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Monday, 23 May 2011

Why LinkedIn Will NOT Be a $25 Billion Company in 5 Years

Thursday May 19, 2011 was a remarkable day on the NYSE stock exchange. It was the day of the LinkedIN (LNKD) IPO.
A total of 7.84 mln shares in LinkedIn were initially sold for $45 each and last Thursday the share got its ‘maiden voyage’ on the New York Stock Exchange: the first day of trade.
And what a day it was: after an opening of $83 the rate of the stock soared to $120 and after that returned to about $100. On Friday it seemed that the initial enthusiasm dropped a little. After a day where the rate moved around the opening price, the stock dropped $7 to end at $93.
Those are trading days that make excellent / lucky traders rich and average traders poor. Would you have bought 1000 shares at the initial offered price of $45 and you would have sold those for about $110, you would have had a ‘healthy’ profit of $65,000 on an investment of $45000. That would be a nice story to tell to your wife. However, would you have bought 1000 shares for $120 each and sold it for $100, you would have had a loss of $20,000 on an investment of $120,000.
But that is not my point. This is… Especially 12-10 years ago in the period 1999-2001, there were more IPO’s like LinkedIn: in the USA, but also in my tiny country The Netherlands. Dutch Internet companies like WorldOnline and Newconomy were brought to the financial markets and collected enormous amounts of shareholder money. Even frequencies for future mobile phone network service techniques, like UMTS (Universal Mobile Telecommunications Systems) were auctioned for billions of dollars everywhere in Europe.
The stories sounded surprisingly familiar: these companies and techniques all would crack the code of making profits for eternity and they would change the world as we know it today. And the fact that they made hardly any profits at the time was a fact that could easily be neglected, because the future looked so promising. Now ten years later most of those companies don’t exist anymore, or lead an average existence as “mainstream company”. And the UMTS auctions brought a number of large telecom providers almost on its knees.
And do you remember the beginning of the nineties, when the world’s favorite company Microsoft had a stock value of 1 trillion dollar?! (I write it in full, so I’m sure you read it correctly). Do you think the guys that bought those shares at that peak rate did make any money on it? And do you feel lucky? Well, do you?
Let me make one thing clear: I am convinced of the power of the market. In the time of Tulip Mania in The Netherlands (17th century; please checkout Wall Street II, Money never sleeps), the price of tulip bulbs soared to unbelievable levels, due to ‘the market’. The price of a tulip bulb was 1000 Dutch guilders in 1623, about $500. However, if you look at purchase power of a guilder in those days, it was rather $5000 in current dollars. Was the market wrong? Of course it was! It was total idiocy. But the market made that kind of idiocy possible. That is how powerful the market is.
But do you know who had the last laugh? The trader that sold those tulip bulbs for a record price to a poor SOB, just before the markets imploded. After that happened, it became clear that tulip bulbs are nothing more than just… tulip bulbs. Beautiful in their own right, but not worth $500 a piece.
Picture courtesy of

And that story paints an important difference between a trader and an investor:

·         a trader needs to make immediate profits at whatever price, from the difference between purchase and sales prices of whatever he sells. And a trader must limit his losses by stepping out in time when prices drop.
·         An investor, however, must pay such a price that his investments yield enough money in the years after purchase to return the investment plus an extra profit. Those yields exist of paid-out dividends throughout the years and eventually the sales price of the stock.

