Flipping through the current issue of Forbes – “Get Rich from Obama” is the cover – I find money manager James O’Shaughnessy saying LinkedIn Corp. is his top “sell” recommendation for the President’s second term. Says Forbes: “No matter how he looks at the numbers, LinkedIn … is overpriced. The stock trades at 600 times trailing earnings and has a price-to-sales ratio of 12.75.”
I get it. I’ve been there. In advance of its 2011 initial public offering, I said LinkedIn Corp. was expensive at $35 (U.S.). It hit $122 its first day, never traded below $55 and now sits over $100.
Since then, I’ve gotten a little soft on companies with price-earnings ratios over 100. (See my column on Facebook). And I’ve been wary of doubling down and telling people to avoid LinkedIn at the new, higher prices.
I may even suggest you consider buying, as hard as it is for you and me to believe. And in doing so, I’m getting a little help from Henry Blodget.
Mr. Blodget, chief executive officer and editor of the Business Insider website, recently penned a piece, “By The Way, LinkedIn’s Profit is Going to Explode.” It was driven by comments by LinkedIn CEO Jeff Weiner at Business Insider’s “Ignition: Future of Digital” conference.
Part of the bullish case is noting LinkedIn, on which users post résumés and other career information, now has 187 million members. It is adding a new one every two seconds, and plans to keep going until it has all the world’s 3.3 billion professionals online. (It will fall short, of course, but by how much is unclear.)
Mr. Blodget points out that all the money LinkedIn is spending on sales and marketing and IT to grow internationally is depressing the company’s profit margins and misleading investors about its earnings potential.
LinkedIn has gross margins – revenue minus its cost of goods sold – of 85 per cent. Facebook Inc. and Google Inc. have gross margins of 75 per cent and 65 per cent, respectively.
That suggests, Mr. Blodget says, that LinkedIn should be able to achieve at least the 30 per cent operating margins that Facebook and Google are posting, and perhaps 40 per cent or 50 per cent, rather than the paltry 2 per cent margin it currently records.
Mr. Blodget didn’t do this math, but I did, with an assist from Standard & Poor’s Capital IQ:
LinkedIn posted revenue of $836-million in the 12 months ended Sept. 30, a 92 per cent gain over the prior year. If revenue increases at a similar rate each of the next two years, and operating margins rise to 50 per cent in the 12 months ending in September, 2014, LinkedIn would post nearly $1-billion in net income, assuming normal tax rates.
Want to be more conservative, yet still bullish? Assume 80 per cent sales growth in the next 12 months and 70 per cent in the year after that. Plug in a more modest 30 per cent operating margin in 2014, and you get $500-million in net income.
LinkedIn posted just $17-million in profit in the last 12 months. Getting to either of those numbers from $17-million counts as “explosive.” And it helps explain why the company has a market capitalization of more than $11-billion.
Now, you are either a reader who knows who Henry Blodget is, or needs to have it pointed out. Mr. Blodget was one of the star analysts of the Internet bubble, working first for CIBC Oppenheimer and then Merrill Lynch. Having published research at odds with his private opinions on the stocks he covered, he settled fraud charges with the U.S. Securities and Exchange Commission and is banned from the securities industry.
So you may dismiss him and his bullishness as an unfortunate reminder of the ill-fated tech euphoria. And, to be fair, I’ve out-Blodgeted Mr. Blodget with my own hypotheticals, suggesting numbers that are beyond what most sell-side analysts seem to suggest for LinkedIn’s future.
I think the scenario shows, however, that people aren’t paying a 600 P/E for LinkedIn because they want a company that made $17-million last year. They’re paying it to get on a path to $1-billion in profits not so long from now.
For sure? No way. LinkedIn at $100 is still very risky. I’m not going to do it. But am I going to call you foolish if you buy the shares? Not any more.