I like LinkedIn's (NYSE:LNKD) business. I think LNKD is a clear leader in this transition to web-based professional networks and recruiting resources. I think the field will display strong network effects (employees will want to be where employers are, employers will want to check where employees are). I think the whole business will be amenable to sustainably high margins. But there is something which bugs me. And that something is the reason why I am writing this article.
You see, LNKD seems to be a company built to feed families in San Francisco. I say "San Francisco" but LNKD is headquartered in Mountain View. It's just that one can kind of consider "San Francisco" to be the whole region bordering San Francisco Bay. It's all within a 40 mile or so radius.
Why do I say this? Consider the following (Source: Q4 2015/2015 earnings report):
- LNKD had 2015 adjusted EBITDA of $780 million.
- It had operating cash flow of $807 million.
- From this operating cash flow, we should remove capex of $507 million.
- So, theoretically, LNKD had free cash flow (FCF) of $300 million.
- However, all of this free cash flow and then some came from stock-based compensation (SBC), at $510 million. So if we exclude SBC from FCF, LNKD had negative FCF to the tune of $210 million.
- Also, 2/3rds of its adjusted EBITDA is coming from SBC.
- Furthermore, SBC was also 17% of revenues.
- LNKD runs at a GAAP loss fully on account of SBC.
- Also amazingly, LNKD's "additional paid-in capital", powered by option exercises and stock grants, went up by a whopping $1.3 billion during the year. All of LNKD's equity growth, and then some, comes from this.
We can thus say that all of the cash being generated by LNKD is coming from paying employees with stock or stock options. Moreover, LNKD had average employment throughout 2015 of ~7856 employees. If we divide its SBC by that number of employees, we come to a staggering sum of nearly $65,000 per employee in SBC alone.
It is not a stretch to say that at this point, LNKD is being run for its employees, and not its shareholders. I can give two examples which make this even clearer.
What If Microsoft (NASDAQ:MSFT) Did The Same?
First, although Microsoft is headquartered in Seattle, Washington, and although Seattle has lower labor costs than San Francisco, it should be said Microsoft's advantage goes farther than that. After all, contrary to emerging web companies which still have a large part of its workforce concentrated near headquarters (mostly in California), a large company like Microsoft is already spread throughout the world. This puts most of its employees in lower-cost jurisdictions.
Still, the same math I applied to LNKD comes to ~$21,000 per employee in stock-based compensation when applied to Microsoft. Were this level the same as LNKD's, and Microsoft would have had to pay a further $8 billion in SBC. This would wipe out nearly 2/3rds of Microsoft's FY2015 reported net earnings.
Microsoft would then also be working to feed families the world over, but would leave precious little to feed shareholders.
Even More Surreal, Salesforce.com (NYSE:CRM)
Salesforce.com is known for lavishly throwing stock options and stock grants at its employees. One would think that it was the poster boy out there for "Feeding Families In San Francisco".
Alas, that's not to be so. CRM had average employment throughout FY2015 of ~14,500 employees. To these, it paid SBC in the amount of $565 million. This comes to ~$39,000 per employee. This is a full $26,000 short of LNKD. The surprise is complete.
I want to like LNKD. But LNKD needs to do something about its excessive SBC before it can be liked.
As it is, LNKD looks like an interesting business that's being run solely for the benefit of its employees. Said another way, it's being run to feed families in San Francisco. And those must be very happy families to boot, but a measure of that happiness is now coming at LNKD's shareholders' expense.
Disclosure: I/we 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.