So a trader must look differently at the price action than an investor. For a trader yesterday morning was a golden opportunity, but for an investor it was hysteria at its worst, in my opinion.
Professor Conor Sen of Minyanville ( wrote a very interesting article last Thursday: Why LinkedIn Will Be a $25 Billion Company in 5 Years. I will write here some pertinent snips:
In 2010 it took in $243 million in revenues. In the first quarter of 2011 it took in $94 million, up 110% from $44.7 million a year ago. That makes trailing 12-month revenues $292 million. What sort of multiple does that deserve? For comparison, recent high-flyer Internet stocks like OpenTable (OPEN) SINA Corp (SINA), and Baidu(BIDU) trade at 18.9x, 17.0x, and 25.4x, respectively. Facebook 2010 revenues were roughly $2 billion, and with some estimating a current value of $70 billion, that'd put Facebook around 35x sales. LinkedIn going public at $4.5 billion, or 15.4x trailing 12-month revenues, seems entirely reasonable by comparison$.
Let's say LinkedIn grows revenues at 95% in 2011, 75% in 2012, 60% in 2013, 45% in 2014, and 35% in 2015. That would put 2015 revenues at $2.6 billion. Doesn't seem crazy. As the chart below shows, as recently as the end of 2005, Google, eBay(EBAY), and Yahoo(YHOO) all traded at price/sales ratios north of 10. These companies were all fairly mature growers at that point, as LinkedIn should be in 2015. Skype just sold for 10x revenues. And 10 times 2015 revenues of $2.6 billion would give LinkedIn a market cap of $26 billion. If I'mMicrosoft (MSFT), Google, or Facebook I buy LinkedIn for $10 billion this morning, assuming they'd sell, and consider myself lucky.
If Conor Sen invested in stocks LinkedIn on Thursday morning and he sold them just before peak rate, he is a hero under the traders. But should you take his advice seriously as an investment advice? To be able to answer that question, you should know what LinkedIn makes its money with.
However, first let’s take a look at Conor Sen's figures, but let’s also look at the profits in the previous years. And let me be bold by adding a forecast for the profit development in the coming years. This forecast is based on the assumption that the company will become more profitable initially, but profits will diminish eventually, due to rising costs. The company itself states about this:
We expect that, in the future, as our net revenue increases to higher levels our revenue growth rate will decline over time, and we may not be able to generate sufficient revenue to sustain our profitability. We also expect our costs to increase in future periods, which could negatively affect our future operating results. In particular, in 2011, our philosophy is to continue to invest for future growth, and as a result we do not expect to be profitable on a GAAP basis in 2011.
In my forecast, I take LinkedIn’s statement about future declining profitability into account, by letting it rise initially from 2012 - 2013 and letting it decline again in 2014. In 2011 the company doesn’t expect any profit at all (bold text):
2011        -/- 1% to +1% of revenue
2012        + 7%
2013        + 9%
2014        + 8%
2015        + 7%

Growth (C. Sen)
Revenue for that year
Real / Forecasted Profit
$79 mln
$4.5 mln
$120 mln
$3.9 mln
$243 mln
$15.4 mln
$474 mln
  $4.7 mln - $4.7 mln
$829 mln
$58.0 mln
$1327 mln
$119.4 mln („)
$1924 mln
$153.9 mln („)
$2597 mln
$181.8 mln („)

I think that only a stock price vs. profit ratio of 15-20 times is healthy and thus a stock price vs. revenue ratio of 10 is not healthy. If you agree with this concept and with my forecast of future profits, than a market capitalization of $3.6 bln in 2015 would be more appropriate, instead of $26 bln. If you divide this through 94.5 mln shares (the total amount), the future stockprice in 2015 would be $38.5, instead of $275.

But there is more: there has been a very clear shift in revenue from Premium Subscriptions to Hiring Solutions. Premium Subscriptions delivered 45% of revenue in 2008, but delivered only 25% of revenue in 2010. Hiring solutions delivered only 22% in 2008, but delivered a strong 42% in 2010.

LinkedIn: Revenues per activity (figures:

And what are those activities? LinkedIn itself states:
Hiring Solutions. Revenue from our hiring solutions is derived primarily from the sale of our LinkedIn Corporate Solutions and LinkedIn Jobs products. LinkedIn Corporate Solutions allow enterprises and professional organizations to identify job candidates based on industry, job function, geography, experience, education, and other specifications. Our customers can also purchase job slots to utilize job postings on our website throughout the contract term. 
Marketing Solutions. Revenue from our marketing solutions is derived primarily from fees we receive from marketers, principally advertising agencies and direct advertisers, for display and text ads on our website. We also provide a self-service advertising solution that allows marketers to directly create and place ads on prominent pages on our website. Revenue from display or text ads is generally recognized when the advertisement is displayed on our website. 
Premium Subscriptions. Revenue from our premium subscriptions is derived primarily from online sales of our Business, Business Plus and Executive subscription products. These products provide our members, acting as individuals or on behalf of their enterprises or professional organizations, with access to more tools and features than our free membership, including enhanced search results, enhanced communication capability, improved organizational functionality and priority customer support.

