In a recent Forbes article, contributor Daniel Fisher suggests that LinkedIn (LNKD) is a more "clever" way to play the social networking craze than Facebook (FB). The argument hinges on the supposed superiority of Linkedin's business model -- the company generates most of its revenue by charging employers to search LinkedIn member profiles for prospective hires. Fisher asserts that this more "conventional" way of doing things is a far more predictable revenue generator than selling advertisements and, as such, will ultimately prove to be a more reliable generator of free cash flow. There are multiple problems with this idea.
First, Fisher bases the argument on the fact that LinkedIn generated free cash flow of $41 million in the first quarter of 2012 while Facebook's free cash flow was negative $50 million for the same period. What he doesn't mention is that LinkedIn's trailing twelve month (TTM) free cash flow was around $75 million (according to YCharts and Yahoo Finance) while Facebook had TTM free cash flow of $470 million. Additionally, Fisher notes that
A stock is only worth the cash its owners can reasonably expect to claim in the future, and the more reliable that stream of cash proves to be, the more valuable the stock
This may be true, and while there is no way to tell what the future holds regarding how effective a revenue-generator Facebook's ad business will be, what is known is that Facebook had nearly $4 billion in cash at the end of 2011 and will be sitting on roughly $10.3 billion after its IPO. Given this, it certainly appears as though Facebook will have some time to figure out how to monetize its 901 million members before it is forced to break open its employees' piggy banks and count loose change.
The idea that LinkedIn's business model is a more reliable revenue generator seems spurious as well. Technically it depends on how you define "reliable," but if we are talking about total revenue generated, there simply is no comparison: Facebook generated $3.7 billion last year to LinkedIn's $522 million. If you define the success of a business model in terms of profitability (which seems like the only real way to define success), the comparison is downright embarrassing: Facebook's 2011 net profit was $1 billion while LinkedIn managed a meager $12 million (Facebook made 83 times as much money). Mr. Fisher acknowledges these rather unflattering comparisons in his article. I could go on, but I think the point is made: no matter how uncertain the future of Facebook's business model, as of now, there is simply no comparison between LinkedIn and Facebook. Keeping that in mind, investors should consider the fact that Facebook's IPO price was $38 dollars -- about a third of LinkedIn's share price. Why should LinkedIn trade at any premium to Facebook at all? Based on the numbers, there is no reason whatsoever to pay two or three times Facebook's price for LinkedIn shares.
Leaving the Facebook comparisons aside and going back to fundamentals, LinkedIn trades for around 170 times forward earnings. Looking into 2013, the number doesn't look much more reasonable: LinkedIn trades for 90 times 2013 earnings estimates. If the rationale for this ridiculous price is "growth potential," investors need to find another excuse: LinkedIn's net income fell 22% from 2010 to 2011. Additionally, costs are rising -- fast. LinkedIn's sales and marketing expenses soared 200% in 2011 while its product development costs jumped 100%. Costs then, are rising faster than revenue (net revenue rose 100% last year). All of these figures can be found in LinkedIn's 2011 annual report.
Investors should of course, keep in mind that the fact that LinkedIn is far too expensive doesn't mean Facebook is fairly valued at half of LinkedIn's price. All social media stocks look expensive right now. The point is that LinkedIn seems to be the most overvalued of the group. Short LinkedIn or Long LinkedIn puts.
Disclosure: Long LNKD puts
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