LinkedIn Corp. Hits an Expected Speed Bump in China

Source: LinkedIn.

Sooner or later, this was bound to happen. After LinkedIn (LNKD.DL) 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 (META 2.74%) and Twitter (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.

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.