Is Linkedin A Dead-End Investment?
Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
A dead-end investment is a stock that presents no real upside over a period of many years. This can be due to valuation, lack of growth, or a number of other catalysts that could keep a stock from trading higher. Linkedin (NYSE: LNKD) has been one of the more controversial stocks since its IPO, therefore I am looking to determine whether it is a dead-end investment.
For some reason, we have a tendency to value internet, and now cloud, based companies higher than any other industry. Earlier this month Workday (NYSE: WDAY) began trading with a price/sales of 50! Most value investors would consider a price/earnings ratio of 50 to be expensive, much less a price/sales ratio of 50. However, because the company has posted sales growth of 100% in a struggling economy the market is willing to place dot-com era valuations on the stock. The only problem is that it puts the company in a Google like situation, where once the excitement fades the stock trades flat for a period of many years while earnings match metrics/valuation.
In regards to Linkedin, it is a company that is seeing revenue growth of near 100%, therefore its price/sales of 15.44 seems relatively cheap compared to Workday. The company has done well at transitioning itself from a social media website to a job based company that continues to grow. However, we never once valued careerbuilder.com at $11 billion, and that sooner or later Linkedin is going to see slowing growth and its valuation could fall.
With a forward P/E ratio of 84.31 my belief is that Linkedin will continue to trade in its current range until trading at 40 times earnings. That is of course if the company can maintain its level of growth, and support from investors, which I believe it will not.
Since Linkedin is a company that is based on revenue growth, with no real consistency in margins, let’s take a look at its growth and compare it to Facebook (NASDAQ: FB). Linkedin returned revenue of $522.19 million in 2011, and most are projecting that the company will see full-year revenue of $880-$950 million, therefore growth of about 75%.
I don’t think anyone would argue that the business opportunities for Facebook far exceed Linkedin, due to one billion users to monetize. Therefore, I find it interesting that Facebook’s growth continued to explode until reaching resistance this year. From 2008-2009 it saw revenue growth of 185%, 2009-2010 of 154%, 2010-2011 of 88%, and during its most recent quarter grew revenue by 32%. The point is that investors can’t expect Linkedin to continue its 80-100% sales growth for the next five years. Eventually growth will slow, but at what point is anyone’s guess.
The natural course of an aggressive growth business cycle is that eventually sales will slow. There’s no company that can maintain 100% sales growth forever, and the determinants depend on the industry. Of all the promising, fast-growing technology companies of the last five-10 years, including: Amazon, Facebook, and Google, Linkedin may have the greatest valuation, and the least long-term promise.
In my opinion, Linkedin is in a no-win situation, with a ridiculous valuation and growth that cannot continue. Linkedin has just 90 million members to monetize, while Facebook has over one billion. The company simply does not have the available resources nor is it in the industry to reach revenue in the multi-billions, which is needed to maintain its valuation.
I see one of two scenarios for Linkedin: It trades $100-$120 for the next four years or falls once quarterly sales slow to 30-40%. The company’s short-term guidance is strong, therefore it might be a good play prior to earnings. Personally, I would use the opportunity of earnings, if it trades higher, to take profits, as future upside appears minimal. My reasoning: If Facebook began to see significant revenue declines after $2.5 billion in annual revenue, then Linkedin’s decline will be much sooner with less users to monetize. And I wouldn’t be surprised if this current quarter, or next, is the last good growth period in Linkedin’s history.
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BrianNichols has no positions in the stocks mentioned above. The Motley Fool owns shares of Facebook and LinkedIn and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Facebook 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.If you have questions about this post or the Fool’s blog network, click here for information.