Why LinkedIn Isn't Done Yet

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

There’s something to be said of a company that sees its stock price nearly triple from its IPO in one year; then, when the biggest company in its sector has an IPO that flops, it continues to move up. What’s said? “The stock has significantly outperformed both the market and peers over the past 12 months, so we’re downgrading it.” I’m paraphrasing, but that’s essentially what Barclays Capital analyst Mark May wrote in his report on LinkedIn (NYSE: LNKD) last week.

Interestingly, May maintained a positive outlook on the stock saying, “we remain positive on both the short-term (fourth-quarter) as well as the long-term outlook.” He also kept his price target of $125 on the stock, representing greater than an 11% upside from where the stock trades today.

The result of this oh-so-terrible report caused LinkedIn shares to drop 2% while the market rallied on the fiscal cliff resolution. LinkedIn shares remain at the same levels as last week, and I believe the market’s reaction is short term, and it won’t be long before LinkedIn reaches that $125 mark and moves through the resistance it felt there in September.

OMG P/E!

Dissenters of LinkedIn’s stock take one look at the price-earnings ratio and say, “See, it’s overpriced!” With a trailing P/E over 700, it’s easy to get scared and look for less expensive options elsewhere. This is similar to the argument people have that Amazon (NASDAQ: AMZN) is overpriced. Yet, the company’s stock continues moving up.

Still, with all this talk about these stocks being overly expensive, short interest remains relatively low. As a percentage of float, LinkedIn shorts represent 8.9%. This compares favorably with Facebook (NASDAQ: FB), which recently started coming back in favor with investors, and still sports a short interest of 11.7%. Although, that is a vast improvement over where it was in mid-November when shorts represented more than 20% of the float.

So why is it okay for some companies like Amazon and LinkedIn to have astronomically high P/E’s and others say a stock is overvalued with a P/E above 20? The stocks with really high P/E ratios usually have really low earnings, and huge potential for those earnings to improve over time. Therefore, people are willing to pay more now for each penny of earnings the company made in the last year. I believe LinkedIn is a company with great potential to grow earnings at a rapid pace.

How to Make Money in Social Networking

Unlike most social networking sites like Facebook and Twitter where the majority of revenue is generated by selling advertisements, LinkedIn only produces about 25% of its revenue from advertising through what it calls Marketing Solutions. That’s not to say LinkedIn isn’t a good advertising company. Revenues from Marketing Solutions increased 65% year-over-year in the first nine months of 2012.

In fact, many companies may prefer advertising on LinkedIn with its extremely focused niche. As a network for professionals and job seekers, LinkedIn provides a highly valuable user base. That’s why while Facebook, Twitter, and Google (NASDAQ: GOOG) only make money when users click on ads, LinkedIn gets paid every time an ad is displayed regardless of clicks. Companies are willing to pay just to get their name in front of LinkedIn’s high-value users.

However, as I mentioned earlier, advertising only makes up about one-fourth of the company’s revenues. The majority of revenues come from LinkedIn’s Talent Solutions (formerly Hiring Solutions). This is a subscription-based model that allows companies better access to individuals in the LinkedIn network - individuals who show the qualities companies are looking for to fill open positions. This is by far the company’s biggest cash generator representing nearly 55% of revenues in the first 9 months of 2012.

Furthermore, LinkedIn offers premium subscription services to job seekers and professionals. This allows them to contact individuals outside of their immediate network and make new connections that would otherwise be much more difficult to create. This represents the remaining 20% of revenues for LinkedIn. (All information comes from LinkedIn’s most recent 10-Q)

I’m a big fan of recurring revenue models. With 75% of LinkedIn’s revenues derived from subscriptions, it establishes a solid baseline upon which the company can grow its sales.

How to Grow a Social Network

In the course of my research, I found that Facebook has more users than LinkedIn. It’s a shocker, I know, but the numbers don’t lie. Facebook is incredibly addictive and sticky and engages its users. It is a model to be envied, and even imitated. Over the last six months, LinkedIn has started focusing on how to increase engagement of its users, and keep them on the website longer.

The most obvious improvement is the Homepage, which shows interesting articles from around the web along with status updates from people in users’ networks. Sound familiar? Since its introduction, engagement has improved 60%, and status updates reached an all-time high.

LinkedIn also started sending users “Notifications,” which alert members to activity relevant to their LinkedIn experience. The company reports since the rollout, social gestures (likes, comments, shares) increased more than 4X in the third quarter.

Overall, unique visiting members grew 22% last quarter, and page views grew 44%. This implies that users are spending more time on the website, which will directly increase advertising revenues and ought to lead to higher conversions on premium subscriptions.

The Missing Link

The LinkedIn business model is different from the more popular social networks. I think it’s a very smart and strong model with its focus on highly valuable client base. There’s still a lot the company could add to it in the future. For example, with all of the user data the company collects, it could provide research reports much like how ADP creates job reports. I’m sure Silicon Valley’s Executive of the Year, Jeff Weiner, has a few ideas to add revenue streams. In the meantime, I’m content to watch user engagement, advertising sales, subscriptions, and the stock price all increase.


adamlevy owns shares of Amazon.com. The Motley Fool recommends Amazon.com, Facebook, Google, and LinkedIn. The Motley Fool owns shares of Amazon.com, Facebook, Google, and LinkedIn. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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