The Social Media Bubble
There currently exists a massive social media stock bubble that has helped grow the valuation of LinkedIn (NYSE:LNKD) to the point where no traditional valuation method can justify the valuation the market is supporting. This article is an attempt to explain the author's belief that there is a considerable and basic mispricing of LinkedIn's stock. Additionally, the author's research had led to the development of estimates that clearly support the case that LinkedIn has the third largest U.S. social media userbase, behind Facebook (NASDAQ:FB) and also Twitter (NYSE:TWTR). LinkedIn's calculation of its userbase misrepresents that it is the second largest social media userbase in the U.S.
Valuations Based on the Price to Users Ratio: Market Implications
In a recent article by this author, the term "Price to Users" was introduced and defined as a social media stock's market capitalization divided by the stock's userbase. Monthly Active Users ("MAU") is defined in the SEC filings of Facebook and Twitter and is used as the "userbase" figure in the calculation of the Price to Users ratio for each stock. LinkedIn refers to their users as "registered users." LinkedIn's registered users is the figure used as the "userbase" figure for the calculation of the Price to Users ratio for LinkedIn. There are differences between the calculations that use MAU (Facebook and Twitter), and the LinkedIn calculation that support the premise for this article. The premise of the previous article was simply to display a surprising correlation between LinkedIn, Facebook, and Twitter. Each of the stocks was trading at a Price to User ratio of approximately 100. If this correlation occurred for just two of the three stocks on the same day you could suggest it was a coincidence. When three stocks commonly followed and compared by investors and others within the capital market sector correlate so well, it is more than just a coincidence. Furthermore, this ratio has remained approximately constant for the past week, since Twitter's IPO.
The market is valuing these companies based on their userbase rather than sales, earnings, equity or any other traditional method. The biggest flaw in this scenario is that each userbase is considered to be comparable. This article suggests an important and perhaps the most significant reason why they are not comparable.
Figures as of November 13, 2013
The correlation of the valuations is likely because of the factors below:
- The market assumes that the registered user calculations by LinkedIn are comparable and calculated in a somewhat similar way as Facebook and Twitter calculate their MAU.
- The market does not appear to be considering that all three companies have a significant but unequal number or percentage of their users that do not represent human beings or that are duplicate accounts ("Fake Users"). For purposes of this article, this author is ignoring the impact of Fake Users. That topic is another large unknown at this point and needs to be discussed in depth in order to estimate the impact or potential impact on valuations. Even still, any attempt to measure Fake Users is likely a waste of time in this author's opinion. Only the companies themselves can potentially generate accurate estimates and for the most part they do not appear motivated to do so.
- The management of LinkedIn, Facebook and Twitter clearly measure their growth based on users, and may not necessarily consider traditional metrics such as revenues or net income (loss) as being more important than user figures and user growth, respectively. Each company's SEC filings specifically identify users and user growth as key indicators of the success or failure and trends of their business operations. An argument that these specific user-related key indicators are the primary driving force of each company's business operations and decision-making processes is not difficult to make. Dick Costolo, Twitter's CEO, specifically stated this case on the day of Twitter's IPO. A majority of investors obviously agree with him. The correlation discussed herein proves that Twitter is being valued based on its userbase. If management is primarily measuring their growth based on its userbase then shouldn't the market consider valuing the stocks based on that data? Whether or not you, the reader, or I, the author, agree with this or not, the market is clearly valuing these stocks based on users.
- This may be an arguable statement but this author believes the valuations of LinkedIn, Facebook and Twitter are correlated very closely at this time because the market doesn't know enough about each company's user data in order to differentiate between each company and determine a more accurate methodology of valuing each company's users, and therefore each company's stock. The valuations are simplistic at this time and need to be improved to account for differences between each company's userbase, products, business stage and general business plan, among others. It is also possible that Price to Users is only a temporary metric being used by the market. Also, the reliance on that metric could change entirely and be replaced by other more traditional valuation methods or even methods that have yet to be envisioned.
Extremely Limited User Data
The user data provided by these three companies is severely lacking. This author suspects these stocks will trade in a correlated fashion until the bubble bursts and the support for one of the stocks dissipates. It is a familiar story. However, the cause of the bubble bursting may end up being unique. Basic logic suggests that if the stocks are being valued based on the Price to Users ratio, then when one of the factors impacting that ratio changes substantially or is in question, then the valuations will be recalculated and the chance of large upward or downward price movement becomes real.
The Downside, LinkedIn's Registered User Data is In Focus
As discussed previously, Facebook and Twitter measure and disclose MAU in their annual and quarterly SEC filings. These are current figures that represent active use of Facebook and Twitter products in each quarterly period. LinkedIn measures "registered users" as defined below in their September 30, 2013 quarterly filing.
"We define the number of registered members in our network as the number of individual users who have created a member profile on our website as of the date of measurement."
"The number of registered members in our network is higher than the number of actual members because some members have multiple registrations, other members have died or become incapacitated, and others may have registered under fictitious names."
The userbase figure the market is basing LinkedIn's valuation off of is inflated, perhaps by a large percentage, because LinkedIn includes as a user, any profile that has ever been created. There is no consideration for users who created a profile and are no longer actively using LinkedIn's product offerings.
