This article is an analysis of LinkedIn's (LNKD) current business and future prospects as demonstrated by their fourth quarter performance. After review, we have come to the following conclusions:
- LinkedIn's fourth quarter was an excellent performance, both operationally and financially;
- LinkedIn's competitive outlook is unchanged: they remain the market leader for professional networking;
- We believe that LinkedIn's stock valuation is too high and does not reflect the fast-growing competitive threat posed by Facebook and private companies using Facebook's platform to offer services that compete with LinkedIn;
- We remain at a Hold/Neutral on LinkedIn's stock.
After the market close on Thursday, February 9, LinkedIn reported its fiscal 2011 fourth quarter (December) results. The company reported non-GAAP earnings per share of $0.12, which was $0.05 ahead of the $0.07 consensus (14 analysts) estimate. Revenue of $167.7m (up 105% year-over-year) was also firmly ahead of the $159.4m consensus. Other metrics included:
For the whole company:
- Total Registered Users: 145m at 12/31/11, up 60% y/y; 150m+ at the end of January;
- 60% of users are non-U.S;
- 16 languages now supported;
- LinkedIn.com had 24.4m unique visitors in December, up 71% y/y; the 44th largest site by unique visitor. By comparison, Facebook was #2 with 171.5m unique visitors, up 25% y/y.
For the Hiring Solutions segment:
- Hiring Solutions: $84.9m, 50% of total revenue, up 136% y/y (was +160% y/y growth in Q3);
- 9200 corporate (LCS) customers; up 139% y/y and up from 7400 at the end of September, 2011;
- ARPU for the 9200 LCS customers rose 10% y/y;
- ARPU for total Hiring Solutions segment declined 4% y/y.
For the Marketing Solutions segment:
- Marketing Solutions: $49.5m, 30% of total revenue, up 77% y/y; (was +113% in Q3);
For the Premium Subscriptions segment:
- Premium Subscriptions: $33.3m, 20% of total revenue, up 87% y/y (was + 81% in Q3)
- Mobile Access to the site: 15% of unique visitors;
- Gross Margins (non-GAAP): 86%, vs. 82% y/y;
- Q4 Cash Flow from Operations: $24m;
- Q4 Free Cash Flow: $4m Cash Flow;
- Q4 Total Cash Flow : $189m, though $178m of that was from the recent follow-on offering.
- For FQ1 (March): Revenue in a range of $170m - $175m, compared with the $169.3m consensus estimate; EBITDA in a range of $25m - $27m.
- For full Fiscal 2012 (December): Revenue in a range of $840m - $860m, well ahead of the $812.9m consensus; EBITDA in a range of $155m - $165m.
What It Means:
LinkedIn's fourth quarter was virtually flawless. The company executed in all segments, met operating targets and furthered growth initiatives (e.g. mobile, Student/Young Professional) and set realistic, though still impressive operational and financial targets for the current quarter and all of 2012.
New sales & marketing offices in Japan, India and Brazil will help further LinkedIn's sales goals (though LinkedIn still lacks a direct sales presence in Russia and China, two key BRIC markets).
On Friday, February 10, LinkedIn's share price responded to the excellent performance by rising 18% to nearly $90, only slightly above today's stock price.
Postives/Upward changes to expectations:
- Membership grew 60% y/y…while…unique member visits to LinkedIn in grew 67% y/y…while…member page views in Q4 grew faster still at 77%. This progression is immensely powerful, and explains neatly why revenue growth is faster still, at 105% in the quarter.
- Good traction in their student/post-college offering, described by management as their fastest-growing demographic (no doubt off a small base);
- Among Premium Subscribers, there is a mix shift from monthly to annual contract lengths, with no appreciable increase in churn. This is very positive, signaling a net increase in the high value placed on LinkedIn in general, and the Premium Subscription in particular.
Negatives/Downward changes to expectations:
- The first deceleration in revenue growth, down to 105% y/y, from 126% in the September 2011 quarter. Hardly falling off a cliff, but the deceleration reverses a multi-year trend of accelerating growth. We attribute the deceleration simply to the Law of Large Numbers, and not to any material weakness in the company's business model.
- A slight deceleration in member growth, from 63% y/y growth in the September 2011 quarter, to 60% growth in the December quarter. Again, this is hardly an abrupt stop, but a change in direction nonetheless.