So if you look at the current figures from LinkedIn, it seems that Hiring Solutions (roughly translated recruitment) is the future mainstay of the business. Will this indeed be the future cashcow of LinkedIn?

Stepstone ASA, one of the largest European online recruitment organizations and subsidiary of Axel Springer Verlag (a large German publisher) tells about recruiting via social media in a July, 2010 report

Extremely poor return on investment from using social media for recruitment
European StepStone survey reveals social networks aren’t yet up to speed compared with other recruitment channels 
Half of job seekers in Europe use social media for finding a job, but only a minority responds to job messages via social networks. This is the result of an international survey conducted by StepStone, one of the most successful online job boards in Europe. 37% of European organisations use social media during their recruitment process, mainly to search for people who match the profile they’re looking for. Checking a future employee’s background is the second most important reason why recruiters use social media. 
Posting jobs on social media isn’t quite so important for recruiters — in fact, it comes in only in 5th place. 
Among job seekers, less than a quarter respond to job messages via social media. As for background checks, a whopping 60% of people don’t appreciate recruiters snooping around in their private social media profiles.

Ralf Baumann, CEO StepStone: "With social media having taken off like a rocket, recruiters are now starting to embrace them, especially given the millions of profiles that are accessible for free or next to nothing. Most individuals, however, use social media mainly for private reasons, which explains their reluctance to open up their profiles to recruiting companies. Privacy is still high on their agenda." 
Half of recruiting organisations have never sourced candidates via social media. 
Compared to other recruitment channels, social media cannot yet compete on overall recruitment results, where job boards score best (3.59 on a scale of 5) and social media come in last (2.66/5).

Of course, you always have to be careful with investigations done by large market parties on competitive channels that those parties don’t use. This is also the case with Stepstone, that is a direct competitor of LinkedIn.
But the statements on the privacy of users and the poor Return on Investments (ROI) make sense to me. However, privacy might not be such a problem with LinkedIn, as this is already more a business-oriented network than a social network.
The moral of this story: LinkedIn itself is afraid its costs may increase strongly in the coming years and its profitability may decline. Besides that, LinkedIn might not be as strong in recruitment (yet) as its most important competition: the real recruiters. And as the number of profiles in LinkedIn remains increasing, the number of unused, poorly updated and/or unusable profiles will increase to. This might turn searching for good candidates via LinkedIn into searching a needle in an enormous heystack.
And remember: the only true assets of LinkedIn are those profiles. And please remember too that Microsoft, Yahoo and Google needed desperately to diversify itself to maintain their revenue growth and profitability at the current levels. For LinkedIn that will be quite hard, as their only assets are those profiles. I’m afraid that LinkedIn might turn into a dog, instead of a cash cow. $45 per share was in my opinion already very high, but $90-$100 is ridiculous.
Finally I want to give you some inside information: I am a LinkedIn member since 2007, because I’m an IT dude and IT dudes are supposed to be on LinkedIn. After repeating for 4 years that I was LinkedOff®, due to being utterly bored with LinkedIn, I refreshed my profile to plug my website (
  • do I like LinkedIn? Not really 
  • do I use LinkedIn in my daily work? Not really 
  • do I check LinkedIn very often? Not really 
  • do I update LinkedIn regularly? Not really
    Can somebody please explain me what is the point of LinkedIn, except for looking for profiles of candidates for a job or for browsing through it to find that old colleague and / or that beautiful girl that you met once at the office?
    The information there is:
    • not very accurate as little people update their profiles once a month or even four times a year; 
    • not very personal as it contains only business information 
    • not very funny to look at (see the former bullet) 
    • not very useful too, as you need a real resumee of potential candidates anyway.
    Is there anybody that got a job, only by being on LinkedIn and without getting acquainted with that company first? I have my doubts about that. That makes LinkedIn useful at best, but nothing more than useful.
    Of course I can proof my point only in five years from now. But I am sure that LinkedIn will be hype #36 on internet and will yield its investors from Thursday afternoon only very little money in the future, compared to their initial investment. And for Professor Conor Sen? I hope he can show me why I am terribly wrong. And then I will invest with a happy smile.

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