LinkedIn Follows Google’s Lead By Making Search Smarter

LinkedIn (NASDAQ:LNKD) recently made some changes to its search tool that are aimed at making search more convenient and intelligent for the users. With this change, LinkedIn users don’t need to search for people and companies independently, instead they’ll see the relevant lists from different categories as they type in the search query.

The company has designed an algorithm that will adapt to a user’s preference over time. The suggestions and auto-complete features will help in faster and more convenient searches. A lot of this sounds similar to what Google (NASDAQ:GOOG) has done with its search engine over the years. Even Facebook (NASDAQ:FB) is doing something similar with its graph search functionality.

The bigger picture is that as LinkedIn’s user base and user engagement grow, the company will need to better organize the data resulting from this growth. There is a great value in targeted and relevant searches. They not only improve the user experience but also help marketers, recruiters and sales professionals in efficiently reaching out to potential customers and candidates.

See our complete analysis for LinkedIn

Intent Is To Improve The User Experience And Drive Higher User Engagement

LinkedIn is not just about recruiting anymore; it is becoming a great platform for marketers to find potential customers for their products through LinkedIn’s tools. As the company heads into 2013, the growth from the sheer user base expansion may slow down and the company will have to shift its focus on increasing user engagement and better monetization of its platform. Improving the search capability is one of the many steps that the company is taking to ensure this.

Other efforts to increase user engagement include features such as likes, automated updates, ability to follow thought leaders, endorse each other, etc. This is likely to drive the usage of the site and increase the number of page views per visitor. In addition to this, increased user engagement will enhance LinkedIn’s user data. This in turn will help in more targeted advertisements that generate higher return on investment (ROI) and hence command higher pricing.

However, There Are Risks To Consider

The current market price implies much higher growth than we currently forecast. LinkedIn has had to incur high operating expenses to fuel its rapid expansion. We expect it to rein in expenses going forward and project its expenses (as a percentage of gross profit) to decline every year. However, even if you assume that LinkedIn’s expenses will reduce by a lot more than what we currently expect, this will not move the stock’s value meaningfully.

The two cost items that investors should consider are R&D (research and development) and SG&A (selling, general and administrative). These two figures stood at 25% and 49% of LinkedIn’s total gross profits, respectively, in 2012. We forecast the R&D figure to drop to 15% by the end of our forecast period and the SG&A figure to decline to 35% during the same period. If LinkedIn has to claim any justification for its current market price, it will need to leverage its growing user base much more efficiently than we currently see.

We also believe that the market is not pricing in future competitive risks adequately. Although LinkedIn currently has a unique advantage of mixing social networking with recruitment services, other Internet giants can leverage their data and experience to do something similar. These include Google and Facebook which have a vast amount of information and influence over their Internet user base to allow them to create viable recruitment portals to pose a serious threat to LinkedIn.

Facebook has already started moving in this direction with its Social Jobs app and may slowly create an ecosystem for professionals. LinkedIn currently has a brand that is recognized in the professional context, but so did Netflix (NASDAQ:NFLX) (in context of Internet video) at one point of time. It didn’t take long for companies with deep pockets to come up with competing services.

Our price estimate for LinkedIn stands at $90, implying a discount of about 50% to the market price.

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