Valuation (DCF and Comparative Analysis):
As part of our analysis of LinkedIn, we maintain a Discounted Cash Flow (DCF) model for the company. We have updated the parameters with the most recent Q4 data to arrive at our DCF value:
Term: 5 years;
Initial Cash Flow: $44.0 million (this represents the annual free cash flow for LinkedIn's just-completed fiscal year);
Short Term Cash Flow Growth Rate: 20% (far lower than the recent 100%+ revenue and cash flow growth rates, but probably sustainable over the next five years;
Long Term Cash Flow Growth Rate: 5%;
Discount Rate: 8.77% (derived using CAPM: Risk Free Rate = 3.10% from the 30-year Treasury Bond; 4.4% equity risk premium from Ibbotson; and an estimated Beta of 1.30);
Current Share Count: 108.612 million (materially higher than just two months ago, thanks to the secondary offering.
Using these inputs, our calculated DCF value per LinkedIn share is $21.20, almost exactly ¼ of the current share price. Think our 20% five-year growth rate is too low? At 50% growth, the DCF value jumps to $62.19, much closer to today's price, but still 27% below it.
If you want to say that a DCF model doesn't really adequately value a young, ultra-fast-growth company like LinkedIn, we'd have to agree with you. But it does offer a picture of what the share price might be were either:
1) growth to abruptly slow - not especially likely, given the very early penetration of LinkedIn's total addressable market(s); or
2) LinkedIn's valuation to be re-assessed, were word to spread more widely of the speed and strength of competitive threats from Facebook in concert with BranchOut, BeKnown, Identified, Talent.me, etc. We view this latter scenario as not merely a possibility, but likely.
The following table compares LinkedIn and six other technology service and software-as-a-service companies:
Op CF Margins
MRQ Rev Growth
Float: Shares Out
LTM=Last 12 months, CF=Cash Flow, MRQ=Most Recent Qtr.
The primary conclusions we draw from this table are:
- LinkedIn is most comparable to Zillow: two recently public companies, with triple-digit growth rates, triple-digit P:E valuations and very low floats, with a flood of shares un-locking in the coming year. Zillow, however, lack's LinkedIn's "Facebook Problem;" i.e., a major competitive threat.
- You have to be impressed by Google's 25% growth rate, given the company's size. But with the acquisition of Motorola Mobility, Google's business model will instantly change to lower profits and lower growth. The benefits of the MMI acquisition seem dubious to us, and to others it seems.
- LinkedIn's relatively low float will be changing again soon, as an additional 55m shares (out of 117m total shares and un-exercised options) "un-lock" on February 27. Roughly 90% of these un-locking shares are held by co-founder Reid Hoffman and two venture capital firms, Sequoia Capital and Greylock Partners. Our experience is that VC firms are price insensitive when it comes to monetizing their investments. But it also wouldn't surprise us to find LinkedIn filing for another follow-on offering to facilitate a more orderly distribution of all those shares.
What You Should Do About It (Buy, Sell or Hold?):
We are maintaining our "Hold/Neutral" rating on shares of LinkedIn. The company continues to do everything right. Our reluctance to own shares is only because we don't believe the world at large understands the competitive threats posed by Facebook and the well-funded private companies tapping Facebook's database of 850 million user profiles.
How serious are these threats? Consider Identified, a private company that uses Facebook profile data to create a score of how desirable a particular a particular person might be to a potential employer. This in turn creates a motivation for Facebook users to "professional-ize" their profiles, knowing they are potentially being sifted by companies looking for talent. With 180 million Facebook profiles already in Identified's database, critical mass is not a problem.
It's absolutely true that LinkedIn's demographics skew older and more professional than Facebook's membership. And it's absolutely true that most Facebook users' profiles are not created with an eye toward attracting a job. But it's also apparently true that quite a few LinkedIn employees, including their CEO Jeff Weiner, have themselves signed up with Identified and created profiles. All in the name of researching the competition? Of course. But one wonders…
At a current forward Price:Earnings ratio of 121, LinkedIn is priced for perfection. To the company's credit, operational and financial execution has been virtually perfect not only for LinkedIn's three reported quarters as a public company, but also for about the last three years of its existence. And we don't foresee any change to that track record.
All we see is a great company with still-modest though well-funded competition and a share price that we think reflects much of the former, and not enough of the latter.
Please see our complete research report on LinkedIn, published on Seeking Alpha in December 2011.
Additional disclosure: I am long ARBA in the Separately Managed Account product for which I am the portfolio manager and in which I am an investor.