Tuesday, May 10, 2011

Should You Park Your Cash in LinkedIn's IPO?

It has been a long time since a wave of venture-backed information technology initial public offering (IPOs) from the U.S. went out to investors. Sure there have been IPOs of plenty of Chinese startups and leveraged buyout firms have been selling themselves and their debt-laden properties to the public in recent years. But wireless network provider, Boingo Wireless (NASDAQ: WIFI) went public last week. And LinkedIn (prospective listing NYSE: LNKD), a business networking site, may soon help kick off a new wave of venture-backed IT startups to go public. Should you invest?

In considering such decisions, it helps to have a framework. And this one is adapted from my 2001 book, e-Stocks. I'd suggest looking at LinkedIn from four perspectives:
  • Industry. Is the industry in which the company competes large, rapidly growing and profitable?
  • Competitive Position. Does the company have a dominant position in the industry?
  • Management Team. Is the company's management team likely to be able to lead the company effectively in the future?
  • Valuation. Does the price leave room for upside growth?
The professional networking industry is large -- although it's difficult to put a precise number on just how large. LinkedIn's prospectus claims that the company has "more than 100 million members in over 200 countries and territories."

And its rapid growth attests to the growth opportunities in the industry and to LinkedIn's competitive advantage. Between 2003 and 2011, its membership count has grown at a 145% compound annual growth rate from 78,000 members to over 100 million. In the process, LinkedIn has found ways to monetize that growth by offering marketing solutions in September 2004, hiring solutions in March 2005, premium subscriptions in August 2005, and Corporate Solutions (a hiring service), in March 2008.

LinkedIn has succeeded in attracting a sizable customer base. In 2010, 3,900 companies used its  hiring solutions were used by nearly 3,900 companies and by the end of March 2011, that figure had grown to "nearly 4,800 companies, including 73 of the Fortune 100." In 2010, 33,000 small and medium-sized businesses used its marketing solutions.

LinkedIn's management team has impressive depth. Reid Hoffman, its chair, was an executive at PayPal and its CEO, Jeffrey Weiner, was an executive at Yahoo (NASDAQ: YHOO). Its other executives and board members reads like a who's who of 1990s Internet stars. Bringing LinkedIn to the stage of issuing public shares suggests that they were not content to rest on their previous laurels and that their prior public company success may help them manage LinkedIn.

The final question is whether the valuation is reasonable. If it sells shares at $35, it will be valuing itself at a P/E of 206 based on 2010 earnings per share of $0.17. That sounds really high -- given that the S&P 500's P/E is about 16. In LinkedIn's defense, its 2010 revenue grew 102% to $243.1 million while its $15.4 million in net income was 487% above 2009's level.

If LinkedIn could keep that momentum going, its Price/Earnings to Growth (PEG) ratio would be an attractive 0.42. But the company expects to lose money in 2011 as it invests for growth.

So while LinkedIn has a strong management team going after a big market with an effective competitive strategy, its high valuation and uncertain financial prospects make an investment in its stock a pretty risky bet.


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