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Pencils IRA Purchase: LinkedIn (LNKD)



March 15, 2014 – Comments (0) | RELATED TICKERS: LNKD.DL

The Pencils IRA Project is dedicated to building a portfolio of promising businesses that can be followed and replicated by both young and new IRA investors. Each holding of the Pencils IRA Project must meet the five pillars of a "megagrower" business -- purpose-driven business, innovative products, visionary leadership, increasing cash flow production, and strong company culture -- with significant potential to create stakeholder value and substantially beat the market over the long haul. Learn more about the Pencils IRA Project here: 

The second addition to my personal real-money Pencils IRA Project portfolio is LinkedIn (LNKD), the rapidly-growing professional social networking platform that is familiar to many college students and young adults. LinkedIn is quickly proving that its service entails much more than a place to stash a resume, with the company's average monthly number of unique visitors totaling 183 million in 2013, up 45% from 2012. The company stacks up quite well with our five "megagrower pillars" and offers extensive potential to reward patient long-term investors, as we will explore below. 

1. Purpose-driven business

"People matter." These are the words Reid Hoffman, LinkedIn's founder and chairman, uses to describe his interest in the social media phenomena and motivation to start LinkedIn. 

LinkedIn's purpose, in a nutshell, is to create economic opportunity for every professional in the world (3.3 billion individuals and counting). "I can't think of a more worthwhile purpose than investing in tools that create economic opportunity for people," says LinkedIn CEO Jeff Weiner. So far as purpose-driven businesses are concerned, LinkedIn is at the top of the list with its focus on utilizing social media platforms to empower people economically worldwide. 

2. Innovative products and services

LinkedIn has an expanding arsenal of social networking products to serve a growing worldwide base of professionals. LinkedIn ended 2013 with 277 million registered members, adding 75 million members in 2013 alone (70% of those new members coming from outside the U.S.). The company's product offerings fall into three general categories: Talent Solutions, Marketing Solutions, and Premium Subscriptions. 

LinkedIn's largest segment -- Talent Solutions -- saw revenue grow 64.19% in 2013 to $859.67 million. Talent Solutions focuses on providing tools (such as Linkedin Recruiter) for professional organizations and enterprises to post jobs and recruit top talent among those in the job seeking pool. Corporate customers under contract with LinkedIn grew 49% year-over-year in the 4Q 2013 to 24,500.

In February, LinkedIn announced its $120 million acquisition of Bright, a company specializing in data insights and developing algorithms to help match prospective employers with job seekers. Eduardo Vivas, founder of Bright, shared his excitement of Bright joining the LinkedIn team: 

"Today, employers complain that there are no qualified applicants, yet qualified applicants often have their resumes overlooked. This marketplace inefficiency called for a technological solution and we resolved to heed that call.... We decided to join LinkedIn because of what we lacked – the ability to apply this technology across the entire economy. We share LinkedIn’s passion for connecting talent with opportunity at massive scale. And we agree that the old models for online recruiting are hopelessly broken." 

LinkedIn's Marketing Solutions segment's revenue grew 40.3% in 2013 to $362.36 million. This segment generates revenue primarily through outside advertisers and a new option for users to pay for "sponsored posts" similar to Facebook and Twitter. LinkedIn's Premium Subscriptions segment -- built on the monthly and annual premium member subscribers (who receive expanded services on LinkedIn compared to traditional members) -- also saw impressive growth in 2013, with revenue increasing 60.9% to $306.51 million. 

2014 will bring the full unveiling of several new offerings from LinkedIn. The company's Sales Solutions segment -- a service for sales professionals to build connections, find leads, and shorten the "sales cycle" -- will become a core component of the business this year. LinkedIn's original content continues to find momentum through its Pulse professional news app (delivering personalized professional news to each user), a new publishing platform for members to publish original content through blogs on LinkedIn, and the company's "Influencers" program, where notable individuals (including Barack Obama, Bill Gates, and Motley Fool co-founder and CEO Tom Gardner) publish original articles on LinkedIn.

With an expanding arsenal of tools for professionals around the world LinkedIn is poised, in the words of The Washington Post's Sarah Halzack, "to become the virtual town square for our professional lives." LinkedIn plowed $395.64 million -- or 25.88% of the company's 2013 revenue -- into product development in 2013. Innovation is ingrained in LinkedIn's DNA, as evidenced by the company's global expansion to countries such as China, product development with Sales Solutions and the publishing platform, and ongoing expansion of recruiting services and capabilities. 

