Can LinkedIn Turn it Around?

LinkedIn (LNKD.DL) reported their 2016 earnings a few weeks ago, and despite solid growth, the Street punished the stock.

In this clip, Sean O'Reilly and Dylan Lewis go over the numbers from the earnings report and explain what spooked investors. Also, they look at the company as long-term investors -- how solid LinkedIn's business segments and plans for growth are, how big of a threat competition is, and -- of course -- whether or not the stock is a buy for investors at this discounted price. 

A full transcript follows the video.

This podcast was recorded on Feb. 26, 2016. 

Sean O'Reilly: Dylan Lewis just viewed my LinkedIn profile, but didn't connect with me. Should I be offended? All that and more on this tech edition of Industry Focus.

Greetings, Fools! Sean O'Reilly here at Fool headquarters in Alexandria, Virginia. It is Friday, February 26th, 2016, and joining me to talk about why LinkedIn can't get any love from investors is Mr. Dylan Lewis. What's up, man?

Dylan Lewis: I'm doing alright. We are friends on Facebook (META -10.56%). 

O'Reilly: Right. It's a big deal.

Lewis: I don't know if we're connected on LinkedIn.

O'Reilly: Okay, just for everybody to know, I totally made up that opening line just to be funny. I haven't seen him. It's kind of weird to me how, whenever you log in to LinkedIn, you can see who's been looking at you all the time. It's unsettling.

Lewis: It's very creepy.

O'Reilly: It's like ... a girl I dated 10 years ago looked at my LinkedIn profile? Like, what?

Lewis: Yeah, it's kind of bizarre. But, I guess that's the nudge you get to check back in.

O'Reilly: "I'll connect with them!"

Lewis: That's how you get back into the system. Because, you always get those emails, "People are looking at your profile."

O'Reilly: Yeah. And then, of course, the workaround is incognito mode!

Lewis: I do that all the time. If I'm trying to find a contact at a distribution outlet or something like that, I'm just like, "Oh, I'll just go incognito."

O'Reilly: Does LinkedIn know that the only proper way to use their site for any reasonably intelligent person is incognito mode?

Lewis: I guess, unless you're going to request the person whose profile you're looking at.

O'Reilly: Right.

Lewis: But then, if it's the wrong person, then it's awkward.

O'Reilly: It's all awkward and weird, yeah.

Lewis: It's all cyber-awkwardness.

O'Reilly: So, LinkedIn reported earnings a few weeks ago. 

Lewis: Yeah, early February.

O'Reilly: It did not go well. Probably should review that before we talk about why they can't get love and why it's maybe a buy now, we don't know ... So, how did it go? How were the earnings?

Lewis: Yeah, the theme for this week was beat-up tech stocks, and originally, we were going to talk about a couple companies, and then ...

O'Reilly: Then you just fell in the rabbit hole of LinkedIn. (laughs) 

Lewis: Just started doing our homework, and I was like, "You know what? We're just going to talk all about LinkedIn this show."

O'Reilly: Beautiful.

Lewis: So, LinkedIn, they reported in early February, stock shed 40% of the value after they reported earnings. 

O'Reilly: Were you there? Well, yeah, you were there, and you saw, like, the look on Michael Douglass's face and stuff.

Lewis: Yeah.

O'Reilly: That's one of our co-workers.

Lewis: It's one of his largest holdings, I think.

O'Reilly: Yeah. And we're really sorry, Michael. Anyways. But, the earnings were good, though! I was rereading the release before we came down here, and they're still growing. Like, a lot.

Lewis: It's really awesome to see, these great backward-looking things. But the forward-looking results ...

O'Reilly: Not so good, yeah.

Lewis: Not so hot. So, the issue here was not the report numbers, as we talked about. Quarterly revenue $862 million, 34% increase over a comparable prior year period. They beat forecasts of $845 million to $850 million. Adjusted EBITDA was $249 million, which was beyond management's guided range of $210 million. And just to look at some of the business segment growth, Talent Solutions, which is roughly 2/3 of their total revenue, grew 45% year over year--

O'Reilly: (whistles)

Lewis: --to $535 million. Marketing Solutions and Premium subscriptions grew at 20% and 19%, and those are their three major--

O'Reilly: Well, yeah, and it's not surprising that Talent Solutions is 2/3 of their revenue, and that's what they do for basically professional recruiters and all that stuff.

