A number of months ago, we wrote about Netflix (NFLX) and how we thought the shares were absurdly overvalued: Netflix Valuation: Completely Absurd, Significantly Overvalued. The stock was trading around $250 per share at that time, and now it’s trading for less than $100 per share. Today, we’re making a similar valuation call on LinkedIn (LNKD).
LinkedIn posted third-quarter results Thursday after the close. When a company is growing as fast as LinkedIn, the year-over-year comparisons become relatively meaningless, and at the end of the day, we think earnings (and by extension cash flow) is what drives long-term equity prices. Our view is that the firm’s stock price will continue to hum along, until the Street grows impatient with the name (that is, the syndicate backs away upon lockup expiration), setting the table for the beginnings of a tumble. Our significantly below-market $55 fair value estimate remains unchanged. In the spirit of transparency, our initiation piece on LinkedIn can be viewed here.
LinkedIn grew revenue 126% in the quarter (as members advanced 63%) led by a more-than-doubling of revenue from hiring solutions and marketing solutions, while non-GAAP earnings per share reached $0.06—again, not that impressive for a firm that is trading above $80 per share. Interestingly, non-GAAP net income only increased $600,000 (yes, that’s $0.6 million) from the same period a year ago—far from material expansion (how LinkedIn—or perhaps more appropriate, the sell side—has convinced the market of its current price-to-earnings multiple is beyond us). Adjusted EBITDA margins held steady at 18%, revealing little operating leverage in the business, at least currently.
The firm also issued a shelf registration for $100 million Thursday, the beginning of substantial dilution that holders of this stock should expect, as LinkedIn continues to be in need of cash (a shelf is the subsequent sale of additional shares). This is a huge red flag. LinkedIn could have easily raised more money at its initial public offering just a few months ago, but it decided to keep the float small to drive a huge spike when its shares first began trading. What happens when LinkedIn actually releases as many shares as it needs to drive its desired growth? Well, that’s when the bubble begins to deflate, and we believe the beginning of the decline is near.
Looking forward, the professional social-networking provider expects revenue this year to reach as much as $512 million on the high end (up from $485 million). We expect continued substantial growth, but LinkedIn would have to maintain an unbelievable trajectory for a very long time to justify its current share price. Remember, this is the identical thesis we had on Netflix before its dramatic price decline (click here to view what LinkedIn would need to achieve to justify its lofty price). We remain on the sidelines and are currently evaluating opening a put option in the portfolio of our Best Ideas Newsletter, with timing and the premium paid for volatility the only outstanding considerations.