Is the LinkedIn IPO a Good Deal

Among social networks, LinkedIn is a fascinating outlier.  It’s by far the largest professional network, and as such it personifies the debate over whether people want different networks for different purposes.  I think the answer is yes.  Both Facebook and LinkedIn are based on webs of relationships, but no degree of privacy controls or slapped-on features can turn Facebook into an effective business networking tool.  Perhaps I’m biased.  For me, Facebook is a place to socialize, while LinkedIn is a place to promote myself professionally.  Just because two products look similar, it doesn’t mean they do the same job.

Let’s take a closer look at LinkedIn now that the company is moving towards an IPO.

LinkedIn’s Economics

LinkedIn users should be much more profitable than general social networking users because both those users and people who want to reach them are more willing to pay for features.  According to comScore, LinkedIn had 26 million unique visitors in December 2010, which works out to revenue per user of over $9.  According to recent reports, that’s more than twice the per-user performance of Facebook.

So then why is LinkedIn, at $3 billion, worth so much less than Facebook at $70 billion or so?  It really boils down to size and profitability.  Facebook apparently made about $500 million in profits in 2010 off of $2 billion in revenue, while LinkedIn only managed $15.4 million on $243 million in revenue.  That’s a 25% profit margin versus a 6% profit margin.  As it turns out, a rough PEG (price/earnings/growth) ratio for the two companies shows that LinkedIn is valued over twice as highly as Facebook based on 2010 profits and growth!  That Facebook valuation is starting to look better.

What’s unclear is how much LinkedIn is investing in future growth and to what extent it’s simply in a lower-margin business than Facebook.  While individual Facebook users are not necessarily that valuable, the business as a whole appears to be an incredible profit machine.

Sales and Marketing Costs

What’s even more intriguing is LinkedIn’s Q1 2011 numbers.  Sales and marketing expenses went from 23% of revenue to 31%, and net income dropped from 6.3% in 2010 to just 1.4% in Q1 2011.  At first I was surprised at the big jump in expenses, but on further reflection, I don’t think this is necessarily a bad sign.  LinkedIn is in a large and relatively open market.  In fact, I can’t believe no serious competitors have cropped up.  That’s a story in itself.  Anyway, the firm is in land-grab mode.  Spending heavily on sales and marketing now to build greater barriers to entry (in the form of more registered users, data, and corporate customers for recruiting and marketing) makes sense.

Of course, that position assumes that there is no permanent shift towards a much higher cost to acquire and retain customers.  That is a potential concern.  LinkedIn’s channel mix is slowly shifting from online to field sales (up from 47% to 56% in the last two years), which according to the company’s disclosure is associated with a longer sales cycles and higher sales costs.  It does also result in higher average selling prices, so it doesn’t appear to be a significant concern yet.

However, it does illustrate the limits of LinkedIn’s virality.  Facebook has built a huge viral engine on photo tagging, newsfeeds, and social games, and the draw of professional connections is certainly weaker for the average person.  As an aside, there are of course limits to Facebook’s growth curve as well, with some claiming that Facebook penetration tops out at around 50% of the population in most countries.

Revenue Breakdown

The revenue breakdown by product also reveals a lot about LinkedIn’s future direction.  There are three product categories, hiring solutions, marketing solutions, and premium subscriptions.  Hiring solutions revenue grew 182% from 2009 to 2010 and now makes up 42% of the company’s revenue.  In contrast, premium subscriptions grew 35% on 64% growth in registered users.  Advertising growth fell in the middle at 107%.  Clearly, the average user doesn’t see much need for a premium subscription, while recruiters can’t get enough of LinkedIn’s services.  Companies tend to follow their most profitable customers, so I expect LinkedIn to start offering much more sophisticated recruiting solutions over time.  I’m curious to see how they fare against other up-and-coming recruiting companies like TheLadders, Indeed, and Simply Hired.

So Is It a Good Deal?

If LinkedIn didn’t exist, someone would have to create it.  The online resume and professional network are basic features of modern life, and LinkedIn has hitched itself to a new consumer behavior that will only continue to grow.  As an individual, I wish LinkedIn would provide more useful features, but as a hypothetical investor, I see an ongoing growth story in this company.  The question, as always, is how much one is willing to pay for that growth, and that’s one I have a hard time answering.  LinkedIn’s venture capital investors, Sequoia Capital, Greylock Partners, and Bessemer Ventures, made up of infinitely better investors than me, are sitting on their shares and not participating in the IPO.  That suggests they expect the value of the company to continue climbing sharply.


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  • http://twitter.com/clientonomy mac

    Good post.

    Outside of the statistics, Linkedin are in real danger of going off-track. If they do so, then they will be worth much less than currently quoted.
    For example, many Linkedin users now join to gain access to forums. However, months ago they encouraged many of these to become ‘open’. The result? Spam. Tons of it. Some forums are now nothing but spam.

    Many users of Linkedin are now becoming fed up with this. Facebook must be looking on and rubbing their hands in glee.

    Mac at http://Clientonomy.com

    Regards.

  • http://www.brekiri.com/ Greg4

    Honestly, I never found the groups that useful in the first place. They
    seemed full of people either selling services or pontificating to little
    effect. What did you like about them? I’d love to see LinkedIn do a better
    job of exposing very niche business knowledge. You’re right that opening up
    the groups is probably a step in the wrong direction, unless they introduce
    better moderation. Maybe they should use Facebook comments? ;-)

  • http://twitter.com/alokjs Alok Saldanha

     You have to push pretty hard on growth to get to the current valuation, we’re talking at least four years of 100% growth. You can check out a couple models here:

    https://www.trefis.com/comments?ticker=LNKD&shr=61

    or build your own:

    https://www.trefis.com/company?hm=LNKD.trefis&shr=61&from=share

  • Anonymous

    I don’t have any confidence in LinkedIn to achieve the quality product that will encourage mass use that will justify their insane valuation. Yes, millions of people have LinkedIn accounts, but the only real use it has is for unemployed people. If you have a job, there’s very little incentive to log in every day and use its features. Facebook has such devotion among businesses that there are even services such as http://facebook.popularfans.com that sell Facebook fans. What does LinkedIn do that also inspires such similar loyalty? Nothing. In conclusion, I have little confidence in LinkedIn right now despite so many user accounts they have and would not invest in that team right now.

  • http://www.brekiri.com/ Greg4

    Interesting site, Alok. I like the direction you’re going in. The slide shows from your first link unfortunately didn’t work for me. 

  • http://www.brekiri.com/ Greg4

    It’s clearly not just for unemployed people. Anyone who is in sales, who is raising capital, or otherwise doing network-related work is on LinkedIn a lot. But I do agree that they need to improve their core networking features.

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