Why I'm Buying LinkedIn
I've written before about how this is the year the Internet IPO returns.
Well today LinkedIn is going public. And it will be a doozie. In fact, at $45 per share they have priced at the top of their price range.
This values the company at $4.25 billion. However, even with the lofty valuation and the real risks, I plan on buying LinkedIn (LNKD) stock today and over the next couple of weeks as the stock fluctuates. Here are the main reasons:
1. It is a True Network Effect Business - LinkedIn becomes more valuable the bigger it gets. Not only to the members themselves but more imporantly, to recruiters. The larger the talent pool is, the more valuable LinkedIn is for finding potential job candidates.
2. The Market Opportunity is Enormous - LinkedIn is in one of the largest and untapped markets. The worldwide talent acquisition market is estimated to be at $85B. And the hiring solutions market is estimated to be at $27B. Compare this to LinkedIn's ~$100mm revenues from "Hiring Solutions", and you see their market penetration is very small. So there is a lot of room for LinkedIn to grow.
Moreover, as the chart from SAI below shows, hirings solutions is LinkedIn's fastest growing business (see point #1 as to why).
3. It is Becoming a True Platform - LinkedIn is slowly becoming a true platform. Just as Facebook and Twitter have done, LinkedIn is creating a platform that allows their data to be accessed by 3rd parties via APIs. As the company has matured, so has their APIs. This should open up all sorts of possibilities to other developers and solidifies LinkedIn as the Internet's "professional graph."
Platform companies are very rare. As LinkedIn becomes more ubiquitous around the Web, the platform will start to manifest itself in the financials eventually.
4. Valuation is More Reasonable at a Second Glance - As this anonymous institutional money manager explains, LinkedIn's valuation is much more reasonable when viewed in light of these platform / network effect / hyper growth companies (hint: see OpenTable):
To account for the rapid growth, we need to look out a few years and see where earnings can be to derive a target for the stock in a few years. It seems that the industry expects the company to generate over $950m in revenues, EBITDA margins near 25%, and EPS of > $1 of EPS in 2014. However, I think these estimates may prove conservative, as a company typically gives guidance to its bankers that it feels is readily achievable (so it is more likely to beat Street estimates).
Hence, I think that the company can probably do over $1b in revenues in 2014, likely still growing >20% for $1.2b in revenues for 2015. At a 27% margin (the company said long term margins should be > 30%), that would equate to ~$325m of EBITDA, EPS > $1.60 and FCF >$210m. Quality Software as a Service (SaaS) companies like Salesforce or Concur can trade anywhere from 5-7x forward sales. So with $1.2b in revenues in 2015, a 6x multiple would imply an Enterprise value of $7.2b in 2014 - adding in the cash and cash flow over that time and that would be a over an $8b equity value for >$80 a share 3 years from now. That would imply over 125% return from the IPO if done at $35. Similarly, applying a 50x forward PE multiple (reasonable as EPS should still be growing 50%+ at that point) to the EPS of $1.60 in 2015 would imply a target >$80 a share. Applying a similar free cash flow multiple would also support this level. Lastly, the top SaaS names can warrant a forward EBITDA multiple of 20-30x. Applying a 25x forward multiple would also derive a stock greater than $80 in 2014.
5. The 3 Largest VCs are not selling any shares - It should be a telling sign that the 3 largest venture capital investors are NOT selling their shares. Very little management is selling either. These folks are very experienced investors who are in it for the long haul - and so am I.
Summary. LinkedIn is a unique platform company with strong leadership that is executing well in a very large market. While LinkedIn's stock may look expensive in the short term, I think it is a great long term investment. The valuation is certainly lofty but I think it is one that LinkedIn will easily grow into.
