LinkedIn (LNKD) is the world's largest professional network on the internet, with more than 200 million members worldwide as of December 2012. It is a useful site that I personally visit on a regular basis. This article is by no means an indictment of the LinkedIn service. Rather it is an analysis of the risks associated with the company's shares at current prices.
First the good news: LinkedIn has no long-term debt, minimal current competition, attractive margins and high historical revenue growth rates. LinkedIn's stock is a darling of momentum investors currently and has exhibited robust relative strength since the beginning of the year.
Now the bad news: LinkedIn justifiably topped the list of 11 Egregiously Extended Stocks Vulnerable to Rally Reversal identified by Alan Brochstein in his March 10th Seeking Alpha piece. And that was at a lower share price and before the disclosure of this week's continued shedding of shares by LinkedIn's Board and Management (discussed below).
By almost any traditional valuation metric, LinkedIn shares are wildly overvalued. But the bulls will remind you that this is not a traditional company as it has above average margins and historical growth rate. Let's just look at one valuation metric to make the point: LinkedIn's Free Cash Flow in 2012 was $141.65 million (Cash from Operations $267.07 - Capex of $125.42 million). The current market cap is $19.262 billion. At this current rate of free cash flow generation, it would take the company over 135 years to earn back its current market capitalization. Given the half-life of Social Web companies (think MySpace, Digg, etc.), this is a risky play to say the least. A view which insiders seem to share.
While the sale of company shares by executive management and Board members is not alarming by itself, the magnitude of sales is. Just in the past few weeks, insiders - including the CEO, CFO and members of the Board - sold tens of millions of dollars worth of LinkedIn stock.
Over the past six months, insiders have sold 2,841,960 shares in 106 transactions. And over the past year, insiders have sold 6,477,752 shares worth $756,563,678.
Granted these were planned sales per the 10b5-1 sales plan. But the plan was to sell, not to hold on to the shares so the effect is the same. I challenge the reader to find any other company that even comes close to this amount of stock sold as a proportion of stock held by insiders.
The current high valuation can be attributed to the company's attractive margins and its high historical growth rate. However, with 200 million members worldwide (most non-paying), it won't be long before LinkedIn reaches its saturation point. Unlike Facebook (FB), LinkedIn is a useful tool to only a relatively limited subset of the world's population. Nearly anyone for whom LinkedIn is useful is already a member.
One element of LinkedIn's investment story is that the company is less reliant on advertising revenues than other social web sites like Facebook. LinkedIn sells premium services to a small subset of its members and is continually working to enhance its service to attract more paying members and increase user engagement. When a stock is priced for perfection, only perfect execution and a friendly competitive environment can prevent a fall from grace. With insiders having taken much of their chips off the table, the execution piece is a risky bet. Regarding competition, both well-funded New York City start-up Relationship Science and Monster are each vying for different piece of the LinkedIn pie.
It is a matter of time before institutional profit-taking kicks in and LNKD shares return to less stratospheric levels. A fall back to the $100 area would result in a stock price that is still quite rich by nearly every valuation metric. At these levels, the risk-reward clearly favors the bears.
Additional disclosure: I have a position in LNKD puts