The following is written by an institutional investor who bought LinkedIn’s stock (LNKD) on the IPO and is hanging on to the shares. The investor is not buying more stock at ~$100 a share, and not recommending that anyone else buy it at this level.
The Bottom Line
Since my original post on Monday about why I was so bullish on the impending LinkedIn IPO, I saw quite a bit of interest. With the tremendous ~109% pop in the stock in its first day of trading, many questioned me on whether we were officially in a bubble.
Knowing I was going out on a limb in my original post and that many naysayers would line up to knock me down (i.e. see original post’s comments section), I had tried to sketch a value that I felt was conservative / highly defensible. So what do I think now? Let’s start with the obvious – LinkedIn is clearly expensive in the short term on even more bullish estimates. Most of the comments I have seen seem to agree that LinkedIn is in a bubble.
However, I will take a differentiated position and argue that while LinkedIn is clearly not cheap, if one is willing to look longer term, there is still a decent return to be made. I caution that given the run today, it is reasonable to assume that in the near term, investors digest their gains and the stock takes a break or gives back some gains — but those with a longer term horizon can still do well.
Revisiting My Estimates and Looking at the Assumptions
To get a more accurate gauge of fair value, I first needed to revisit my longer term estimates to see where I may have been overly conservative.
Revenues — $1.6b by 2015?. Starting from the top, if I assume that the company can slightly beat 2011 industry expectations by ~5-10%, then the company could do ~80% revenue growth this year at $440m. Using my previous estimates, I had revenues decelerating in 2012 relatively sharply from the ~80% growth in 2011 to <40% growth in 2012. While I did this to be conservative, it is likely too conservative (and therefore not as accurate).
For comparison sakes, after Google grew 80% in 2006, the next year the company grew 60%, or a drop of 20 points. Shutterfly also similarly dropped about 20 points of growth in 2005 from 2004’s 75% level. While I know these companies are not perfect comparisons, they do demonstrate what is likely a more reasonable deceleration. So, if my 2012 revenue growth is now a more realistic ~60%, or a 20 point drop from 2011’s growth, then that would imply revenues of ~$700m, which is higher than expectations of ~$600m.
Taking my revenue growth down 15 points for the next two years and then moderating from there, would imply over ~$1.6b of revenue in 2015, a ~45% CAGR 2010-2015 (recall in the original post, I painted a market size scenario where LinkedIn could achieve >$3b of revenues in the long term). Moreover, realise that $1.6b of revenue would still only be ~5% of the ~$30b Hiring Solutions market at that point.
One lesson I learned long ago came from Amazon and its revenue growth – many investors (including me) got that trajectory wrong by being too conservative. Amazon was growing 23% in 2005, and most models assumed growth would steadily decline from there (i.e. 20% in 2006, 17% in 2007 etc). However, Amazon ended up opening up more merchandise categories and actually accelerating revenue growth in 2006 and 2007 (today is still grows >35%). So my point is that sometimes the Street over simplistically decelerates revenue growth too quickly, masking potential upside.
EBITDA Margins Could Approach 40%? The company has guided that long term EBITDA margins should be “30% +”. In my previous post, I estimated up to 27% margins to be conservative; however, it is likely that the company expects to achieve higher than its guidance — in addition, Internet businesses can do 35-55% margins quite typically. Hence, it’s not unreasonable to think LinkedIn could reach EBITDA margins in the high 30%’s. Applying at 38% margin to the $$1.6b of revenues would derive EBITDA of ~$625m in 2015. Assuming a 40% tax rate and ignoring interest income benefit, would imply ~$375m of pro forma Net Income. Dividing by the fully diluted shares could therefore drive ~$3.50 of EPS in 2015. As for free cash flow, ~60% of EBITDA appears reasonable (to allow for taxes, and assuming the working capital benefit from annual subscriptions offsets capex). That would drive free cash flow close to pro forma net income in 2015.
What do the Valuation Multiples Say? Looking at the multiples based on the closing price of $94.25, LNKD trades at ~14x forward sales. To put that in context, the best SaaS companies trade at 5-7x forward sales. The closing price would also imply the company trades at ~100x forward EBITDA, vs the best SaaS companies that trade at 20-40x. Forward PE is not too meaningful since the company is hitting an EPS inflection point. So by looking at these near term multiples, there’s no denying LinkedIn is expensive. One bit of caution here on these multiples is that the near term financials are likely suppressed due to the investment period the company is going through as it builds for the long term.
So Is LinkedIn a Bubble? While it is clearly expensive on the near term projections, I can see how for longer term investors, there is still further upside over time. Let’s take a closer look: if we use the projections discussed above and apply forward multiples for top SaaS companies, we can derive a 2014 value of ~$150. As I said, I can see EPS of ~$3.50 in 2015, which would be growing ~50% – so using a PE-to-growth of 1.0 and applying a 50x PE multiple (top SaaS companies get 40-60x forward multiples) would imply a value ~$170 in 2014.
In addition, if one looks at the 2015 EBITDA of ~$625m growing >50% and we apply a multiple of 25x (best SaaS companies that trade at 20-40x), that would derive a ~$150 value in 2014. Further, since free cash flow should approximate pro forma EPS in 2015, that would also imply a value of ~$170 in 2014. Lastly, with top SaaS companies getting 5-7x forward multiples, if we generously applied a 8x forward multiple one would get ~$125 value for the shares. Averaging all 4 methods, would derive a value of ~$150 in 2014. That implies ~60% upside by 2014 from the close, or ~16% annualized return.
So, the main takeaway is that LinkedIn is clearly not cheap, but if one is willing to look longer term, there is still a decent return to be made. It is reasonable to assume that in the near term investors digest their gains and the stock takes a break or gives back some gains, but those with a longer term horizon can still do well.
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