I've recommended shorting LinkedIn (LNKD) in the past and I've been at best, too early; at worst, just wrong. The problem with shorting a GAAP stock (Growth At Any Price), is that since it's already detached from fundamentals; simply pointing out that the valuation is unsupportable doesn't make the current investor base care. What's needed to make fundamentals matter again is a disruption of the growth story. In my view, 2Q earnings could be that disruptive event that refocuses investors on LinkedIn's aggressive and ultimately unsupportable valuation. Let me walk through my thinking.
In my view, given that the firm is trading at 17x TTM revenue and 11x forward revenue, most investors do not own it because they think the stock is cheap, they own it because they expect it to grow faster than the market expects it to grow. And they expect the stock to continue its upward march, so long as the firm continues this cycle of beat & raise. Valuation doesn't factor into the equation--the stock is expected to go higher with each upward revision of estimates. That is until the firm misses.
A miss forces investors to recalibrate what the long-term value of the stock actually is. In a nutshell, after a miss, fundamentals matter again, and that's a problem for a stock trading at 17x TTM revenue. In the analysis below, I walk through why I think we might be in for our first revenue growth disappointment for the firm since it went public and where I think the stock could trade post that event.
Revenue Growth Could Disappoint in 2Q for the First Time Since the Company Went Public
A Short, But Continuous History of Manufacturing Large Beats - Over its admittedly short history as a public company, LinkedIn has consistently under-promised and over-delivered. Over the last three quarters, the firm has delivered revenue beats ranging from $12mm to $16mm vs the guidance mid-point (see table below):
Consensus Doesn't Stray Far From Guidance, Producing Beats On Earnings Day - While the street on average comes in slightly higher than the high-end of guidance, they seem unwilling to truly make independent estimates that differ from management's guidance. Over the last few quarters that has produced solid top-line beats of $9mm to $16mm the stock has generally reacted very positively to these beats (see table below for details):
ITG, However, Has A Much Better Track Record Of Projecting Revenue & Sees A Miss Coming - ITG has generally done a much better job at forecasting revenue and three of the last four quarters was within $6mm of the final number. The consensus number has always missed by more than $6m. The firm is currently forecasting $214mm for 2Q12, which is below the high-end of guidance ($215mm) and below current consensus ($216mm).
A Revenue "Miss/Disappointment" Could Reverse The Stock's Positive Momentum - Given that the firm's valuation is already disconnected from fundamentals, valuation is unlikely to matter until there is a crack in the firm's growth story. I believe a revenue miss could very well provide that crack and get investors to focus on the firm's potentially unsupportable valuation. What's nice about the current situation is that the buy-side has likely grown accustomed to beats and so if I'm wrong, the stock won't necessarily pop, but if I'm right, we could see a very serious correction in the name, basically an asymmetric risk profile.
The Final Piece Of The Mosaic, Anecdotal Evidence - While I certainly acknowledge this is just anecdotal evidence, as a LinkedIn user, I have received two different emails from LinkedIn asking me to become a premium member for 50%-off. I received both of these emails in the second half of June and while it certainly might be coincidental, I'm inclined to believe that it may be a last-ditch effort by LinkedIn to juice revenue in the last 15 days of the quarter. The fact that the offer expires on June 28th further deepens my suspicions. Keep in mind that management may have been distracted by the recent security breach, which may have resulted in them taking their eye off the ball.
50%+ Fall Back Down To Intrinsic Value of $48 - I've done a fair bit of work on LinkedIn which you can read about here, but a key conclusion of this work is that LinkedIn's intrinsic value (at least based on my assumptions) is around $48 (over a 50% discount from current levels). If the firm were to disappoint in 2Q, I suspect it would partially close the gap between its current price and its intrinsic value, but I suspect it will likely take a few consecutive quarters of disappointment before the stock actually trades all the way down to the 40s.
A Quick Caveat on ITG's Estimates - While ITG has certainly been more accurate than the general consensus number, ITG's current estimate only incorporates data through May 31st and is subject to revision post-quarter close. Historically, ITG has generally revised their estimates upwards as we get closer to the quarter end. I expect ITG's final estimate will come out around July 20th and if it's still around the same level ($214mm), my confidence will be much greater that the stock could trade down.
Bottom Line - I believe LinkedIn's valuation is unsupportable long-term and in my view 2Q earnings could be the catalyst which refocuses investors on fundamentals.
Other LinkedIn Articles - I've written about LinkedIn a few other times and I believe analysts looking to understand this story more will benefit by flipping through them. They deal with two general topics. First, sell-side analysts using unrealistic assumptions to justify their steep target prices and second with the high level of insider selling (the insider selling article is a bit dated, but the selling has continued unabated).
- Explaining An Unjustifiable Valuation - Why Wall Street Is Incentivized To Prop Up LinkedIn
- 49 Red Flags--Heavy Insider Selling
As always, your comments and questions are always appreciated.
Additional disclosure: I have been short LNKD for a few months now and have written about my position previously.