LinkedIn's Honeymoon Is Officially Over

| About: LinkedIn (LNKD)

LinkedIn (NYSE:LNKD) reported Q3 results last night beating on both the bottom and top line and guiding in line with consensus for Q4. The headlines are pretty much more of the same, with those in love with the stock citing this as further evidence that LinkedIn has a 'great' business model, and is consequently a no-brainer buy.

Now, I am not going to bother with the nonsense of getting into how ludicrous these people often sound as plenty of fantastic businesses are often matched with stock prices that produce returns that would make you think you just invested in a failing business model; I've done all I can on that front. What I want to focus on today is how LinkedIn's Q3 results confirmed my previous suspicion that its growth rate is starting to really taper off.

As I discussed in my last piece, when it comes to subscription model revenue driven companies, the key metric to track is deferred revenue. In LinkedIn's case, with subscription related revenue at about 75% of total revenue, the deferred revenue line item on the balance sheet provides an excellent leading indicator of where top line growth is heading.

Last quarter, with Q/Q deferred revenue coming in at just a hair below 10%, you got your first indicator that LinkedIn's rapid revenue growth was starting to markedly slow, as that number was less than half the 21% average of the previous four quarters. But one quarter does not make a trend, so anyone investing in this stock had to be paying close attention to where deferred revenue would come in this quarter. Well, at a Q3 increase of 8.7% over Q2, a new trend can now be confirmed. LinkedIn's subscription growth is officially starting to rapidly slow down, and with marketing revenue literally flat over last quarter (though this is seasonal - the overall rate is slowing too here). You don't need to be a rocket scientist to extrapolate where overall revenue growth is heading. If deferred revenue has grown at an average of 9.5% for the last six months, that implies that LinkedIn revenue is about to follow a Facebook 2011/2012-like trajectory. Not groundbreaking news when you consider that growth of higher bases obviously gets much tougher, but definitely not want you want to see if you are long the stock at these valuations.

But don't expect the sell-side to harp on this. They are so infatuated with LinkedIn that not a single analyst mentioned the words 'deferred revenue' last night. In fact, if you want to entertain yourself, pull up the LinkedIn Q3 transcript and do a search for the words 'deferred revenue'. You will discover that 'deferred revenue' comes up exactly zero times, pretty impressive when you consider this is a subscription revenue business, and that the word revenue was used precisely 27x on the call. If I hadn't already been accustomed to this sheep like behavior, I'd cite this as evidence of a conspiracy to deceive. But I am long past that. This game has been going on forever - who am I to suddenly come along and complain about the rules? Anyway, looking at the table below you can see that LinkedIn's key metrics are all heading in the wrong direction.

LinkedIn Talent/ Premium Revenue Q/Q Deferred Revenue Q/Q Users Q/Q
2Q2011 24% 21% 14%
3Q2011 21% 15% 13%
4Q2011 19% 23% 11%
1Q2012 19% 24% 11%
2Q2012 18% 10% 8%
3Q2012 13.9% 8.7% 7%

Now think about what this implies going forward. LinkedIn is on pace to grow total revenue 80% over last year. The Street is currently looking for revenue growth of 52% for next year. At an average 9.5% deferred revenue growth for the last two quarters, with the rate still decelerating, do you think that target makes sense?

And what about the valuation?

On a fully diluted basis LinkedIn's stock price as of yesterday's close gave the company an enterprise value of $11.5 billion. That means LinkedIn is trading at 58x its expected 2012 adjusted EBITDA of $200 million. To put that in perspective, Facebook (NASDAQ:FB) trades at EV/ADJ EBITDA multiple of 20x. And remember these valuation metrics are custom designed to avoid the heavy stock expensing being used by these companies.

Conclusion: LinkedIn is now entering the danger zone period as a growth momentum stock, and has now become a no-brainer short and hold.

Disclosure: I am short LNKD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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