Jason Stipp: I am Jason Stipp for Morningstar.
LinkedIn had an IPO that started with a bang--up at one point a 135%. Investors obviously very excited about this company, but what is the real quality of the business and what is it actually worth?
I am here today with Paul Larson. He is an equity strategist and editor of Morningstar StockInvestor. He is going to dig into the details a little bit and give us his take on LinkedIn.
Thanks for joining me, Paul.
Paul Larson: Thanks for having me.
Stipp: The first question for you: Before we even talk about the stock price, I know the stock price is what's on everyone's mind today because it's just such a powerful runup, but before we even talk about that, I want to talk about the business of LinkedIn. It's got a narrow moat. What's behind that?
Larson: It is a good business at LinkedIn, and we do think it has an economic moat, a narrow moat at this point in time, and it's basically the network effect. And this is an effect where when you have a network, the value of the network grows exponentially with each node that you add to the network, and LinkedIn basically has that critical mass of people using the site, posting their professional information, and they are far and away the largest site in terms of users posting this sort of information, and they have that network effect, that critical mass that no one else is anywhere close to having.
Stipp: So I want to talk a little bit about some of their competitors, because Facebook also has a similar network effect of people putting profile information in there and having connections and being able to chat with each other, and check each others' profiles. Is Facebook a competitive threat here?
Larson: Well, they are certainly a competitive threat, but at this point in time I think Facebook would have to come out with a different offering than what they currently have, because what Facebook is, is primarily a social site, and LinkedIn is primarily a professional site. And as people we have different personas. We're different people on a Friday night, drinking beers with our buddies than we are on Monday morning when we’re wearing our suit and tie at work. And LinkedIn caters to that suit and tie professional persona, which you probably want to keep separate from your personal persona, which you're sharing with your buddies online. Facebook is primarily a social site, where you're trading pictures of the kids or the dogs or whatever, where LinkedIn is primarily professional, and I don't think those two networks are necessarily compatible.
Stipp: So they both have the network effect just for different parts of our lives. So I want to talk a little bit about how LinkedIn makes money. Because the network effect is obviously very powerful. One of the classic examples that we've talked about is eBay. For eBay, they take a little bit of that transaction, they take a little cut of that, and so the revenue model is very clear. But how is LinkedIn taking advantage of their network effect to actually generate sales?
Larson: Well, right now they are primarily an ad-driven site. They are more about driving traffic to the site and attaining users, and they are very early in their efforts to actually monetise all that traffic that they have. They also get a little bit of money from companies that can use the site to mine for information for recruiting purposes, but again this is also a very nascent business.
Stipp: So, we're still going to wait and see how much they are able to monetise the effect. I think there could be bit of uncertainty there. You mentioned that there is some aspect of job-hunting on the site. So is Monster (MWW) and CareerBuilder, are they potentially also rivals to LinkedIn?
Larson: They are potentially rivals in that they are both sites that are used for recruiting, but I think they are totally different business models because LinkedIn is primarily a peer-to-peer type site where the Monsters and CareerBuilders--these are more companies posting job openings. You don’t necessarily have that social networking effect like you have at LinkedIn
Stipp: So obviously a company that has a pretty good start here on the fundamentals of the business, but does it have a good enough start to merit over a 100% run-up on the first day of its IPO?
Larson: Well, the valuation at LinkedIn is very rich right now, and when you look at the expectations that are priced into the stock, they are very high. Our fair value estimate is well below the current stock price. We think the stock is worth $27, and the expectations priced in at $27, we're assuming that the stock is going to grow its sales roughly sevenfold over the next five years, and that its earnings grow 15-fold over what they earned last year, and these are the projections that are baked into our $27 fair value estimate. To get the stock to be worth $100 a share or so, you would have to assume something along the lines of a 25 times growth in sales over what they earned in 2010. Now this is going to be a high-growth company, that I'm quite confident, but again these hurdles are just so exceptionally high. I think the better bet is on the under.
Stipp: So how has their growth been so far, though, from what we know about how they've been able to grow their sales? Is it so impossible to think that they could have explosive growth going forward, or what's baked in for the next few years for us?
Larson: Well, I think they will indeed have explosive growth. In 2010 they more than doubled their sales, and we expect them to nearly triple their sales in 2011 as they ramp up some of the monetisation efforts that they have.
That said, this is a company where the growth is probably going to be very front-loaded. Like a lot of other dotcoms, this is a capital-light business model. It's not like they have to go and build all these brick-and-mortar stores around the country in order to achieve this growth. This is growth that is going to happen in a relatively short amount of time.
So I would expect, again, very high growth rates over the next couple of years, but then also this company to reach maturity fairly soon sometime probably within the next five or six years.
Stipp: Okay, Paul, so then my next question for you is, why has it been bid up so much? What's behind all of the optimism around this company?
Larson: Well, I think it is a dotcom with a real business model, and I'm getting a little bit of deja vu from the dotcom days here, and I think ... it's interesting that this is coming in advance of what we expect to be a Facebook IPO. This is sort of a preview regarding the excitement that surrounds Facebook, and I think some of the Facebook excitement is certainly rubbed off here.
Stipp: Some of the social media, I think, being able to get a piece of that, which hasn't really been available on a big scale quite yet?
Larson: Oh, absolutely.
Stipp: So, the last thing for you then, Paul, when you think of this broadly and how much excitement is generated over this IPO, do you think it's a bad sign for the market that people are just a little bit too excited, a little bit too exuberant, willing to take on just too much risk? Is this something that should be worrisome?
Larson: It is a little bit worrisome that the stock has gotten bid up so high, but then you could also spin this and say, "Well, it's also a good sign that investors have come out of the bunker mentality a little bit and are willing to take on a little bit of risk and get out of the negative real yield, fixed investments that are out there right now and willing to take a little bit of risk." So from that standpoint it's not necessarily all bad.
Stipp: So it could be a glass half-empty, glass half-full. It's an interesting one to keep an eye on anyway. Thanks for joining me, Paul.
Larson: Thanks for having me.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.
