6 Reasons to Sell This Internet Company

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

LinkedIn (NYSE: LNKD) holds the title of the world's largest professional network, with more than 200 million members. According to comScore, LinkedIn is the 23rd most visited Internet property around the globe. However, the company's competitive advantages are minimal; it is no Amazon in terms of having a wide moat, but it surely trades like one. Before buying into the LinkedIn story, investors should evaluate its dark side. 

1. Its Competitive Advantage Is Not Durable

LinkedIn is a good company with an innovative twist to existing social media platforms. However, the business doesn't have a wide moat, since its users are not sticky. The professional nature of the company lessens the excitement and hype, which is predominant amongst other social media platforms.

The perception of LinkedIn by many users as 'boring' can be a problematic situation in the long run. The limited barriers to entry, especially for Internet companies with a strong user base like Google (NASDAQ: GOOG) and Microsoft, doesn't help either. 

2. Dwindling User Engagement

For the new age Web 2.0 companies, the main goal is to sign up users and engage them. Once the user eyeballs are in place, the group can be monetized through various means, with the most popular choice being ad revenue. But the honeymoon phase for LinkedIn just might have ended. User engagement on desktop is headed downwards. Cumulative page views are down for two consecutive quarters, from 9.4 billion views to 8.9 billion views, according to comScore data. This just might be an early red flag for LinkedIn's investor base.

Also, the actual number of members is lower than the registered number of members, as there are duplicate and fictitious accounts. Fake accounts are not a problem for LinkedIn alone, social media rivals, Facebook (NASDAQ: FB) and Twitter face this problem as well. However, the bigger issue is that a small number of active users generate the lion's share of page views, which contributes in overstating the page views per member.

3. Revenue Streams Are Slowing Down

Most of LinkedIn's revenues flow in from the Talent Solutions business. In its 2012 Q3, that segment was responsible for 55% of total revenues. LinkedIn will continue to eat away a large portion of the talent solutions pie, as competing platforms like Monster (NYSE: MWW) continues to struggle.

However, the addressable market of the talent solutions and premium subscriptions business is not very big, and they make up 75% of total revenues for LinkedIn. And soon or later, revenues from the hiring solutions business will hit a ceiling. Advertising revenue from its platform hasn't taken off and will be hard to attract marketers. Advertisers get more users and better targeting capabilities with LinkedIn’s internet rivals, Facebook and Google. 

LinkedIn utilizes a subscription based revenue model that spans out over a quarter, six months and longer. A key metric for such companies happen to be, deferred revenue (unearned revenue). Why? Because LinkedIn receives cash up front for the services it will provide, and records it as deferred revenue and recognizes them as revenue over the next quarter or more. A look at the deferred revenue as a % of total revenue of LinkedIn portrays a decline in growth, and is a sign of things to come.   

4. Competition Will Intensify 

Facebook has already teamed up with Monster and a few other sites for the roll-out of the Social Jobs App. Facebook's launch of the Graph Search along with Monster's sequential decline in revenues, are just added incentives for these two companies  to build a strong recruiting platform together.

With 5x more users than LinkedIn's 200 million, Facebook can eat away at LinkedIn's recruitment solutions revenue. As these two companies fight for user engagement on their respective platforms, it would be an added enticement for Facebook to build the recruitment portal by teaming up with Monster. 

Google+ locks horns with LinkedIn for user engagement as well. And it is ramping up its offerings by offering Google+ Hangouts and other Enterprise based solutions for corporate accounts. And also, most of the traffic on LinkedIn is directed from Google's search, which also poses additional threats. 

5. Mobile Monetization

Not surprisingly, roughly 25% of all unique visitors on LinkedIn are from mobile. The secular shift towards mobile-based devices will certainly ramp up that number over time. Unfortunately for the company, mobile monetization hasn't taken off yet. And very likely, user engagement on mobile in terms of page views, will be a lot lower than desktop, which is another negative for the company. 

6. Valuation

With respect to paying an exorbitant price for a good company, the evergreen Warren Buffett puts it best: "What is smart at one price is dumb at another."

LinkedIn is poised for growth, at least in the near term. The small size of its revenue base alone will lead to double digit growth for the next few quarters, until that number will fall off a cliff. LinkedIn has outperformed the S&P 500 in 2012 handsomely, and now trades at a TTM P/E of roughly 780, and a forward P/E of around 92. Both of these P/E multiples can be justified for companies with extremely high competitive advantages like Amazon or Facebook, but not for companies with minimal barriers to entry like LinkedIn. 

The Bottom Line

The company is in good standing and growing, too, but the astronomically high valuation of LinkedIn reduces the potential for long-term upside in the company. Unless the company manages to widen its competitive advantage in the near term, a wait-and-watch approach sounds about right for LinkedIn.  

ishfaque has no position in any stocks mentioned. The Motley Fool recommends Facebook, Google, and LinkedIn. The Motley Fool owns shares of 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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