Why LinkedIn Corp Is Worth Every Penny

Source: LinkedIn.

No matter how you slice it, LinkedIn (NYSE: LNKD  ) is a pricey stock. But that doesn't mean it can't be worth the premium. In fact, LinkedIn is worth every penny. Here's why.

Of all the social networks, LinkedIn easily has the best business with the strongest monetization strategy. Yet, it's actually the cheapest of the three major players by some valuation metrics like price-to-sales. One partial explanation for this discount is that LinkedIn's top line is growing at a slightly slower pace.


Price-to-sales (TTM)

Sales growth (TTM)










Source: Reuters. TTM = trailing-12-month.

What's not shown in this table is how incredibly sustainable LinkedIn's business is since it has utterly dominated the professional niche of the social media sector.

Why LinkedIn is different
Naturally, LinkedIn relies heavily on network effects. But in this case, LinkedIn's business benefits in 2 ways as its base of registered members (currently over 313 million) continues to grow. The value proposition that LinkedIn offers to both members and corporate solutions customers strengthens as the member base grows.

As the professional networker has grown its member base by more than fourfold over the past four years, the number of corporate solutions customers has increased by 14-fold to over 28,000.

Source: SEC filings.

It's this growth in corporate solutions customers that is particularly impressive, as these are the customers that drive nearly 60% of the business through the talent solutions segment.

Source: SEC filings.

Users of ad-based social networks generally don't like when their data is being sold to advertisers. Users of LinkedIn generally don't mind when their data is being sold to possible recruiters that might make them a job offer. In effect, LinkedIn gets to play both sides of the job market as the ongoing social networking revolution rages on.

That's just one of several important differentiators that LinkedIn enjoys relative to its ad-based peers.

Another important distinction is that LinkedIn has immense growth opportunities in China, just recently launching a localized version of its site in Simplified Chinese. Meanwhile, Facebook and Twitter remain blocked in the Middle Kingdom. The company had approximately 4 million members in China in February, and hopes to grow that figure to over 140 million in the coming years. Judging by how member growth has translated into revenue growth up until now, there's a lot to be bullish on if LinkedIn can approach its full potential in China.

The advertising business is still young
LinkedIn does have an advertising business like Facebook and Twitter, but naturally there's a professional angle that it can leverage: business-to-business (B2B) marketing. That's exactly why LinkedIn agreed to acquire Bizo last month for $175 million, a player in the B2B market with proprietary data management and targeting technology catered toward advertising to professionals.

Sponsored Stories have done wonders for Facebook's business, particularly in mobile. Sponsored Updates are doing likewise for LinkedIn's marketing solutions segment as it shifts away from traditional display ads. Sponsored Updates now comprise 28% of this segment, less than a year after launch.

Right now, we're talking about a segment that has generated $410 million in revenue over the past 12 months. That's a drop in the bucket compared to the roughly $30 billion broader B2B market. The advertising business has nowhere to go but up.

To scale or not to scale, that is the question
I highly prefer companies whose cost structures exhibit operating leverage. That typically includes companies with a high proportion of fixed costs relative to variable costs. That paves the way for revenue growth outpacing expense growth, which leads to profitability expanding as the business grows.

As far as LinkedIn's fixed costs go, the majority of its infrastructure spending goes toward its data center buildout. Capital expenditures related to data centers have held back LinkedIn's free cash flow in recent years, but it's a necessary investment associated with rapid geographical expansion.

Starting in 2013, LinkedIn decided on a data center strategy that would involve building three self-managed facilities around the world over the span of three years. By shifting to self-managed infrastructure, LinkedIn will eventually save 50% on operating expenses per data center in the long-term. After the program concludes next year, capital expenditures will revert back to approximately 10% of revenue. At that point, LinkedIn's capital needs will mitigate and investors should enjoy a nice margin tailwind.

LinkedIn does face a variable cost structure around its sales channels, though. Approximately 60% of LinkedIn's revenue in any given quarter is typically generated through its offline field sales organization. Increasing the headcount within LinkedIn's field salesforce is what's driving LinkedIn's sales and marketing expenses higher, jumping 61% last year.

Since the majority of LinkedIn's revenue is still being generated through this channel, which is less scalable than its online sales channel, LinkedIn's overall operating leverage and scalability suffer modestly. Sales and marketing expense is typically about a third of revenue.

The good news is that LinkedIn's salesforce is very effective (remember the aforementioned outsized increase in corporate solutions customers?), and is largely responsible for driving recent revenue gains. Scalability implications aside, that's money well spent. The net result is that LinkedIn's business over the long-term will be quite scalable, like most Internet services, especially once its data center buildout is complete.

Foolish bottom line
None of this is to say that LinkedIn will be in the clear in the years to come. In the grand scheme of things, the broader social media sector is rather immature. Even though LinkedIn is cheaper than its peers by some measures, the whole sector's valuation is up for debate, especially as the entire sector is priced for growth.

If LinkedIn's growth trajectory gets derailed or otherwise questioned by investors, shares could get punished quite badly. They already had in fact, pulling back a painful 45% between September and May before the current recovery had taken hold. As with most growth stocks, high expectations are being priced into the stock right now, and LinkedIn will need to deliver in order to satisfy investors.

All that said, don't underestimate LinkedIn.

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Read/Post Comments (2) | Recommend This Article (50)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 21, 2014, at 4:23 PM, BillFromNY wrote:

    A terrific defense of the valuation of LinkedIn. The problem is that when Mr. Market decides that the tech stocks have become overvalued, it doesn't call in company management to debate the topic. It doesn't even have an internal analysis of each company that brings up the points that you have made.

    Mr. Market determines that you are overvalued by looking at a few numbers and fractions derived from your financial statements. These are the same fractions that Mr. Market has used to value corporations since your great, great grandfather worked for J.P. Morgan himself.

    If, as a result, it finds that your numbers are out of whack, then it strikes you on the head with a rubber mallet until your numbers are in whack again. Unfortunately for LinkedIn, its numbers require many, many blows to the head before they finally leave you alone.

    If you have a long, say ten year outlook for LinkedIn, and you can psychologically handle the paper loss of so much money, and you can live with so much dead money sitting there waiting for LinkedIn to finally be worth the same or greater amount than you paid for it, then you have no problem.

  • Report this Comment On August 21, 2014, at 11:35 PM, CoreAndExplore wrote:

    I shorted LNKD with my CAPS pick at $253, and closed the pick at $157 (for a score of about 50). At the time made the original pick, LNKD was outrageously priced, especially considering the margins at the time, but it is quite a bit more compelling a year or so later, although it was obviously a much better entry point at around $150 than it is today. I do think it's still priced for near perfection, but the top and bottom line growth should be very very good for some time. This is an intriguing growth story, and one to monitor for better entry points IMO.

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Evan Niu

Evan is a Senior Technology Specialist at The Motley Fool. He was previously a Senior Trading Specialist at a major discount broker. Evan graduated from the University of Texas at Austin, and is a CFA charterholder.

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