LinkedIn: Good Company, Bad Stock

by Justin Dove

LinkedIn: Good Company, Bad Stock

by Justin Dove, Investment U Research

Wednesday, August 10, 2011

Were you one of the millions of people who flocked to the website after LinkedIn's IPO in May?

Publicity generated from the stock’s success spurred rapid growth in usage for LinkedIn (NYSE: LNKD), its quarterly report suggests.

Membership spiked to 115.8 million in the second quarter, a 61-percent increase over the same quarter last year. Unique viewers jumped 83 percent and page views increased by 80 percent. All this traffic helped LinkedIn beat Wall Street estimates and show a 120-percent increase in revenue.

"In the second quarter, we saw record levels of members, unique visitors and page views, while revenue growth further accelerated," said Jeff Weiner, CEO of LinkedIn. "Going forward, we plan to continue to invest in our team, technology and products in order to increase the value we deliver to members and realize the full potential of the LinkedIn platform."

Sounds great, right? Not so fast…

LinkedIn's Stock Experiences Quite the Ride

LinkedIn’s stock had an interesting start. It more than doubled the opening price of $45 on its first day, closing at $94.25. Within a month, it was down in the $60s. Then, in late June analysts from Morgan Stanley, UBS, Bank of America, Merrill Lynch and JPMorgan Chase upgraded the stock and set price targets between $85 and $92.

“While valuation is very rich, our positive view is based on the opportunity for LinkedIn to report significant near-term upside given the strong IPO branding event, and significant medium-term upside if LinkedIn can execute on its international expansion and consumer engagement strategies,” Justin Post of Bank of America Merrill Lynch wrote in a note to clients.

As if these guys were prophets, the stock shot back up, moving past the price targets and into triple digits. Since early July it’s been hovering around $100 per share.

Why LinkedIn's Stock Is Flying Too High

Solid revenue growth and the reasons Mr. Post listed paint a very optimistic picture of LinkedIn. But there are a few reasons to think its stock is flying a bit too high...

  • Steven Sordello, LinkedIn’s Chief Financial Officer, told Financial Times: “We had a significant event in the second quarter with the IPO, what we saw was a bump in engagement metrics, particularly in May and June. That’s something we’re not expecting to sustain.” Most of the revenue was generated by LinkedIn’s corporate recruiting service. But it’s definitely concerning to hear the CFO expect engagement to drop for a company that’s supposed to be rapidly growing.

  • LinkedIn, like many IPOs, had a lock-up agreement. That means that insiders and venture capitalists (or investors who bought the stock pre-IPO on a secondary marketplace like SharesPost) can’t sell stock for six months following an IPO. This helps stabilize the stock in its early days. It also leads to possible dips in stock value around the time of expiration. The agreements for LinkedIn will expire in November.

  • We’re told that P/E ratios aren’t very important for companies early in development. This is true in most cases. However, at eight years old, LinkedIn isn’t necessarily a baby. It’s also trading at 1000 times earnings. Earnings will have to eventually multiply by a factor of 100 or the price of the stock will have to come down. It may take a while for LinkedIn to start generating around $450 million in net income, so the latter looks more likely for now.

LinkedIn: A Good Company, But A Bad Stock

LinkedIn looks like a great company. Its revenue is increasing rapidly and the number of users is on the rise. The company is reinvesting most of its earnings in order to continue growth. The idea is great and the product is functional.

Unfortunately, the stock isn’t very attractive. As Ken Sena, an analyst at Evercore Partners, told Bloomberg: “We’re already significantly bullish in our estimates. We have trouble getting to a valuation that approaches near to where it’s currently trading at.”

This extremely high valuation, mixed with looming lock-up agreements expiring in November, doesn’t bode well for LinkedIn’s stock. Keep an eye on it after November though, as a sell-off could create a good opportunity.

Good investing,

Justin Dove

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