Seeking Alpha
Newsletter provider, dividend investing, long/short equity
Profile| Send Message| ()  

Write down this ticker symbol – (NYSE: LNKD) – and track it when the stock market opens on Thursday. Why? Because LinkedIn is the first in a string of highly anticipated social networking-related companies to go public. And if this IPO flops, it’s game over for social media.

Sounds dire, I know. But it’s true. Allow me to tell you why – and more importantly, what to expect.

They Say Privacy is Passé… So Prove It!

The explosion of social media-related companies in recent years has emanated from one theory: That privacy is passé.

That’s definitely a new way of thinking, as I’m pretty sure the average octogenarian isn’t hip to the ins and outs of social networking. And this Thursday, that new belief will be put to a definitive test when online professional networking company, LinkedIn, goes public.

Yes, LinkedIn is a wildly popular company, boasting 100 million registered members – but will that translate into stock market profits?

You see, Wall Street institutions aren’t adverse to taking risks with their money on startups. But they require rewards. Otherwise their money finds a new home. So with a host of social networking companies waiting in the IPO pipeline (or considering an IPO), LinkedIn represents a bellwether for the entire space.

If its stock flops, Wall Street’s smart money is going to rush for the exits and it will be “game over” for social media.

Or more simply put, if Wall Street can’t profit from its social media investments, it’s not going to make any further investments. Period.

Here’s why I don’t think that’s going to be the case with LinkedIn, though.

Demand? Check. But Profits?

LinkedIn’s IPO already benefits from strong investor demand. In fact, the rumor mill suggests – and my institutional contacts confirm – that the deal is oversubscribed. In other words, more investors want to buy shares than the company is selling.

When demand outstrips supply like this for an IPO, it finds an outlet in the aftermarket and often translates into steady buying in the days after a company goes public.

Furthermore, shares have recently traded on the secondary markets for as much as $31 a pop. That suggests that the proposed price range of $32 to $35 per share isn’t too rich for investors.

But it takes much more than hype to fuel a stock price over the long term.

For LinkedIn to be a true standout and increase wealth multiple times over like internet sensation Google (Nasdaq: GOOG), the underlying business must hold promise.

And LinkedIn’s does. In fact, it possesses all the key characteristics of a successful IPO.

Five Hallmarks of a Hot IPO

~ Age: The older and more established a company is when it goes public, the better the stock tends to perform. And founded in 2003, LinkedIn isn’t an unproven start-up. It’s been around long enough to demonstrate viability. That’s not something you could say about most IPOs during the dot-com collapse. The average IPO back then hit the public market at just four to five years of age.

~ Revenue: In another sign of its maturity, LinkedIn boasts over $240 million in sales. Research from University of Florida professor, Jay Ritter, shows that companies with more than $50 million in sales before they go public perform best, rising by an average of 38.8% over three years. That compares to only a 5% rise for companies with less than $50 million in sales at the time of their IPO.

~ Verifiable Growth Opportunity: An IPO is an investment in the future growth of a company. And LinkedIn boasts ample growth opportunities, penetrating less than 1% of a market worth $27 billion, according to IDC. In other words, growth hasn’t peaked… it’s just gaining traction.

~ Profitability: As I’ve said countless times before, share prices ultimately follow earnings. And the performance of IPOs during the dot-com era proves my point perfectly.

Roughly 70% to 80% of companies that went public during that period were unprofitable. And go figure… roughly the same amount of companies crashed and burned in the aftermarket.

On the other hand, LinkedIn turned the corner on profitability last year. And as its sales increase, net income and the share price are bound to follow.

~ Valuation: Investors hate to overpay. Based on the terms of LinkedIn’s IPO, the company is going to be valued at about $3 billion. That might seem like a stretch, given its current sales and profitability levels. But remember, the stock market is a forward-looking beast. Since LinkedIn could conservatively generate $1 billion in sales by 2014, the company’s easily worth more than $60 per share, based on price-to-sales ratios for other established internet service companies.

In addition, it’s never a bad sign when corporate officers and directors are retaining a 56.3% stake in a company post-IPO. That’s the case with LinkedIn. Clearly they’re betting on much more growth to come. And I would, too.

Add it all up and I’d hold off on writing any obituaries. LinkedIn’s IPO promises to be a coming-of-age party for social networking companies… not a funeral.

Source: Is This Week's LinkedIn IPO Hot or Not?