Is LinkedIn’s Astronomical Valuation Justified?
Soroush 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) is not Facebook (NASDAQ: FB); and investors should be thankful. LinkedIn, which has emerged as the foremost professional network in the United States, boasts a far more stable and diversified business model, combined with the promise of supercharging users’ professional networks. In similar fashion to Facebook several years ago, LinkedIn is undergoing a phase of rapid user growth and has the potential to attain the ubiquity and near-utility status of Facebook but with significantly brighter prospects for profitability, despite what Mark Zuckerberg may have up his sleeve. But does its growth and success justify current valuation metrics?
LinkedIn’s member base (both domestic and international), revenues, net income, features, groups, and company pages have all been growing rapidly. A few quick facts:
- As of March 31, 2012, LinkedIn had over 161 million members (up from 131 million in November 2011), making it the largest professional networking site in the world.
- LinkedIn’s corporate hiring solutions are used by 82 of the Fortune 100 companies.
- Over 400,000 unique domains use the LinkedIn share button.
- The quarter ended March 31, 2012 was the seventh straight quarter in which revenues doubled from the same period in the previous year.
Membership growth alone – as many Facebook critics point out – does not translate into substantial revenue growth or profitability. However, as per the first sentence, LinkedIn is not Facebook. While Facebook relies on targeted advertising (the effectiveness of which is highly disputed) and rents extracted from external application developers sponging off of the social network’s platform and user base, LinkedIn boasts a more consistent and more diversified revenue stream.
The company cites three primary “monetized solutions” in its annual report for 2011: Hiring Solutions, Marketing Solutions, and Premium Subscriptions. The Hiring Solutions segment provides avenues for matching qualified job candidates with employers through such conduits as LinkedIn Recruiter, Recruitment Media, and Referral Engine as well as TalentMatch and “Jobs You May be Interested In." The company also offers these services in their premium incarnations with added features in return for an extra fee.
LinkedIn’s Marketing Solutions segment includes various advertising features for companies and recruiters as well as white papers, sponsorships, and recommendation advertisements. Finally, the company’s Premium Subscriptions segment offers users such services as premium search filters, 3rd degree anonymity, and additional statistics regarding profile views.
The company’s business model is exceptional compared to those of other social networking sites by virtue of its deft synthesis of user interactivity – a defining feature of social media – and traditional advertising and recruiting techniques. LinkedIn’s novel business model has been the foundation of its extraordinary financial success thus far.
The company’s results for the quarter ended March 31, 2012 were simply incredible.
Revenue By Geographic Region
Revenue by Product: Total and As Percent of Total
Abbreviated Income Statements: Total and Common Size
Geographically, most of LinkedIn’s member base is North American, and the region also provides much of its revenue. However, while North American membership grew substantially in the most recent quarter, membership in the Asia-Pacific region and Africa led regional membership growth with 56.5% and 73%, respectively, over the same quarter of 2011. Emerging markets in particular exhibited extremely strong growth, led by Indonesia with 111%. Although American users are, per capita, the most profitable for LinkedIn, rapid international growth will be a boon for the company. Perhaps more importantly, LinkedIn did not have to sacrifice revenue growth for membership growth during the period. Rather, total revenues grew 101%. And net income growth over the previous period topped 140%. LinkedIn’s costs fell as a percentage of revenues. The company’s operating margin grew nearly five fold to 5.5%. Its net income margin only expanded modestly (by about 0.5%) as a result of the shift from a tax benefit in the same quarter of 2011 to a tax provision equal to just over 50% of operating income. Diluted EPS were $0.04. Overall, very strong results for the quarter ended March 31, 2012. Margins, however, are fairly lackluster, despite recent improvement. ROI, ROA, and ROE are all under 5% for the last twelve months.
LNKD is due to release its next quarterly earnings report on August 2. Analyst EPS estimates range from the low single digits to $0.20, with a consensus of $0.15. If membership growth can be sustained and margins maintained, revenue will continue to grow fairly rapidly. If margins can be improved concurrently – as many analysts are predicting – LNKD will have an excellent 2012.
LinkedIn is the largest professional networking site in the world, and, like Facebook, it has more or less achieved critical mass; smaller competitors are being squeezed because more users sign up for LinkedIn for its massive network. Viadeo is a distant second in the online professional networking sector with a mere 35 million members. XING is third with 10 million. Neither have the growth momentum to rival the LinkedIn juggernaut.
LinkedIn has grown its mobile user base through the introduction of Apple‘s (NASDAQ: AAPL) iPhone and iPad apps. Nearly 22% of all visitors login through mobile devices. LinkedIn has also complemented organic growth with its recent acquisition of Slideshare, and there have even been rumors of the company making an offer for Monster (NYSE: MWW) – a weakened headhunting competitor that is rapidly losing market share.
There are a number of risks to LinkedIn’s profitability and growth. First, it should be noted that membership growth has fallen from its peak in 2011, and, as the market becomes saturated in the United States, growth may continue to fall. Also among these risks is the possibility of another security breach; the company’s recent failure to protect the passwords of millions of users was a major black eye. The incident has caused some legal headaches for the company but the negative impact of any adverse ruling will be a temporary charge and ultimately have no significant impact on earnings in the long run. Finally, the company needs to continue to improve its average revenue per user and per customer. Failure to do so will greatly hamper earnings growth.
LinkedIn is highly valued by the market. It has a P/E ratio of over 700 (ttm) and a forward P/E around 90. Assuming membership continues to increase at the previous quarter’s year-over-year pace of 58% (rounded down to 50% for the sake of conservatism), average revenue per user stagnates at a similarly conservative $1.15, and margins remain level at 5.6% and 2.6% for operating and net income, respectively, LinkedIn would produce the following results in the period ended March 2013.
Do these conclusions warrant LNKD’s current valuation metrics? Assuming the number of shares used to calculate diluted EPS remains stagnant at about 112,000, quarterly EPS for the period would be $0.07. This is far below analyst projections for the next quarter (consensus EPS of $0.15). However, annualized revenue based on these assumptions is roughly in line with company guidance for the full year of 2012. Since customer and membership growth appear to have peaked in 2011, these cannot be the sole drivers of expected earnings growth.
Thus, LinkedIn must rely on margin improvement and ARPU expansion to support earnings growth over and above this benchmark – and thus justify its astronomical P/E ratio. Perhaps continued P/E multiple expansion will support capital gains for individual investors, but its current P/E is already very high. This basic model makes a number of assumptions that are poorly aligned with reality and very conservative compared to analyst estimates. However, it is food for thought: In the absence of an increase in membership growth rate, LinkedIn more or less has to expand margins.
Personally, I have neither the confidence in the company’s ability to expand margins to justify current valuations nor the stomach to pay the going P/E multiple. Company growth may continue to be spectacular (though possibly less so than in previous quarters), but the potential for capital gains for ordinary investors is questionable.
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This article is written by Denis Hurley and edited by Jake Mann. They don't own shares in any of the companies mentioned above. The Motley Fool owns shares of Apple, Facebook, and LinkedIn. Motley Fool newsletter services recommend Apple 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.