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LinkedIn IPO: An expensive and unproven venture

With initial public offering numbers like $25-billion (U.S.) for Groupon and $50-billion-plus for Facebook being tossed around, a valuation of $3-billion for LinkedIn Corp. looks downright reasonable.

After all, Groupon seems ephemeral and Facebook is for fun, but LinkedIn is for serious business - social networking and résumé-posting by more than 100 million professionals and corporate types.

Yet a look at LinkedIn's numbers suggests that its IPO, scheduled for this week, is going to feature valuations that are distinctly lofty by any normal standard.

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First, the basics: LinkedIn's 2010 revenue came in at $243-million. Profit was $15.4-million.

At the top end of LinkedIn's proposed offering range of $32 to $35, the company will have multiples of nearly 220 times profit. By comparison, the S&P 500 is trading at around 14 times its expected 2011 operating earnings.

Value investors looking for cheap stocks can bow out now. But what if you have an appetite for pricey growth stocks and are willing to buy into what could be one of the dominant companies in the social networking space?

The first challenge is to get a handle on LinkedIn's expected growth rate. From 2009 to 2010, revenue increased by 102 per cent and income increased by 487 per cent.

The question is how sustainable those growth rates are now that LinkedIn's audience already spans much of corporate North America. A look at the risk factors in the company's prospectus provides an interesting warning. There, the company acknowledges that the number of its registered members is higher than the number of actual members because "some members have multiple registrations, other members have died or become incapacitated, and others may have registered under fictitious names."

Certainly, this is a problem for all social networking sites; LinkedIn's warning that "we do not have a reliable system to accurately identify the number of actual members" will probably be found in other social media companies' disclosures if they choose to go through the IPO process.

Big Risk

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But another portion of this risk factor is unlikely to be found in a future disclosure from, say, the heavily-used Facebook.

LinkedIn says "a substantial majority of our members do not visit our website on a monthly basis, and a substantial majority of our page views are generated by a minority of our members." If the company can't "increase the breadth and frequency of our visiting members," it acknowledges, then its growth will fall short of expectations, and its profits and stock price will follow.

The 2010 results, broken down on a per-member basis, show that LinkedIn brought in just over $3 in revenue and recorded about 20 cents in profit per member in 2010.

Here's the problem: Most of the company's revenue comes not from the members themselves, most of whom opt for free usage of the site rather than a more expensive premium subscription. Instead, the company brings in most of its money from corporations that use LinkedIn as a recruiting or marketing tool.

LinkedIn says it believes its offerings, in which companies can use the user profiles to identify both active and passive job candidates, are cheaper than traditional recruiting firms.

For LinkedIn to keep these corporate customers happy, it is likely to need to provide a user base that's more active than what it's describing.

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In the short term, the company's profitability is going to get worse before it gets better. LinkedIn says it will "invest heavily" in product development this year and "aggressively expand" its field sales staff, and it forecasts a 2011 net loss of unspecified size.

There is another area of concern: The company plans to maintain a dual-class voting structure, so investors who buy the roughly 10 per cent of the company that will be up for sale in this week's IPO will get just one vote per share, compared to the early owners' ten votes per share. As a result, new investors will have minimal voice in the company's governance.

Now, to be fair, LinkedIn is the undoubted category leader for professional social networking. While it's possible that other big concerns - Google, Facebook, et al. - could begin to step into LinkedIn's space, the company has a clear head start.

Will buying the stock provide long-term gains, however? Only investors with a healthy appetite for risk should consider linking up with LinkedIn.

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About the Author
Business and investing reporter and columnist

A business journalist since 1994, David Milstead began writing for The Globe and Mail in 2009. During eight years at the Rocky Mountain News in Denver, Colo., he individually or jointly won nine national awards from SABEW, the Society of American Business Editors and Writers. He has also worked at the Wall Street Journal. More

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