By Matt Doiron
With shares of online career networking site LinkedIn (LNKD) bouncing between $100 and $110 over the last month and a half, Chase Coleman's Tiger Global Management team had a decision to make. Tiger Global had bought into LinkedIn at a very low price -- 2.4 million shares out of the 4 million shares the fund had reported holding at the beginning of 2012 at an average cost basis of $13 per share (read previous coverage of Tiger Global's investment in LinkedIn).
With LinkedIn seemingly impervious to the hammering that social media stocks such as Facebook (FB) and Zynga (ZNGA) were taking (Facebook is down nearly 40% from the price of its IPO just two and a half months ago, and Zynga is down two-thirds from its December IPO price), was it time to take some profits? Or should Tiger Global stay invested in a stock with a trailing P/E of 714 and a forward P/E of 84?
The Tiger Global team chose the first option, dumping 1.6 million shares of LinkedIn between mid-June and late July and earning massive carry for the fund. The largest sales took place at a price above $105, but more recent sales have come as low as $100.99 per share. Tiger Global still owns a large number of shares that equate to 3.3% ownership of the company.
Other hedge funds that reported owning the stock in March included York Capital Management and Conatus Capital Management, which initiated positions of 840,000 and 740,000 shares, respectively, in the first quarter of 2012.
LinkedIn's high earnings multiples do not necessarily make sense over a longer time frame, either. Sell-side analysts estimate earnings growth rates over the next five years that imply a PEG ratio of 2.3; even Facebook, Zynga, and Groupon (GRPN) are in the 1.3-1.8 range, and therefore, are better priced for expected growth. In order to buy LinkedIn -- or even continue to hold it in a portfolio -- an investor must be confident that the company's revenue model trumps that of these other companies to an even greater degree than Street analysts believe.
LinkedIn does have a history of blowing past analyst expectations: over the trailing four quarters, it has reported earnings of 43 cents per share, versus a total of 9 cents per share that analysts expected going in to those reports. If LinkedIn continues to quadruple analyst expectations -- if analysts underestimate the company by the same magnitude they have in the past -- then the forward P/E comes down to 21, which would be reasonable for a technology company experiencing solid growth.
The company's 10-Q for the first quarter of 2012 reported doubling revenue compared to the first quarter of 2011, and more than doubling net income. Growth was led by Hiring Solutions, LinkedIn's largest business unit, which serves hiring managers and third-party recruiters. Revenue growth was lower in the U.S. -- "only" 86%, compared to the same quarter the previous year -- but strong performance in smaller markets in the rest of the world made up for it. Furthermore, much of this growth came from greater efficiency, as unique visitors and page views only rose 30-40%.
We have already discussed LinkedIn's high valuation multiples, which compare unfavorably to the forward price-to-earnings ratios of 36 and 26 for Facebook and Zynga, respectively. LinkedIn might also be compared to online job posting site, Monster Worldwide (MWW), which looks even better. It trades at 15 times its trailing earnings, and 16 times its forward earnings estimates. In fact, on a trailing basis, it has earned three times as much net income and nearly twice as much EBITDA -- and yet has a market cap less than a tenth of LinkedIn's. Its PEG ratio is 1.42, in the same range as the social media stocks. The market, therefore, expects that the combination of social media and job searches deserves a much greater multiple on growth than either factor by itself.
LinkedIn reports its second quarter earnings on Thursday, August 2. Given the high expectations for the company, we would not advise being long and would consider a small short position, in case the company reports a negative earnings surprise. In fact, if Facebook's recent earnings report was any guide, even meeting earnings estimates could disappoint optimistic investors (who, judging by the valuation multiples, expect the company to outperform analyst expectations) and send the stock price down to double digits.