LinkedIn was founded in 2002. How many LinkedIn profiles have been created and abandoned in the last 11 years? It is impossible that this number is not significant. An investor is left to just guess how many active users LinkedIn has and just how serious this issue is.
This author considers the inflated LinkedIn registered users figure to be the single largest threat to the current market sentiment that considers each of these companies' users to be comparable. Even Fake User estimates do not appear as significant as this issue is. Of the three companies, Twitter, has suggested its Fake Users represent the highest percentage of users among those disclosed by LinkedIn, Facebook and Twitter. This figure is estimated by Twitter to be approximately 13%. The abandoned LinkedIn profiles appear to be more than twice as large as the largest Fake User estimates.
A 29% implied downside exists in LinkedIn's stock, based on the calculations in the table below. These calculations are made in an attempt to generate LinkedIn userbase figures that are comparable to Facebook and Twitter's MAU.
* The Actual Current Userbase figures for Facebook and Twitter represent their disclosed MAU figures for the three months ended September 30, 2013. LinkedIn does not disclose a comparable figure. Instead, they disclose a figure referred to as "Unique Visitors," which appears to this author, to be the most comparable figure, though still a flawed figure, to the MAU figures provided by Facebook and Twitter. Unique Visitors is defined by LinkedIn in its SEC filings as the following:
"We base unique visitors on data provided by comScore, a leading provider of digital marketing intelligence. comScore defines unique visitors as users who have visited our desktop website (which excludes mobile engagement) at least once during a month regardless of whether they are a member."
This author believes the mobile segment of users for all three companies is very difficult to measure due to a variety of factors including automated mobile apps data refreshing. These companies have disclosed such difficulties. The author makes no attempt to estimate and compare the mobile segment of each userbase. There is an obvious risk that the true active userbase of LinkedIn, if including mobile users, is in excess of 184 million users. Conversely, there is also a risk that further supports the downside in LinkedIn. LinkedIn's estimated 184 million Active Current Userbase may actually even be overstated due to the fact that the data from comScore tracks total visitors, "excluding mobile engagement," to LinkedIn.com, and does not discount the 184 million for visitors who are not LinkedIn members. In that instance the implied downside could exceed 29%.
Large price movements in LinkedIn and Facebook are now much more likely given the userbase and other data that became public information as Twitter completed its IPO. Direct comparisons to Facebook are no longer the best comparative analysis available for LinkedIn. Additional data provided by Twitter should provide for more accurate analysis of LinkedIn in some or even many ways. Analysis by traditional bank analysts, countless investors, and a general increased competitive capital markets effort by each company will result in more detailed userbase figures and projected userbase growth. This is inevitable. These companies will be forced to release the data we all know they have but have been so reluctant to release. These three companies represent perhaps three of the most powerful big data companies in the world. They have the data. It's just a matter of time before they release it. As each company releases more data, and specifically more accurate data, the re-valuation of these stocks will be instantaneous. Short-term volatility in these stocks will likely increase exponentially. This pressure to release this data is already building. This author will suggest that the data is released in each company's forthcoming annual reports that should be filed in either late January or early February 2014. However, to limit the volatility in their stocks this author believes management of each company will take a conservative approach. This author believes enhanced userbase data will be released steadily over time, and likely in the next three months, up until the 2013 earnings are released.
LinkedIn has released almost no useful information about its userbase. Its registered user figures are not comparable to Facebook or Twitter's MAU figures. In fact, the registered user figures are potentially meaningless and misleading. The methodology used to calculate the figures is massively flawed and has no basis being considered accurate current active userbase data. As a result, LinkedIn is under the most pressure of all three companies and will be the first to release data calculated in a comparable fashion to Facebook and Twitter's MAU. There is no positive, no upside, in this data. It is all bad news because the market currently considers all users for each company to be equals. It also seems likely that LinkedIn will be forced to release its Fake User data as well. The holidays are upon us very soon. There is no better time to begin releasing this data than over a holiday season when perhaps a few less investors will be paying attention to the market and LinkedIn's SEC filings.
A few facts should easily support an argument that there is no likely short-term catalyst that should drive LinkedIn's current valuation upward in any meaningful way.
- LinkedIn's current price to earnings ("P/E") is approximately 8 times that of Facebook (994.46/124.58 = 8). Many investors claim Facebook is overvalued. LinkedIn is on another level and cannot possibly justify a price to earnings at the current level. An increase in the stock price and therefore also the P/E in the short term is an even more absurd notion.
- LinkedIn, Facebook and Twitter have all recently reported their financial results. The next reporting date for all three companies is in February 2014, though there is some history with these companies filing in late January. It is doubtful new financial operating results of any kind will be published between now and when the preliminary earnings or annual reports are released, which would be late January at the earliest.
- This author is not aware of any significant acquisition target that LinkedIn could pursue that if announced, could cause LinkedIn's stock to move upwards aggressively. The holidays are upon us soon as well. This author believes M&A generally is much less active during these next few months.
- LinkedIn's bull case is generally built on the premise that it is a diversified services company and Facebook and Twitter have just one revenue stream based on advertising. This is a fine argument but it does nothing to suggest any short-term catalysts exist for LinkedIn's stock.
Sources: All data is generally taken from SEC filings, Yahoo Finance or articles referenced within this article.
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.