austria whose share prices continued to rise uninterrupted.
The point of a lock-up, it is argued, is to give the market confidence that there isn't going to be an unsteady flow of stock that could prevent the orderly development of a company's share price. If the market expects more supply to follow immediately after the expiry of the lock-up period then the lock-up period itself could have a negative effect. If shares can be placed before the expiry of the lock-up without damaging the share price then investors have nothing to complain about.
There is some truth in that but only as long as everything goes according to plan.
The decision to break the lock-up agreement is supposed to be impartial. But bookrunners for the deal are unlikely to upset a vendor keen to sell before the end of the lock-up, as they will wish to win the imminent share placement.
The temptation to break lock-up agreements is even stronger at the moment as banks continue to bid aggressively for block trades. There hasn't been a single such deal that hasn't been bounced around rivals for some time according to syndicate sources. Vendors will extract whatever benefit they can from this fierce competition. Any claim of impartiality from bookrunners should be taken with a pinch of salt.
Investors need to remember that lock-up agreements, which are made between a selling shareholder and a bank, are only as good as the word of the bank. It is only the investment bank's concern for its reputation that offers protection.
The advantage to be had from breaking a lock-up works only if it is unexpected. If bankers continue to waive them, confidence in lock-ups will fall and such moves will lose their efficacy.
Faced with the possibility of losing money from a few disgruntled investors if a decision to waive a lock-up goes awry and the certainty of losing out on a deal from a vendor unhappy not to be released, bankers seem increasingly willing to take the risk.
Investors should be wary.