Lewis: Yeah. And just as a refresher for the listeners, Talent Solutions Recruiting are generally the recruiting and hiring tools. Marketing Solutions is more of the content marketing, ads, things like that that would show up in your feed. And Premium subscriptions, their other segment, job seekers, recruiters, it's a range of individual users to small-scale recruiting and HR efforts.

O'Reilly: So, again, those were great results. The problem was guidance. Was it that low? Because they grew it, like, 30-35% in most of their segments.

Lewis: Yeah, management offered a revenue target of between $3.6-3.65 billion for fiscal 2016. And basically, at the mid-point of that target range, LinkedIn is pegging revenue growth at about 21% next year. And you look back at what they've done the past couple years, 2013 has year over year growth of 57%, 2014 45%, 2015 35%, and now, they're pegging to 21% for 2016.

O'Reilly: Right. That's a really nice graph you made, by the way. I wish our listeners could see this.

Lewis: It's a nice little chart, yeah, I thought. I was very proud of myself. So, you're seeing that decline happen. And so, part of the frenzy here is slowing growth. And you've been seeing this march down, down, down, over time. It's not crazy. Obviously, as the denominator get larger, growth rates are going to slow.

O'Reilly: Is it ... we'll probably talk about this more in a bit, is it a growth saturation type of thing? Are they just as big as it's going to get, and that's it, or what?

Lewis: Well, it's not really an issue of user growth. That's been fine. I think it's more that, there was kind of this expected floor at a certain level. Maybe it was somewhere in the low 30's for growth. And, given that they are not consistently net income positive, people kind of thought, "Alright, we're going to continue to see this growth, and that will fuel all of the stock price growth, and all the valuation built into the stock at the moment."

O'Reilly: Should we read these numbers off to the listeners? 

Lewis: Yeah.

O'Reilly: Go ahead.

Lewis: So, I mean, it's not a totally fair comparison, because the businesses are a little bit different. But--

O'Reilly: And it's addictive -- we're going to compare them to Facebook anyways!

Lewis: It's hard not to talk about Facebook when you talk about LinkedIn, right? So, just for context on what kind of growth rates they've been experiencing: 2013, 54% year over year. 2014, 58%. 2015, 44%. 2016, they're estimating between 30-40%. So, they're also seeing a decline, if you look at the last three years. It is not quite as steep, and there's still a lot more upside. Obviously, the model's a lot different, and it's much more scalable, because they're just serving up ads. But that might also have added to some of the pessimism a little bit.

O'Reilly: Right.

Lewis: If you look at what is underlying these revised growth rates and why LinkedIn thinks they might be not growing as quickly as they have historically, they're saying that Talent Solutions business segment could decline from roughly 30% growth in 2015 to mid-20% growth. And this is largely related to macro-factors. They cited weakness in Europe, the Middle East, Africa, as well as some of the Asia-Pacific countries, and I think they're at roughly 40% of their business outside of the U.S., and I think that's where a lot of their growth is coming from. And so, a lot of the economic slowdown that we're seeing in some of those--

O'Reilly: Abroad, yeah.

Lewis: --major countries abroad, is going to be problematic for them.

O'Reilly: Got it, cool. Well, before we move on, I wanted to point our listeners to the newly redesigned focus.fool.com. There, you'll discover a special offer to join The Motley Fool's Stock Advisor newsletter for all Industry Focus listeners. All loyal IF listeners have access to a special discount on Stock Advisor that works out to $129 for a full two-year subscription. Just go to focus.fool.com to take advantage of this offer. Once again, that's focus.fool.com.

So, diving back into what 2016 looks like for LinkedIn, what's the outlook for the company?

Lewis: One of the really great questions that I saw in the conference call, Mark Mahaney from RBC Capital Markets had asked if this revised guidance reflected any changes in the competitive landscape or anything like that, because that's something, is there a threat to this core business that you have? Is anyone coming in and stealing business? You talk about, there's things like Facebook at Work, all these little people stealing market share. And Jeff Weiner, CEO, totally dismissed that notion. So, I think, as a shareholder, you have to like that. They are sticking to the narrative and the rhetoric of this being macro-impact and really nothing more. So, obviously, you're going to expect some declining growth rates as a company matures. Hopefully, as we see some stabilization in the next couple years in some of these markets where they're expecting a lot of growth. And this is a story we've seen with tons of earnings reports, with people experiencing issues in China or India or some markets they were expecting huge growth in and the economic downturn has (coughs) halted that a little bit--

O'Reilly: Do you want some of my coffee? (laughs) 

Lewis: (laughs) So, I like the fact that the core business is not riskier.

