To be clear, as value oriented investors, we typically avoid technology stocks and recent initial public offerings. But for those investors who are comfortable paying a premium to own a stock on the forefront of a new trend, there may be reasons to be bullish on the latest hot IPO, LinkedIn Corp (LNKD).
LinkedIn Corp is one of the first in series of high profile technology IPOs that have included Russian internet search company Yandex NV (YNDX) and Renren Inc (RENN) and will likely include: Twitter, Groupon and Facebook. The company's high profile status, overall industry excitement and underpricing by lead underwriters Morgan Stanley (MS) and Merrill Lynch (BAC) caused the stock to roughly double the first day. Because of the first day performance and the pricey valuations, LinkedIn instantly became the subject of unabashedly negative headlines. While we agree that the company appears pricey, we think the following factors may provide investors with reasons to be bullish.
MARKET SENTIMENT IS OVERWHELMINGLY NEGATIVE
Sentiment is not always wrong, but extreme levels can often provide investing opportunities. Now, market sentiment is consistently negative. As a matter of fact, we don't recall the last time a stock was so universally disliked and considered overpriced. On May 23, Bloomberg published an article about how LinkedIn stock could sink to $30 once insiders begin selling shares. This is compared with the $45 that the IPO priced at and the roughly $100 current price! Bloomberg's article relies on the speculation of one interviewee who cites "Econ 101" for his projection. Of course, right or wrong, the bearish sentiment is not unique. Short selling appetite is so strong, that the Wall Street Journalclaims that the annualized cost to borrow LinkedIn shares is around 180%! With a price/sales of 30.86, LinkedIn shares are pricey, but the more overvalued bubble may be among LNKD bears.
TREMENDOUS BUSINESS GROWTH POTENTIAL
The company was initially a social professional network and means to keep up with former co-workers, but the site is quickly evolving into a job search and placement network. Recent growth rates amounted to about one new member joining the network every minute. In each of the last seven years, the website's membership base has roughly doubled. In 2010, about 56% of the company's members were international. As the company continues to build its brand value, its strong foothold in the international marketplace makes future membership growth very promising.
Over the past few years, revenues have grown roughly in line with membership. Profit margins remain slim because of high relative spending to build out the company and defend its competitive position. In 2010, the company had $243.09 million of revenues. In 2011, the company is on a trajectory to report more than $500 million of sales. This would still leave the company with a price/sales ratio of about 17.8.
UNTAPPED MONETIZATION POSSIBILITIES
While membership growth rates are impressive, they are only one half of the explanation for why investors have paid such a premium for shares. LinkedIn investors likely feel that the company has only begun to tap into its money making potential. Current revenues and earnings do not fully reflect the full potential of the site's user base and revenue outlets.
One of the most undervalued statistics may be that 100% of the Fortune 500 companies are represented on the site. Corporations spend a significant amount of resources on recruiting and hiring. If LinkedIn further cements its network and reputation among corporate hiring outlets, the company could significantly increase revenues and increase pricing power by reducing corporate dependence on headhunters and lowering the transaction costs associated with hiring.
There is no question that LinkedIn is a pricey stock based on trailing earnings. The company's growth opportunities are immense, but any stumble in execution is likely to adversely affect the stock price because of the rich valuations. While we are cautious of the stock at current valuations, we still see reasons to be bullish. Investors would be wise to take a closer look at the stock based on the specific reasons mentioned above. This is not a general view of the entire industry. The investment thesis for other IPOs like Yandex NV (YNDX) and Renren Inc (RENN) could be very different.
Disclosure: I own BAC shares.