LinkedIn: Analysts Are Adding To 2013's Momentum After Shares Double

Investors in LinkedIn (LNKD) continue to celebrate, with shares having doubled again in 2013, following the successful public offering in 2011.

Analysts at BMO Capital, which expect an official Chinese launch of the service in 2014, are adding to the momentum, advising clients to buy the shares. Given the unbalanced risk-reward ratio and worrying trends in revenues per user, I am more cautious and remain on the sidelines.

BMO Is Bullish On Chinese Growth

Analysts at BMO Capital upgraded LinkedIn from "Market Perform" to "Outperform." At the same time analyst Daniel Salmon raised the price target by thirty-five bucks to $270 per share, suggesting nearly 20% upside from current levels.

Salmon expects that the company is preparing a formal launch in China, boosting the long-term growth expectations. Management suggested this idea before and Salmon now sees a formal launch in 2014, with monetization occurring in 2015.

The increased focus on salespeople, which are more often using the platform compared to human resource staff, should result in an expected standalone product by 2015. Furthermore the focus on students should grow the subscriber base and result in future monetization, when they start to work.

Salmon notes that the newly introduced "Sponsored Updates" stories appear to be performing well. The mobile application for Talent Solutions works well, and a recovery in Europe and value for companies allows for price hikes in Europe in 2014 and 2015.

Valuation

At the end of October, LinkedIn opened its books for the third quarter of 2013. After a secondary offering, LinkedIn operates with a comfortable cash position of $2.27 billion, while having no debt outstanding. The secondary offering has been a bit surprising given the solid financial state before the offering, suggesting management might believe shares are valued a bit rich at the moment.

Revenues so far this year came in at $1.08 billion, up nearly 62% compared to the comparable period in 2012. GAAP earnings remain very modest although they more than doubled to $23 million.

Trading around $226 per share, the market values LinkedIn at $25.4 billion, or operating assets around $23.1 billion. This values the firm at 15-16 times annual revenues, seen around $1.5 billion for 2013.

Some Historical Perspective

LinkedIn's hugely successful public offering in May of 2011 has been well-covered. Shares famously more than doubled on their opening day, and have steadily risen to highs just north of $250 per share in September. Shares have retreated some 10% ever since.

Despite the modest pullback, shares managed to double so far this year. The reason behind the strong growth is the definitive leadership which LinkedIn has obtained in the professional networking environment, and monetization efforts are paying off. Between 2009 and 2012, the company more than ten-folded its annual revenues to $1.5 billion.

While the company is essentially breaking even on a GAAP basis, investors and management rightfully focus on growth and a strong market position. Earnings are of a secondary focus, given the solid financial position of the firm following the primary and secondary offering.

Investment Thesis

While China is obviously a big potential market for LinkedIn, the solid returns following the public offering have raised expectations to a great extent.

Back in October, following the third quarter earnings release, I last took a look at the company's prospects. Third quarter revenues were up by 56% on the year before, compared to a 62% revenue growth rate in the first nine months of the year. I was a bit worried about the guidance for fourth quarter revenues, implying annual growth in revenues to slow down to 38%. At the same time, I acknowledge that LinkedIn has historically been conservative in its guidance.

CEO Weiner noticed before that LinkedIn could be reaching a saturation point for white-collar workers, notably in the US. For now international growth and developments to the mobile website, the addition of "Sponsored Stories," and the acquisition of Pulse are keeping growth high. The focus in developed markets is changing from user growth to engagement growth, boosting revenues per user.

While the membership of 238 million across the globe is still far lower than Facebook's (FB) user base north of a billion, the market for LinkedIn is arguably smaller. While there is much debate on how big this market could be, it is clear by now is that future revenue growth should come more from higher revenues per user, rather than user growth. Therefore it is quite disappointing to see average revenues per user coming in at $1.52 per user in the third quarter, down a penny compared to the quarter before. This sequential decline is a big red flag to me as LinkedIn's focus is shifting to boost engagement and revenues per user.

Assuming LinkedIn could debut in China and achieve 400 million members by 2015, while boosting ARPU to $2.50 per quarter, revenues of $4 billion per annum are attainable in two year's time. Note that this might be very ambitious. Even when applying operating margins of 25% to such a scenario, resulting in $1 billion in operating earnings, the current valuation is still quite steep.

If such a scenario might occur, a short position might be very risky, as growth prospects post 2015 might be good. Yet a short term correction could be violent and could occur even when a small indication of a crack in the growth story might become apparent.

I think analysts at BMO might be a bit too optimistic and I would not advocate initiating a long position given the risk/return characteristic of the business. I remain on the sidelines with a slight bearish stance. While an outright short position through shares is risky, if the firm grows into the valuation, a short position through out of the money options might be interesting, depending on your time frame and risk tolerance.

Source: LinkedIn: Analysts Are Adding To 2013's Momentum After Shares Double

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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