O'Reilly: Right. So, during the conference call, did he mention any of the growth drivers or anything else they're doing to ... 2016 may be a tough macro year or whatever, but beyond 2016, where else is he looking for growth?

Lewis: I think that's one of the things that I am very optimistic about with this company. So, they have this Sales Navigator in Business Solutions which is basically a social selling tool. The idea here is, it's going to help with lead recommendations for salespeople, contact management--

O'Reilly: That could be huge, yeah.

Lewis: It integrates well with Salesforce. So, it's in part lead generation, and it's in part knowledge management. And I think, in the recent conference call, one of the analysts estimated that it was currently at like a $200 million run rate.

O'Reilly: Did he say to the company, "We've estimated your--"

Lewis: Yeah.

O'Reilly: So, that's what he said, OK.

Lewis: It was in the form of the question, "This is roughly what we're saying, can you confirm that?"

O'Reilly: "Can you say we're insane or not?" (laughs) 

Lewis: Yeah. So, CEO, Jeff Weiner, did not deny that. So, I think that's roughly what you can expect. In the past, the company has said that they can scale that to a $1 billion business. So, huge runaway for growth there. They're obviously still integrating the Lynda acquisition into their offering. They're really just beginning to see a revenue contribution come through from that expedition, and if you remember, correct me, I think it was a $1.5 billion acquisition, I think they saw maybe $49 million in revenue contribution in the most recent quarter. So, it's going to take a while, but I think, as time passes, you're going to see that be more and more creditive to earnings.

O'Reilly: I wonder what they're thinking with that. Because, I understand, if I wanted to learn how to code or something, there's tutorial videos on lynda.com.

Lewis: Yeah, the skill-building integration there is obviously really great. Or, you know, they could do something like certifications, where you take these classes and you're LinkedIn certified in the specific skill--

O'Reilly: Oh man!

Lewis: --that job seekers are--

O'Reilly: I'm LinkedIn certified! (laughs) 

Lewis: Yeah. One of the other really great business segments I'm excited about is their sponsored updates. This is really no different from what you'd see in your Facebook feed, if you were scrolling through and saw an ad for Google or pants or something like that. This segment grew at approximately 85%, and so, ball-parking, that's roughly $90 million, which comes in at over half of the Marketing Solutions revenue. And this is the first time they've been at that level.

O'Reilly: Wow.

Lewis: So, this is something they've talked about in the conference call quite a bit. They're going to continue to feed that segment. They're going to build out some conversion tracking, and targeting tracking to help it be a little bit more valuable to the participating businesses. But, that's obviously a business that scales very well. It's not ever going to be something that is on par with what Facebook is able to do in terms of ads, or what Google does in terms of ads, just because the user base is so much smaller, and I think the cadence that people go back to the platform is not nearly as frequent.

O'Reilly: Right.

Lewis: But I think you have to like -- I mean, I was scrolling through LinkedIn today just to get a UI experience and see exactly how these were being integrated, and it's exactly the same experience that you're used to with all the various social media outlets. 

O'Reilly: Right. Alright, before we sign off, are you freeing up some cash? Are you going shopping for some LinkedIn shares?

Lewis: A lot of Fools seem pretty bullish on it right now.

O'Reilly: A lot of people in this building do like it, so yeah.

Lewis: Yeah. A couple other things I do like, more on the core metrics business side, EBITDA as a percentage of revenue has been consistently trending up. They had a little down-tick early in 2015--

O'Reilly: What do you think -- sorry to interrupt -- about their -- because, Asit Sharma, one of our writers, had a really good analysis, and he noted that the company pretty much always says, you need to not focus on GAP results, where they lost money, and go to EBITDA results, because we have so much stock-based compensation and all that stuff. What do you think about that? (laughs) 

Lewis: You have to pay the piper, right?

O'Reilly: Yeah. (laughs) 

Lewis: (laughs) Like, that's always kind of a cop-out. And that's something we see all the time with tech companies. And actually -

O'Reilly: Well, 15 years ago, there was an open debate, it was like, oh, all these tech companies are using stock options to pay their employees, but they're not expensing them and everything, what's the deal here? And Buffett wrote a really good article about it, and he and Bill Gates -- because Bill Gates started exposing stock options at Microsoft, which was probably a sign that all tech companies should have been doing it -- but, he basically said, it's an expense, and just because it's hard to calculate, doesn't make it not an expense, especially to shareholders.

