Why LinkedIn’s Fundamentals Don’t Support the Market Price

LinkedIn’s (NYSE:LNKD) stock opened at $83 after its IPO was priced at $45 and reached an intra-day high of around $123 on the first day. And then a month of carnage started which saw the stock plummeting by 51% from its all-time high. Even though the stock has impressively recovered, climbing almost 75% from its June 20 lows of $60, we remain fundamentally bearish on LinkedIn.Our valuation is in line with the company’s earlier IPO guidance and slightly higher than the implied valuations at which LinkedIn traded previously on services such as SharePost and SecondMarket.  Below, we highlight the key factors driving the Trefis price estimate for LinkedIn of $30. [1]  We also highlight how the run up in LinkedIn’s stock that has occurred in late June and early July is primarily driven by positive coverage from banks as well as compare how the Trefis revenue estimates for LinkedIn compare to consensus.

How LinkedIn Makes Money

LinkedIn 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.

Our $3.2 billion valuation for LinkedIn breaks-up roughly as follows:

1. Recruitment Services & Job Postings: $1.6 billion (48%)
2. LinkedIn Ads & Marketing: $0.9 billion (28%)
3. Premium Account Subscriptions: $0.5 billion (15%)

A Few Key Insights:

• Although LinkedIn is commonly described as a professional network, most of its value comes from the sales of subscriptions, job postings and recruitment services that make LinkedIn a very different investment compared to Facebook, which relies on advertising. See our analysis of Facebook here.
  • LinkedIn had more than 100 million registered members by March 2011 ^[1] compared with more than 750 million registered users for Facebook. ^[2]
• We estimate the number of job postings on LinkedIn were around 300K in 2010 compared to about 2 million for job site Monster.com. LinkedIn will have to grow job postings significantly over the next few years to support the valuation.
• We estimate that LinkedIn had about 250K of premium account subscribers in 2010 paying on average about $250 annually. We forecast that LinkedIn will grow premium subscribers to over 1 million by the end of the Trefis forecast period.

Wall St. Banks Drive Late June-July Rally

Towards the end of June, banks such as Bank of America and J.P. Morgan released positive initiating coverage of LinkedIn with price targets of $92 and $85, respectively. ^[3] This helped continue LinkedIn’s rally, even though the stock price has now crossed the price targets set by these banks.  It’s unclear what fundamental forecasts the banks are so bullish on that justifies their price estimates.  As we’ve highlighted above, we’re pretty bullish on LinkedIn’s key business drivers as well, yet the resulting valuation doesn’t justify the current stock price.

Comparison of Trefis and Consensus Revenue Forecasts for LinkedIn

One way to compare the Trefis analysis and valuation for LinkedIn to that of others is to look at the consensus revenue forecasts for LinkedIn.  The chart below highlights the growth of LinkedIn’s historical revenues from $32 million in 2007 to about $243 million in 2010.  Based on our forecasts for LinkedIn’s key drivers, we have an implied revenue forecast of about $450 million in 2011 and about $680 million in 2012.  This places us slightly above the low estimate for consensus revenues as of July 2011.

The highest estimates factored into consensus show nearly $900 million in 2011 revenues for LinkedIn and about $3.4 billion in 2012.  The average consensus figures (shown above in purple) are based on a total of 8 analyst estimates and do not include the Trefis estimates.

Trefis Outlook Summary

Overall, LinkedIn will have to maintain the significant fees it charges to corporate and business customers while growing its corporate and business customer base significantly from a few thousand customers today to tens of thousands over the next few years. At the same time, LinkedIn will need to maintain or grow its job post pricing in the face of competition from a variety of sources (Monster, Careerbuilder, TheLadders, Dice).

Continuing to grow the LinkedIn member base, increasing the amount of information that LinkedIn members share and the freshness of that information will be crucial to maintaining demand from recruiters and business for LinkedIn’s services. By having the most comprehensive and up to date information on active and passive job candidates, LinkedIn will position itself to be a destination site for recruiters looking for highly effective, targeted job postings and advertisements.

See additional driver breakdowns in our full analysis for LinkedIn.

Note:

1. Our basic price estimate is $34 but shows $30 after accounting for stock option dilution. We use the Treasury Stock method to determine the net impact of option dilution.  LinkedIn has the equivalent of 16.2 million in shares outstanding in the form of employee stock options and these options have an average strike price of $5.86.  In other words, if someone tried to buy all of LinkedIn today, they would end up having to buy out not only the 94.5 million in class A and class B common stock outstanding, but also about 13.1 million in net converted employee stock options (based on the Trefis valuation of LinkedIn)

1. LinkedIn: About Us [↩]
2. Facebook: Statistics [↩]
3. JP Morgan, BofA start LinkedIn with top rating [↩]