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TMFPostOfTheDay (< 20)

Looking at LinkedIn

Recs

5

February 25, 2014 – Comments (0) | RELATED TICKERS: LNKD

Board: Pencils Palace

Author: TMFPencils

I like a lot of what I see with LinkedIn (LNKD). The stock looks dirt cheap with a P/E over 800, am I right?!

Seriously, though, I think LinkedIn actually has significant upside from today's levels despite its sky-high P/E ratio. CEO Jeff Weiner describes LinkedIn in this way:

"Facebook is massive in scale and scope. Twitter is a public communication forum, but if I'm following you, you're not necessarily following me. LinkedIn is, simply, a professional network."

This would be a natural addition to the Pencils IRA Project at some point. Few college seniors will get by without starting a LinkedIn account, and the company's growth figures validate rapid growth in cumulative users of the service. In the 4Q 2013, the company's premium subscriber base grew 40% to $88 million (one-fifth of over sales). Overall membership increased 37% in 2013. Corporate customers under contract grew 49% year-over-year to 24,500 in the 4Q 2013.

I'll explore these numbers in more depth soon, but wanted to provide a basic overview to get this analysis started. The company's operating cash flow production has been very impressive. Since 2010, LinkedIn has grown operating cash flow production at an average annual pace of 43.19%; between 2012 and 2013 operating cash flow production increased 63.43% to $436.47 million. The company has a stellar balance sheet with $2.33 billion in cash with no debt.

Some folks on CAPS are arguing that LinkedIn's intrinsic value is something like $33 per share (currently the stock is hovering around $190). I think this is a stretch. The company has $19.43 per share in cash alone, with no debt. Not to mention that the company's cash flow production is accelerating, along with increased customer growth and retention rates. LinkedIn is currently valued at $23.1 billion, which isn't cheap, but compared to other social media stocks like Twitter and Facebook, the stock doesn't look as absurdly overvalued as some like to claim.

The stock has such a high P/E ratio because management is heavily reinvesting back into the business. LinkedIn's price/sales ratio is 14.59, compared to Facebook's 21.73 and Twitter's 31.33. Since 2010, LinkedIn has grown sales at an average annual rate of 58.35%; increasing 57.21% in 2013.

If LinkedIn can grow sales at "just" 30% annually for the next five years and trade at a P/S of 8 in five years, the stock would more than double in five years (use the Future Value valuation method, but use sales per share instead of EPS):

13.45*(1.3^5)*8 = $399.51

This is fairly reasonable. And if sales increase 35% annually for the next five years and trade at a P/S of 7 in five years:

13.45*(1.35^5)*7 = $422.17

Maybe these assumptions are too ambitious, but compared to other social media businesses (and considering LinkedIn's consistent revenue expansion) I don't think these are unquestionable assumptions for the company going forward. I still need to do more research about the business and its various components, but thus far LinkedIn looks increasing appealing to me.

To top it off, CEO Jeff Weiner (age 43) has the type of mindset that I like to see in an executive. This quote gives you an idea of the type of leader Weiner strives to be:

"Managers will tell people what to do, whereas leaders will inspire them to do it."

LinkedIn employees rate the company 4.6/5 on Glassdoor (one of the highest ratings in the country), and Weiner has a 98% approval rating (off of over 660 ratings): http://www.glassdoor.com/Reviews/LinkedIn-Reviews-E34865.htm... LinkedIn is rapidly expanding while maintaining one of the top company cultures in the world.

More resources that I aim to explore:

The company's latest earnings report (4Q 2013 results): http://investors.linkedin.com/releasedetail.cfm?ReleaseID=82...

4Q 2013 conference call transcript: http://seekingalpha.com/article/2002241-linkedins-ceo-discus...

LinkedIn looks strikingly overvalued at first glance, as do most social media businesses. LinkedIn, though, is generating cash flow (and revenue) and impressive rates and reinvesting back into the business to generate future growth. This gives the impression that the company is earning very little money when, in fact, the company is building a mountain of cash while reinvesting into the business for future growth. As they say, don't judge a book by its cover. The more I look into LinkedIn, the more I am convinced that the stock actually isn't all that expensive considering current (and projected) growth rates.

I want to explore more specifics about the various components of LinkedIn's business, and aim to post my findings here. I am very intrigued by LinkedIn's story, and the stock looks appealing now that it has been hit down over the past several months. This very well may be one of the next additions to the Pencils IRA Project.

Hope to get some discussion going on this one! What do you think? Is the valuation nuts, or is LinkedIn worth a second and third glance?

Best,
David K 

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