Lewis: Exactly. Yeah, it's something to keep in mind. And I think, perhaps down the road, we should do a stock-based conversation--

O'Reilly: A philosophical debate about-- (laughs) 

Lewis: Or, just take a look at the landscape of tech companies, who's paying what in stock-based compensation, and--

O'Reilly: Do you know how much Larry Ellison, the former CEO but now just chairman of Oracle -- he gets like $200 million a year in stock options.

Lewis: Must be nice. Start a company and then just get stock options.

O'Reilly: And then you can buy one of the Hawaiian Islands. (laughs) 

Lewis: Yeah. (laughs) So, circling back to our conversation--

O'Reilly: That's my fault, I'm sorry. (laughs) 

Lewis: (laughs) No, no worries. So, yeah, EBITDA as a percentage of revenue has generally been trending up. There was a little hiccup in, I think, early 2015. I believe that was related to the Lynda acquisition. But, based on guidance, margins should continue to improve. I think they're pegging somewhere around a 100 basis point improvement in 2016, which is obviously great.

O'Reilly: Do you think that ... how scalable do you think LinkedIn is compared to a Facebook? Because Facebook's just a website, and we're all addicted to it, and we stalk people on it, and then there's ads. I mean, he's talking about getting 3-4 billion humans on this by 2035 or whatever. That's scaleable. (laughs) 

Lewis: Yeah, it's very scalable. I don't know what the job search environment is like abroad, and that's one of the things that's tougher for me to wrap my head around with their international expansion--

O'Reilly: Right, because it's like, Americans use it a lot or whatever.

Lewis: It's very common, like, if you go out for drinks or something like that, and you have a mixed group of people, and you realize that someone that you're chatting with happens to work ... say, for example, we work in editorial, and someone else works at a distribution outlet, it'd be very common for us to reach out and say, "Hey, maybe something works out." I mean, I had a high school friend who works at one of these upstart brokerage account type places reach out and say, "Oh, I realized that you're in financial content, it would totally make sense for us to see if there are any partnerships that we can work out so you guys can be on our platform." So, it totally makes sense, and it's part of the culture here in the U.S. I would think it would have to be the same abroad.

O'Reilly: I would think, but you never know.

Lewis: Yeah, and that's bolstered by what we've seen with user growth. It hasn't really slowed down. One of the other core metrics for the business that I really like, I think, over the past four quarters, it's been consistently between 19-21% year over year. So, that's looked pretty good. All in all, since the post-release sell-off, the stock is up about 10%. So, it dropped around 40%, and it has recovered 10% from where it dropped. So, it is still, I think--

O'Reilly: Way off.

Lewis: It's down in like the $113-114 region.

O'Reilly: Well, its market cap is like, $15 billion, I think. And I see these sales numbers, and I'm like, (groans) talking about $3.5-3.6 billion sales next year. So, it's not profitable, although ... debate ... and it's still, I don't know, 4x or 5x sales. It's kind of like, eh ...

Lewis: Right. But it's at a 37% discount to where it was in early February.

O'Reilly: Yeah. If you're bullish, now's the time.

Lewis: Yes. If you're bullish, now's the time. I also think, when it happened, it felt like a market over-reaction.

O'Reilly: Right, that was brutal. It was just ...

Lewis: It was crazy.

O'Reilly: It was punishing.

Lewis: Basically, I mean, they shaved $13 billion off their market cap in--

O'Reilly: Last year, yeah.

Lewis: Yeah, in a month. So, my takeaways here are, the core businesses seem to be doing fine. Management doesn't seem to be worried about competitive threats to what they're doing. There aren't major players coming in to steal their lunch. User growth is good. EBITDA is trending where you want it to be. And there seems to be a lot of really good growth avenues available to them. So, if you like them, it seems like a great time to add to a position if you already have a position with them. They are on my watch list right now. I want to just wrap up and continue doing a little more homework. But I've had my eye on them for a little bit.

O'Reilly: Cool. Alright. Well, I'll go connect with you on LinkedIn right now. That is it for us, folks. If you're a loyal listener and have questions or comments, we would love to hear from you, just email us at [email protected]. Again, that's [email protected]. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell anything based solely on what you hear on this program. For Dylan Lewis, I'm Sean O'Reilly. Thanks for listening and Fool on!