LinkedIn (NYSE:LNKD) is one a poster child of Internet boom which is driving up valuations of tech companies with little to no profits all around the Valley. It competes with Monster (NYSE:MWW) in the recruitment services market, as well as social networking portals like Facebook and Twitter. The company also faces competition from Google (NASDAQ:GOOG) and Yahoo (NASDAQ:YHOO) in the online advertising market. We currently have a $44 Trefis price estimate for LinkedIn, which stands nearly 60% below its market price.
While this is partly because we use a diluted share count to arrive at our stock price estimate, most of the difference could be attributed to unbridled optimism regarding LinkedIn’s growth prospects by the overall market. We currently have pretty optimistic growth projections for LinkedIn, but even that does not justify such a high price for LinkedIn, which is currently trading at a P/E ratio of nearly 1,000 based on 2011 earnings.
Here’s why LinkedIn is worth much less:
Growth expected to slow down
LinkedIn has grown rapidly over the past couple of years, but it cannot be expected to maintain the same pace, going forward. It had an average of 6.5K corporate customers in 2011. We expect that to increase to nearly 36.5K by 2018, as it expands internationally and signs up more corporate customers for its hiring solutions, its most valuable business. We assume a compounded annual growth rate (CAGR) of around 30%, which could be lower if LinkedIn fails to see the same amount of traction in international markets as it has in the U.S.
Average revenue per corporate customer could be lower
We also assume that it will be able to increase its average revenue per business customer in the coming years, by demonstrating greater value to corporate customers and introducing new features and services. However, in order to gain more customers, it may have to reduce pricing for new customers, which could lead to a decline in the average revenue generated per customer, which would mean an even lower valuation for LinkedIn than we currently project.
Ads and marketing revenue growth to eventually slow down
We expect LinkedIn’s advertising and marketing revenues to grow at a CAGR of nearly 26%, based on its expected growth trajectory in global markets as well as an increase in mobile advertising revenue which is expected to drive growth. Even if we assume continued growth in the number of page views as well as average revenue per view as we currently do, it still wouldn’t justify such a high valuation.
You can check how any change in LinkedIn’s unique visitors would impact its value using this chart (see what a huge increase in visitors would be required to warrant its current valuation):
Rising operating expenses may play spoilsport
LinkedIn has had to incur high operating expenses to fuel its rapid expansion. We expect it to rein in the expenses going forward and we project its expenses (as a percentage of gross profit) to decline every year. However, even if you assume that LinkedIn’s expenses will be reduced by a lot more than what we currently project, that still wouldn’t result in such high valuation for the company.
On the contrary, LinkedIn may have to continue to spend greater amounts on R&D and marketing in order to maintain its projected level of growth. In that case, there could be a further downside to its stock price than what we estimate.
We currently have a $44 Trefis price estimate for LinkedIn, which stands nearly 60% below its market price.