Here's Why LinkedIn Is a Risky Bet

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

Contrary to Facebook (NASDAQ: FB), LinkedIn (NYSE: LNKD) has more than doubled since its IPO. The online professional network has enjoyed good dynamics this year, too. Its stock is up 55% this year. There is one thing that LinkedIn shares with Facebook, and it’s the huge current valuation. LinkedIn is trading at a P/E multiple of 524, while Facebook is trading at a 2363 P/E multiple. Sure, stock market is about the future, but can LinkedIn live up to the investors’ expectations?

What would fuel the necessary growth?

LinkedIn has three revenue sources: talent solutions, marketing solutions, and premium subscriptions. Talent solutions, which allows recruiters to find and attract prospective employees, is the biggest revenue source, accounting for 57% of total revenue. Marketing solutions, which gets money from ads, accounts for 23% of total revenue. Premium subscriptions, which offer additional options for interested users, make up 20% of total revenue.

The professional social network is competing with more traditional businesses, such as Monster Worldwide (NYSE: MWW), that offer employment solutions for job seekers and recruiters. As talent solutions make more than half of LinkedIn’s revenue, the developments in this area would be crucial for the success of the company.

The target audience of Monster and LinkedIn intersect, but are not the same. LinkedIn is targeting a more sophisticated audience than the one of Monster. In addition to that, LinkedIn is more about finding people who are not in active job search and offering them an attractive opportunity, while Monster’s service is based on job seekers who are actively searching for a job.

The fact that LinkedIn is targeting a more sophisticated audience would be a growth limiter for the company. There are a lot of jobs, especially in the small business sector, that do not demand their seekers a high level of networking and presentation skills. However, these jobs are crucial for the day-to-day business, and they need to be done. So I would not say that LinkedIn is changing the way every business hires employees.

On the marketing side, LinkedIn’s revenue is projected to grow 46% this year and reach $380 million. Facebook’s ad sales are projected to grow 38% to $5.89 billion. Given extremely high expectations, such level of growth could potentially disappoint LinkedIn investors.

Valuation

Let’s turn to forward P/E instead of the current one. LinkedIn is trading at a forward P/E of 85 while Facebook is trading at a forward P/E of 30. These are all projections, and the companies still have to meet them. It would be extremely hard to do this for LinkedIn. The current state of the world economy is a hurdle to job growth. The job market is sluggish almost everywhere, especially in Europe. While LinkedIn gets most of its revenue from job-related services, it would be hard for the company to overcome this trend. I expect the growth rates of LinkedIn to slow over time.

At the same time, Facebook is more conservatively valued, but it seems like investors want to see real results instead of projections. It affects the stock, which trades way below its IPO price and is down 11% this year.

Monster has lost 4% this year, but trades at an attractive 10.74 P/E and 12.2 forward P/E. The company has recently made strategic moves, exiting China, Brazil, Mexico, and Turkey. Monster states that it is exploring opportunities to sell the company to improve shareholder returns. There is no growth story to follow at Monster. Instead, it’s a profitable business that trades at relatively cheap valuations.

Bottom line

In my opinion, there are limits to LinkedIn's growth. The social network would not be able to grow its active user base forever. There is a certain section of people all around the world who are interested in such a network, and it would be hard to get past this point. In the meantime, the enormous forward P/E tells us that investors are expecting very high growth rates. Price-to-sales of 17.74 and price-to-book of 19.83 tell the same story. When the growth targets would not be met, the stock would suffer. I think it’s just a question of time.

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Vladimir Zernov has no position in any stocks mentioned. The Motley Fool recommends Facebook and LinkedIn. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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