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Carla Dupuis
Fairchild Semiconductors (NYSE: FCS)

Illiquidity Discounts

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Investors value liquidity and would pay more, all else being equal, for an asset that is fully liquid than for an otherwise identical asset that is not fully liquid. Because of the requirements of Rule 144, in particular the six-month holding period before any public resale, restricted stock is valued at a discount from identical shares trading publicly.

Time Decay of the Discount

Because the six-month holding period under Rule 144 is the main driver of the discount, once the restricted stock is issued and sold, the discount should – all else being equal – begin to decline. But there are exceptions to this rule. For example:

  • If the stock becomes much riskier, in the view of the market, the discount could increase.
  • If the stock is sold by an affiliate of the issuer to a non-affiliate, the holding period sometimes restarts, causing the discount to increase.

Restricted Stock Discounts

The level of risk the stock carries, along with the expected holding period left under Rule 144 (or the registration rights agreement), are the main drivers of the discount.  Specifically, in our analysis of the LiquiStat database, Pluris has found the following:

  • Higher discounts for stock with greater volatility.
  • Lower discounts for larger, more stable issuing firms. (In particular, if the market capitalization of the issuer is negatively correlated with the discount).
  • The greater the block size, the higher the discount, especially for thinly traded stocks.
  • Bulletin-board and pink sheet stocks tend to sell at higher discounts.

In addition, the expected time to liquidity is important.  This is often exclusively driven by Rule 144, as the investor either has no registration rights or the issuer lacks the ability to register the shares as promised.  In extreme cases, the issuer may not have filed all of its required filings.  In these situations, the expected time to liquidity may be longer than the Rule 144 holding period.

Warrant Discounts

Warrants also sell at higher discounts from their Black-Scholes values when they carry greater risk.  However, the measures of risk are different, because of the asymmetrical payoff of warrants.  In the LiquiStat database, we have found the following:

  • Warrants are most likely to sell for significantly higher discounts when all or most of their value comes from the Black-Scholes time value – as opposed to the intrinsic value.
  • Lower discounts for high-delta warrants.
  • Lower discounts for high-moneyness warrants.
  • Higher discounts for high-volatility warrants.
  • Higher discount for smaller-capitalization issuers.

For more information on our PIPE security valuations, contact Pluris today.