Last week, professional social networking company LinkedIn (LNKD) announced a breach to its security, suggesting some of the network's 160 million users had passwords stolen. The extent of the attack is unknown, but according to a Reuters article, more than 6 million of the passwords have appeared on underground hacker websites. Oddly, LinkedIn users haven't been notified of the massive breach unless their account information has been compromised. LinkedIn's handling of the situation suggests management knows how critical security is to the long-term value creation ability of the company.
It appears that the company has some serious security issues. According to some security experts (also cited in the Reuters article), the company's security storage methods may not be as sophisticated as they should be. Not only could this situation have legal implications, but we consider user security one of the pivotal issues for any social network. If users are unable to trust their network, we believe there will be room for new competitors to emerge.
With the emergence of BranchOut and Identified on Facebook (FB) as business networking alternatives, we think there's a chance that users will migrate away from LinkedIn. BranchOut already has 4.8 million monthly active users and access to Facebook's enormous user base. With Facebook looking to keep users on its site more than ever, we think the firm will continue to support and aid its applications development. BranchOut and Identify simplify the networking process and allow users to tap into friends connections (which tend to be larger on Facebook than on LinkedIn).
We still think LinkedIn's valuation is absurd, especially in light of the recent security breach which shows the vulnerability of the company's business model. We believe the firm is worth $55 on a discounted cash flow basis and that the forward price-to-earnings ratio of nearly 80x 2012 earnings is completely out of line with the company's ability to generate free cash flow. We will continue to hold a put-option on the firm in the portfolio of our Best Ideas Newsletter at its current valuation.
Additional disclosure: LNKD is included in the portfolio of our Best Ideas Newsletter.