Facebook (FB +0.16%) and LinkedIn (LNKD +0.00%) are among the most innovative companies of our time, and they both provide interesting opportunities for investors to profit from the social networks boom over the next years. However, their business models are quite different, and this has material implications to consider.
Online recruiting
The big cash generator for LinkedIn is talent solutions for employers, which provided 56% of revenue in the last quarter, another 20% of sales came from premium subscriptions and the remaining 23% was produced by advertising.
LinkedIn estimates that its addressable market is worth around $27 billion, and it's an industry in which the company has positioned itself as the disruptive leader. With more than 238 million members and 20,200 companies using its services, LinkedIn has already achieved critical mass, and the company is benefiting from the self-sustainable competitive advantage provided by the network effect.
Users need to be on LinkedIn because professional contacts, potential business partners, and job recruiters are using the platform. Hiring companies want to go where all the good candidates are, especially in the case of LinkedIn, the place where they can even contact people who didn't necessarily apply for a specific job.
The bigger LinkedIn gets, the more valuable the service becomes for both hiring companies and professionals, and this at the same time attracts more users from both sides. A growing platform means that LinkedIn should retain considerable pricing power over time as its services become more valuable.
The service is about much more than online resumes. LinkedIn allows people to build a full blown professional identity online, including the social and professional interactions that come with that. This means that users are unlikely to walk away from LinkedIn anytime soon as they have much invested in the professional network.
The company has delivered earnings results above analyst's expectations in each of the last four quarters. Past performance is no guarantee about the future, but especially when investing in innovative online companies; it's comforting to know that management has the ability to deliver financial results.
Online advertising
Facebook makes most of its money from online advertising, where the company competes against search engines like industry giant Google (GOOG +1.69%) and the reinvigorated Yahoo! (NASDAQ: YHOO) which has been attracting new talent and revitalizing its products under the leadership of Marissa Mayer.
The search business is especially efficient when it comes to online advertising. When it’s put it the right context, an ad can be a valuable service for the user, and this means that companies like Google and Yahoo! are in a position of strength to compete against Facebook. Facebook ads, on the other hand, are mostly an inconvenience for its users.
Besides, costs per click have been falling lately, Google reported a decrease of 6% year over year in costs per click for the last quarter and Yahoo suffered an even bigger decline of 8%. Both companies more than compensated for those falling prices with growing volumes, Google sold 23% more ads and Yahoo increased its volume by 21% in the quarter. However, falling costs per click across the industry represent a considerable risk to watch in the middle term.
There are concerns about Facebook's ability to adapt to the mobile paradigm, even if the company dissipated those fears to some degree with a blowout earnings report in the last quarter. Mobile advertising revenue grew 75% sequentially in the second quarter of 2013, and it now represents 41% of the company´s overall advertising, that's up from the previous quarter when it was at 30%.
News feeds ads were the biggest success drivers for Facebook in mobile during the last quarter, and they have clearly been a smart move by the company. But investors need to consider that these ads were introduced in late 2012, so it's too early to tell what kind of growth Facebook will generate from these products over the long term.
Because news feeds are still quite new, it isn't entirely fair to compare them head to head against the search and display ads used by Google and Yahoo. Novel products usually outgrow existing ones in their first stages, so we need to wait until the dust settles to make a clearer assessment about Facebook and its ability to compete against well established players like the online search engines, especially in the much challenging mobile arena.
Bottom line
The online advertising industry is a fertile ground for growth in the long term, but Facebook is facing fierce competition from Google and Yahoo! among others, and online ad prices could remain under pressure over the next quarters. LinkedIn, on the other hand, is the undisputed leader in online talent solutions, an area with huge long term potential and where no other social network has the same professional focus as LinkedIn.
With more than 1.15 billion monthly active users, Facebook has more friends, but LinkedIn's contacts are more valuable, so I'm picking quality versus quantity and staying with LinkedIn.
