LinkedIn Corp. Hits an Expected Speed Bump in China

Censorship is a necessary evil for any company doing business in China. LinkedIn already knew it would have to play ball, but that doesn't mean users will be happy about it.

Jun 4, 2014 at 7:30PM

Linkedin China Video

Source: LinkedIn.

Sooner or later, this was bound to happen. After LinkedIn (NYSE:LNKD) in February expanded further into China with a Chinese-language beta site to complement the English-language version, censorship was destined to be a sensitive topic. Unfortunately, government censorship is simply a fact of life for any company looking to do business in the Middle Kingdom.

While CEO Jeff Weiner in a February post acknowledged the inherent challenge, given that the business-oriented social media company "fundamentally disagrees with government censorship," LinkedIn has little choice but to play ball if it wants exposure to the estimated 140 million professionals in China. It's a tricky balance, and a real risk factor for growing a presence in the world's second-largest economy.

That's all coming to a head now, as LinkedIn has begun censoring content related to the 25-year anniversary of the Tiananmen Square protests. Google has always had trouble in China over censorship, and is getting blocked even more aggressively today for the same reason.

Even though LinkedIn has been transparent that it will begrudgingly comply with government restrictions, that's little comfort to the users who are being directly affected. A spokesman told The Wall Street Journal that the amount of content being blocked is very small since LinkedIn doesn't focus heavily on political content.

International expansion always comes at a cost, and for LinkedIn that includes infrastructure investments and data center deployments. Last quarter, capital expenditures doubled to nearly $89 million. While LinkedIn doesn't specify how that spending is allocated by geography, a chunk of it is inevitably being invested in expansion in China.

The real risk is that if users shy away from the site because of censorship, then those investments will be for naught. But it's not as if local rivals like Tianji are exempt from censorship requirements, so the grass is not always greener on the other side.

Relative to U.S.-based rivals, China is a unique opportunity for LinkedIn. Facebook (NASDAQ:FB) and Twitter (NYSE:TWTR) continue to be blocked in China, and the government has little reason to let them in. Facebook and Twitter have been associated with numerous social revolutions in recent years, which is something the Chinese government would certainly prefer to avoid. LinkedIn, on the other hand, offers economic opportunities that can help the country prosper.

Company

Price/Sales (TTM)

Price/Free Cash Flow (TTM)

LinkedIn

11.3

544.2

Facebook

18.1

47.6

Twitter

24

N/A

Source: Reuters. TTM = trailing 12 months.

With the company trading at 11.3 times sales, investors are still pricing in significant growth for LinkedIn going forward. LinkedIn's free cash flow is relatively low due to those heavy infrastructure investments, which makes its price-to-free cash flow multiple look pricey.

China is one of LinkedIn's most promising growth prospects, and the company will need to execute there to execute on to justify its premium valuation. For LinkedIn in China, censorship is a necessary evil.

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Evan Niu, CFA owns shares of LinkedIn. Evan Niu, CFA has the following options: short January 2015 $60 puts on Facebook, long January 2015 $35 puts on Facebook, short January 2016 $140 puts on LinkedIn, long January 2016 $125 puts on LinkedIn, long January 2016 $150 calls on LinkedIn, short January 2016 $200 calls on LinkedIn. The Motley Fool recommends Facebook, Google (A shares), Google (C shares), LinkedIn, and Twitter. The Motley Fool owns shares of Facebook, Google (A shares), Google (C shares), and LinkedIn. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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