LinkedIn Sells Off On Sky High Valuations As The Network Potential Continues To Increase

| About: LinkedIn (LNKD)

Shares of LinkedIn (NYSE:LNKD) were trading with sizable losses in Friday's trading session, thereby missing out on a broad-based market rally. On Thursday after the close, the professional online network reported its first quarter results for 2013.

Shares sold-off on the back of a disappointing outlook for the second quarter, as the company remains on track to grow the potential of the network.

First Quarter Results

LinkedIn generated first quarter revenues of $324.7 million, up 72% on the year before. Revenues were up 6.9% compared to fourth quarter revenues and came in ahead of consensus estimates of $318 million.

The company reported non-GAAP earnings of $52.4 million, or $0.45 per diluted share. This is more than three times last year's earnings of $16.9 million. Adjusted EBITDA for the quarter came in at $83.4 million, or 26% of total revenues, a 600 basis point increase on the year. Non-GAAP earnings comfortably beat analysts' projections of $0.31 per share.

Net income according to GAAP principles came in at $22.6 million which compares to just $5.0 million a year before and $11.5 million in the final quarter of 2012. GAAP diluted earnings per share came in at $0.20 per share which compares to earnings of $0.04 per share last year.

CEO Jeff Weiner commented on the developments in the first quarter, "Q1 was a strong quarter for LinkedIn with member engagement and financial results reaching record levels. We remained focused on delivering great products that increasingly make LinkedIn the essential daily resource for global professionals."

A Detailed Look Into The Numbers

LinkedIn has three main sources of revenues.

The largest source is the talent solution business, which reported an 80% revenue increase towards $184.3 million as recruiters across the world increasingly recognize the importance of LinkedIn in their daily activities.

The marketing solution reported a "mere" 56% increase in revenues towards $74.8 million, thereby being the slowest growing business. Revenues were slightly disappointing as investors were looking for increased advertising revenues from the website. Premium subscription growth came in at 73%, totaling $65.6 million in revenues.

Growth across all units was driven by a growing member base, standing at 218 million professionals at the end of the quarter, up 7.9% compared to the fourth quarter of 2012.

Growth was supported by the firm's North American operations, as revenues rose 70% to $225.6 million, thereby generating two-thirds of total revenues. Revenues in Europe, Middle East and Africa were up some 75% to $75.2 million, while revenues in the Asia-Pacific area rose 88% to $24.0 million.

Looking Forward

Accompanied by the first quarter report is the outlook for the current second quarter and the remainder of the year.

Second quarter revenues are expected to come between $342 million and $347 million, up 6.1% on the first quarter and up 51.0% on the year. Adjusted EBITDA is expected to range between $77 million and $79 million, down 6.5% on the first quarter. The second quarter outlook is lower than consensus estimates of $359.7 million.

The guidance for depreciation and amortization charges of around $31 million and $50 million in stock-based compensation reveals that LinkedIn expects to report modest net losses for the second quarter.

LinkedIn raised the full year revenue guidance by $20 million towards $1.43-$1.46 billion, missing consensus estimates of $1.50 billion. Adjusted EBITDA is expected to come in between $330 million and $345 million. Based on depreciation and amortization estimates of $130-$135 million and stock-based compensation of $190-$195 million, LinkedIn expects to roughly break even for the year.


LinkedIn ended its first quarter with $830 million in cash, cash equivalents and short-term investments. The company operates without any debt outstanding, for a strong net cash position.

Based on the company's outlook, LinkedIn is on track to generate annual revenues approaching $1.5 billion for 2013 on which the company could report a small profit.

Factoring in the 13% decline on Friday, the market values LinkedIn around $19.1 billion, or its operating assets around $18.3 billion. This values the company at an astonishing 12.2 times annual revenues.

Given the lack of structural profitability and investment phase in which the company still operates, LinkedIn does not pay a dividend at the moment.

Some Historical Perspective

LinkedIn has gone public about two years ago in a highly successful public offering. Shares more than doubled, ending their first trading day at $94 per share, up from the offering price of $45 per share. Shares mostly traded between $70 and $110 per share for the remainder of 2011 and 2012, and have already risen 53% in 2013, despite Friday's pullback.

The company has seen astonishing growth rates in recent years. Revenues have increased seven-fold between 2009 and 2012 to $972 million. The company turned a $4.0 million loss in 2009 into a modest $21.6 million profit over the past year.

Investment Thesis

Friday's sell-off appears mostly attributable to sky-high expectations. While the company delivered a solid beat for the first quarter, the guidance for the second quarter and remainder of the year was slightly disappointing. First quarter profitability was inflated as LinkedIn shifted research and development recruiting efforts into the second quarter, and the company benefited from the R&D tax credit. LinkedIn paid just $0.7 million in taxes on a reported $23.3 million profit before tax, as a result.

Crucial for any network is to grow the user base and engagement, which combined drive the value of the network. Like competitor Facebook (NASDAQ:FB), which operates a social network, the transition to mobile is also crucial, as more users are accessing the network on their smartphones. LinkedIn said that 30% of its user base accessed its network via mobile phones, compared to 19% last year.

Growth is even more impressive knowing that unique visitor member growth came in at 29%. Pageviews were up 63%, indicating a strong increase in engagement. Despite the strong revenue growth, average revenues per user came in at $1.49 over the past quarter, which compares to $1.35 for Facebook. Given the importance of LinkedIn's possibilities in a person's life, the company should be able to outperform Facebook's ARPU by a wide margin.

Growth has been driven by a constant stream of updates and new tools. The company has launched new initiatives like "Insight", "Identity", "Everywhere" and a new search function, and the company is happy with the initial results. The company furthermore, recently announced the $90 million acquisition of mobile newsreader Pulse to boost advertising revenues on wireless devices.

Investors were running to the emergency doors on Friday as revenue growth is slowing down, and as shares have already risen 53% year to date, thereby boosting the expectations for a blow-out quarter and guidance. Obviously, the first quarter earnings were inflated as mentioned above, as the company is on track to break even for the year. These GAAP earnings do not reflect the "true earnings" capacity of the firm as LinkedIn is investing towards the future to grow the franchise.

Media discussions about price-earnings ratios of a 1,000 are useless as growth names like LinkedIn and Facebook are understating their earnings by investing in the future. If the company manages to grow revenues by 40% per annum going forward, it will be on track to generate annual revenues of $4 billion by 2016. If the company could become a cash cow at that point in time, net margins of 25% are not unthinkable off, resulting in annual earnings of $1 billion.

LinkedIn has been a true success story and its "current" valuation has always been sky high as the company delivered on growth. If the company can continue to profitably expand its operations, the valuation becomes rapidly more acceptable in the future, especially if the company can boost its average revenue per user.

While shorts might see some short-term momentum following the earnings release, they might run the greatest risk in the long run as shares have already quadrupled following their public offering. Not to say the company is a screaming buy either at these levels.

For now, I remain on the sidelines.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.