We put LinkedIn (NYSE:LNKD) in the Danger Zone last August when it was valued at $240/share. Despite its 30% decline since, we remain bearish on the stock. LNKD's 2013 Form 10-K revealed that many of the issues we identified, including slowing growth, declining margins, and hidden liabilities, have worsened. These issues are significant and LNKD remains highly overvalued even after its recent drop.
LNKD's stock valuation embeds significant future profit growth, so it should be of great concern to investors that the company's growth is decelerating. Figure 1 shows that LNKD is experiencing slowing growth in membership, page views, and revenue.
Figure 1: Slowdown in Growth Across Key Activities
Sources: New Constructs, LLC and company filings. Data collection for visitors and page views changed in 2009 so 2010 growth rate is not available.
Investors should be especially concerned over the slowdown in revenue and page view growth. LinkedIn's visitors are engaging with the site less, and the company is having less success in earning revenue from them.
Quarterly numbers suggest the situation could be even worse than expected for LNKD. Unique visitors actually declined quarter over quarter in Q3 and Q4 2013. This decline highlights the problem LNKD faces in trying to differentiate its service. LNKD is just a platform for professionals to connect on, and plenty of other sites can provide that platform. More and more employers are using Facebook (NASDAQ:FB), Twitter (NYSE:TWTR) and Google + (NASDAQ:GOOGL) to assist in recruiting employees.
While LNKD's revenue growth was slower in 2013, 57% is still nothing to sneeze at. Unfortunately, that growth in revenue has not translated into profit growth. In 2013, LNKD only grew after-tax profit (NOPAT) by 6%, from $41 million to $44 million. Its margins contracted from 4% to 3%, and its return on invested capital (ROIC) was cut in half, from 8% to 4%.
The typical justification when revenue growth fails to translate into profits is that the company is spending extra on sales and marketing to fuel further growth. However, LNKD's sales and marketing expense only increased by 60% in 2013, just slightly faster than revenue.
The true culprits for LNKD were its administrative expenses, which increased by 76%, and depreciation and amortization, which increased by 68%. Gross margin also declined by half a percentage point. These are expenses that cannot easily be cut, and the fact that they're growing faster than revenues is a major problem for LNKD.
LNKD doesn't have any debt on its balance sheet, but that doesn't mean there are no liabilities for investors to worry about. The company finances its office space and data centers through the use of off-balance sheet debt in the form of operating leases. LNKD has a total of $965 million in future operating lease obligations, which we discount to a present value of $750 million (28% of net assets).
LNKD also has roughly $400 million in employee stock option liabilities. The company has actually managed to reduce its outstanding options from 8 million at the end of 2012 to 5 million (5% of shares outstanding), but that still leaves a significant liability remaining.
Due to its secondary stock offering last year, LNKD has plenty of cash right now, but since it's had a free cash flow of around -$400 million the past two years, that cash might not last very long.
In order to justify its current valuation of ~$175/share, LNKD would need to grow NOPAT by 30% compounded annually for 23 years. Remember, this company only grew NOPAT by 6% last year. I simply don't see a way for LNKD to achieve the growth implied by its valuation.
If we give LNKD credit for 15% compounded annual NOPAT growth for 15 years, the stock is worth around$25/share. Given the rising costs and competitive pressures LNKD faces, 15% for 15 years, is probably still being quite generous. It is hard to argue that LNKD will come close to justifying its $165/share valuation.
What's more, LNKD executives seem to agree with me, as they've been ditching the stock at alarming rates recently. Over the past six months, insiders have sold 2.7 million shares or 67% of the shares they held. That's right, the company's own executives have reduced their holdings in the stock by 2/3 in just six months. If that's not a red flag, I don't know what is.
Insiders are getting out of this stock, and you should to. LNKD has slowing growth, low profits, and no more market momentum to prop up the price.
Avoid These Funds
Investors should avoid the following ETFs and mutual funds as they allocate significant assets to LNKD and earn our Dangerous-or-worse rating.
- Dunham Focused Large Cap Growth Fund (MUTF:DCFGX): 5.1% allocation to LNKD and Dangerous rating.
- Hennessy Technology Fund (MUTF:HTCIX): 4.3% allocation to LNKD and Dangerous rating.
- Trust for Professional Managers: Geneva Advisors All Cap Growth Fund (MUTF:GNVIX): 3.8% allocation to LNKD and Dangerous rating.
- First Trust Dow Jones Internet Fund (NYSEARCA:FDN): 3.2% allocation to LNKD and Dangerous rating.
- Columbia Select Large Cap Growth ETF (NYSEARCA:RWG): 3.2% allocation to LNKD and Dangerous rating.
- Calamos Mid Cap Growth Fund (MUTF:CMXAX): 3.2% allocation to LNKD and Dangerous rating.
- Turner All Cap Growth Fund (MUTF:TBTBX): 3.1% allocation to LNKD and Dangerous rating.
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Sam McBride contributed to this report.
Disclosure: David Trainer is short LNKD. David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, or theme.
Disclosure: I am short LNKD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.