LinkedIn's Future: The Good, The Bad, The Ugly, And The Exceptional

May.31.12 | About: LinkedIn (LNKD)

Even after the recent pullback, LinkedIn (NYSE:LNKD) has such insane valuations, that it is inevitable that it will crash at some point. It could be this year, or it could be next year, but as soon as year on year revenue growth dips below 60-70%, the stock is in trouble.

The problem with LinkedIn, is that while there are a few job hirers, networkers, and marketers that use it, the vast majority of users are job seekers. Unemployed people are usually tight spenders. Therefore, LinkedIn is going to have a hard time consistently squeezing money out of its users, using ads or otherwise. Marketers and job hirers aren't going to spend a lot of time looking at ads either. They have a job to do, and are usually looking straight past the ads. Networkers are there for the experience, so they might click on an ad or two, but it doesn't look very promising. Those that have stable jobs generally don't use LinkedIn because they have other things to do with their off time besides work.

Here's an example. Imagine a car manufacturer executive who is satisfied with his career and isn't looking for another one. He spends all day making sure the cars are being made, and he speaks with his contacts and customers in the car industry. If he is fooling around on LinkedIn at work, he isn't doing his job. Then when he goes home he might login to Facebook to connect with friends and family. But why would he go on LinkedIn? To try to learn more about cars or meet new people in his industry or some other industry? He doesn't need to deal with work at home, he has a life.

I came to this realization when I purchased the InMail service to try it out. InMail is one way that LinkedIn creates income. InMail allows you to send messages to anyone on LinkedIn without needing an introduction. I sent an InMail to three different portfolio managers who I wanted to meet. All three InMails became "in progress" status meaning they haven't been read yet and all three InMails ended up expiring after a week. That means that those three portfolio managers never logged into their LinkedIn accounts during that week. And why would they? A portfolio manager's job is to find and research good investments. They have their own inner circle that they consult to help them. It would be counterproductive to spend time talking to strangers on LinkedIn about investments.

General Motors said May 15 that it will stop buying advertisements on Facebook--about $10 million a year. "I think we've learned through our experience that the paid advertising is not the best way of activating Facebook," Chris Perry, the VP of global marketing for Chevrolet, told Automotive News.

The automaker will continue to promote its brands and vehicles on Facebook by producing content such as videos, contests and photos designed to engage Facebook users. GM realized that ads have to be engaging to users on Facebook, otherwise they are ineffective.

I believe advertisers will come to the same conclusion on LinkedIn. Ads need to be more engaging for them to have a worthwhile effect. Advertising revenue represented 26% of total revenue for LinkedIn in the first quarter of 2012, compared to 30% in the first quarter of 2011. This shows that it isn't growing as fast as its other segments, and soon it could start dropping off.

LinkedIn has already started to penetrate other geographical markets very nicely. 64% of its revenues are from the US, 22% is from Europe, the Middle East, and Africa, and the rest is from the rest of the world. I don't see that as a positive because it shows that LinkedIn is a mature company and therefore growth is limited. Also, most countries have their own version of LinkedIn, for example, this page shows quite a few Chinese professional networking sites. Everyone in the world wants to be "in" when it comes to their careers and social networking, so most people will create an account when they hear about others using LinkedIn. However, this doesn't mean that they'll continue using the site after their curiosity dies down. Also, new users provide diminishing returns for the Company. For example, if someone in a far away place like South Africa signs up on LinkedIn today, LinkedIn won't make as much money off people in that country because it's poorer than the US and advertisers aren't set up there.

Last year was the perfect timing for LinkedIn to go public. There's a global recession with lots of unemployment and uncertainty. Therefore, job seekers and shifters are in abundance in the world. LinkedIn has grown its revenues quickly since its IPO. However, this fact is a red herring. Those kinds of people aren't looking to speak to their own kind. They want to seek out executives and people with solid job positions. Unfortunately, they won't find many of those people on LinkedIn because they have no use for the site. Also, once the world is out of its recession and people are in stable jobs, there will be less use for LinkedIn.

LinkedIn also has a good share of competition in the US. Here is a list of the 10 Best Job Search Websites, which includes LinkedIn.

Don't get me wrong, I think LinkedIn is a great company and there is a need for a professional online networking site in this world. However, it shouldn't be a $10 billion company. Maybe $3 or $4 billion at the most but only if it becomes and remains the world's premiere job searching site, which remains to be seen.

The Good, The Bad, The Ugly, and the Exceptional

I have four scenarios for LinkedIn: the good, the bad, the ugly, and the exceptional. The good scenario prices the stock at around where it's at today. The bad and ugly scenarios value LinkedIn at much less than it is today. The exceptional scenario prices LinkedIn at $125, which is the price target that Mark Mahoney of Citibank gave the company as he upgraded it from "neutral" to "buy".

The following four discounted cash flow models that each show the different scenario for the company. All three models use an 8% discount rate and are forecasted out to 2043. They all predict that LinkedIn will reach its peak in revenues by 2015.

The reason for such a speedy peak in revenues is because social networking websites often aren't like traditional companies that take decades to reach their peak. Pretty much every working professional in the world has access to and knows about LinkedIn now. Three to four years is enough time for the company to learn how to maximize its revenues. If it doesn't, then some other social networking site will start taking away its market share. Also, after 2015 the world should be further out of the recession, in which case it will be harder for LinkedIn to drum up new business since more people will have steady jobs.

The net present value (NPV) per share is circled in red on the bottom of the spreadsheets.

The "good" scenario is what the market currently expects for LinkedIn. It values the company at $100 a share. It predicts that revenues will rapidly grow from $900 million in 2012 up to $3.8 billion by 2015, and stay there through 2043.

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The "bad" and most likely scenario in my opinion is that net sales will grow from $880 million in 2012 to $2.1 billion in 2015 and stay there through 2043. This would value the stock at $40. I think this is a more appropriate valuation of the company.

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The "ugly" scenario has the company grow to $1.5 billion in revenues by 2015, and stay there through 2043. This would value the stock at $23 per share. This scenario is unlikely, but still possible.

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Then there's the "exceptional" scenario. Mark Mahaney of Citibank upgraded the stock to buy because the company is beating expectations this year, and a survey says more people are going to start looking for jobs on it. For the stock to be worth $125, the company will have to have annual revenues of $4.6 billion from 2015 on. That's more than five times the annual revenues the Company forecasted for 2012. I don't understand how Mr. Mahaney can come to the conclusion that LinkedIn will experience such explosive growth in future years just because it's having a good year now.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.