August 16, 2022

Common Sense: Waiting for Gravity to Hit LinkedIn

After living through two destructive financial bubbles in the last decade, what explains the frenzy? LinkedIn, the professional networking concern, rekindled memories of the late-’90s technology boom and bust when its stock leaped from the offering price of $45 to $122.70 a share on its first day of trading on May 19. “Our mission is to connect the world’s professionals to make them more productive and successful,” its prospectus proclaims. “Our vision is to create economic opportunity for every professional in the world. …We believe we are transforming the way people work by connecting talent with opportunity at massive scale.”

As the first of the social networking concerns to issue shares to the public, LinkedIn makes a good test case for the existence of a social networking bubble. There’s widespread agreement that bubbles occur when a speculative mania causes the price of an asset to soar far above its intrinsic worth. After the mania runs its course, and investors finally recognize the divergence, the bubble typically bursts, causing prices to plunge. Early bubbles were the famous 17th-century Dutch tulip mania and the 18th-century trading in Britain’s South Sea Company.

Spotting a bubble before it deflates has proved difficult, if not impossible, since otherwise bubbles wouldn’t still occur with dismaying frequency. Academic literature is accumulating on the subject, including research into the monetary and fiscal conditions for a bubble and the psychology of herd behavior. Here’s a look at three key bubble symptoms as they apply to LinkedIn:

¶ Are LinkedIn shares priced far above their intrinsic worth?

Valuing a new and potentially disruptive company like LinkedIn is a challenge for even the most sophisticated analysts. After more than doubling on the first day of trading, the company’s shares have continued to continued to gyrate wildly — dropping below $61 at one point, and then rising again this week, closing at $99.60 on Friday.

LinkedIn’s share price should be the present value of its future earnings. Its price-to-earnings ratio, a common test for an overpriced stock, is in the stratosphere. But LinkedIn is too new to have reliable earnings, given its heavy capital investment. So let’s ignore earnings and focus on revenue, which will ultimately be the source of LinkedIn’s profits.

LinkedIn’s revenue for 2010 was $243 million. For the first quarter 2011 it was $94 million; extrapolating from the first quarter, a reasonable estimate for 2011 revenue seems $450 million, or nearly double. At this week’s valuation of $8.8 billion, that represents a current price-to-sales ratio of just over 30.

How does this compare to similar companies? No other company is quite like LinkedIn (which is part of its appeal), but Monster Worldwide and Dice Holdings are two major competitors in the Internet job search arena. Monster’s current price-to-sales ratio is 1.89 and Dice’s is 6.58. Both companies are more mature and slower growing than LinkedIn. Monster reported annual revenue growth for the most recent quarter of 21 percent; Dice reported 49 percent. So given LinkedIn’s revenue growth rate, its price-to-sales ratio should be about twice that of Dice (or about 13), and five times Monster’s (or 10).

But LinkedIn’s ratio of 30 is far above those levels, suggesting that by this measure, LinkedIn is substantially overvalued. At a price-to-sales ratio of 15, LinkedIn shares would be trading at $44 — about where the underwriters priced them. Give it a more generous ratio of 20, and shares still would be just $58.


Article source:

Speak Your Mind