3. Visionary, experienced, innovative leadership 

Reid Hoffman -- who founded LinkedIn in 2003 -- continues to serve as LinkedIn's chairman after serving as executive vice president at PayPal. CEO Jeff Weiner joined LinkedIn in 2008, after spending seven years as an executive at Yahoo. In 2011, Hoffman and Weiner both received the Ernst & Young’s National Entrepreneur of the Year Award. 

Weiner offers a refreshing take on what effective leadership entails. "For me, leadership is the ability to inspire others to achieve shared objectives," says Weiner. "Managers tell people what to do. Leaders inspire them to it." This ethos has helped create a world-class company culture at LinkedIn, which will be explored more in our company culture pillar.

4. Consistently increasing cash flow production

LinkedIn's relatively low net income ($26.77 million in 2013) and sky-high P/E ratio (which exceeds 900) -- both caused by LinkedIn's extensive investments into product development -- can cause some investors (including me, initially) to write off LinkedIn as a wildly overvalued business. However, LinkedIn's cash flow production paints a different story and demonstrates the full ability of the business to generate and retain impressive amounts of cash.

Over the past four years, LinkedIn has managed to grow its base of cumulative registered members from 90.43 million in 2010 to 276.84 million in 2013. This increase in registered members has been accompanied by an average annual increase in operating cash flow production of 43.19% to $436.47 million in 2013. Net sales have also increased at an average rate of 58.35% annually since 2010. 

Since 2011, LinkedIn's free cash flow has grown at an average annual rate of 55.49% to $139.25 million in 2013. This stellar free cash flow production -- which has helped the company accumulate $2.33 billion in cash with zero debt -- gives LinkedIn sufficient ammo to continue plowing funds into product development, acquire businesses such as Bright, and serve as a cushion should the company or economy fall on tough times. (Although, one could argue that a tough economic environment would actually increase the necessity and overall use of LinkedIn's services.)

5. Strong company culture

"If you ask me about culture, the first word that comes to mind is transformation," says CEO Jeff Weiner. For LinkedIn's company culture, this transformation boils down to three critical points: 

1) Transforming the trajectory of LinkedIn's employees' careers; 
2) Transforming LinkedIn and realizing the full potential of the company's platform; 
3) Transforming the world by working toward the company's vision of creating economic opportunity for every professional around the world. 

Weiner and LinkedIn's executive team hold company meetings with employees on a bi-weekly basis, allowing employees to interact with the company's executives in an engaging and relaxed environment. This leadership has helped Weiner garner a 98% approval rating from LinkedIn's employees on Glassdoor, with LinkedIn receiving an employee rating of 4.6/5 based on more than 700 employee reviews. These stellar ratings helped LinkedIn earn the honor of Glassdoor's third best place to work in 2014 among companies with over 1,000 employees. 

Foolish final thoughts

With its expanding social media platform focused on economically empowering the world's growing base of professionals, LinkedIn arguably has the potential to become the most influential and far-reaching social network on a global scale. Few of my college peers will graduate without first starting a profile on LinkedIn and attending a workshop on how to effectively utilize LinkedIn's platform in the job hunt. By focusing on scaling its core mission on a global scale, guided by proven innovative leadership within a world-class company culture, LinkedIn offers tremendous long-term potential that I cannot pass up for the Pencils IRA Project.

While the stock is not exactly cheap with a market cap of $25 billion and a P/S ratio of 16.3, LinkedIn's performance and ongoing innovation has only served to reinforce my confidence in the company's ability to generate value for all its stakeholders (and beat the market in the process). While LinkedIn shares have more than doubled for investors since going public in July 2011, the stock's P/S ratio has been cut in half over the same period. LinkedIn's P/S is quite a bit lower than the P/S ratios of fellow social networking behemoths; Facebook's P/S stands at 22.5, and Twitter trades at a P/S of just under 44.

LinkedIn has been able to grow into its valuation up until this point, and I anticipate that this trend will continue over the next 5-10 years. I believe patient long-term investors will be rewarded by LinkedIn with market-beating returns over the long haul, which is why I am comfortable welcoming the stock to the Pencils IRA Project this month. 

David K

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