Shortly after LinkedIn, the popular professional networking site, went public yesterday morning, its valuation hit $9 billion, even though the company only makes $15 million a year in profit. Have we taken a time machine back to 1999? Is LinkedIn's rocket stock evidence of a new tech bubble, about to be inflated further by likely IPOs from Groupon, Facebook, Zynga, and Twitter? Or is this a reasonable valuation, given pent-up investor demand, the company's strong fundamentals, and its capacity to grow?
There's no doubt that a certain amount of impatient enthusiasm contributed to LinkedIn's spiraling stock price. The investment banks underwriting the deal had planned on issuing stock at $32 to $35 a share. Given investor enthusiasm, they decided this week to ratchet the price up to $42 to $45, ginning up even more excitement. When the stock went public yesterday morning, it skyrocketed, peaking at $122.70 before settling around $100, much to the shock of analysts.
LinkedIn is free for its 100 million users, white-collar professional types. The company makes money in three main ways. First, it puts paid advertising up on the site. Second, it charges individuals between $10 and $50 a month for "premium subscriptions" that allow them to do things like send a message to someone outside their professional network. Third, it charges about 4,000 businesses an annual fee, reportedly about $8,000 a year, to recruit new talent on LinkedIn. Last year, those revenue streams generated a perfectly respectable $15.4 million in profit on $243 million in sales.
But those numbers hardly justify the $100 share price or $9 billion valuation. Consider one of LinkedIn's Web 2.0 peers for the purpose of comparison. Zynga, the maker of the popular game Farmville, also has a reported valuation of $9 billion. But it expects about $630 million in profit on $1.8 billion in turnover this year—meaning it is making 40 times LinkedIn's profit on about 7 times LinkedIn's sales.
Of course, no one really thinks that LinkedIn is worth $9 billion. Analysts calculated the valuation by taking the share price (about $100) and multiplying it by the number of shares (about 88 million). But there are not actually 88 million shares of LinkedIn available. The company put about 8 million shares up yesterday morning, holding about 80 million common shares off the market. It restricted supply. Given the extraordinary investor demand, that meant a very high stock price and a very high implied value.
Jack Hough at SmartMoney worked through the numbers using traditional valuation metrics. He based his findings on the company's initial stock price of $45 and valuation of $4.3 billion. That gave LinkedIn a price-earnings ratio of 275, versus a market average of just 15. (At $100 a share, the p/e would be around 600.) But the-price earnings metric might not be the right one to use. Young, growing companies often have low profit margins that soon expand, particularly after they raise capital from the market. The company's price-sales ratio, a better yardstick, is 14.7, when judging by the $45 price. That makes LinkedIn the most expensive stock in America even before the $100 a share value.
Perhaps investors believe that LinkedIn might start growing and expanding its profit margins rapidly. Perhaps they believe that LinkedIn is ripe for takeover. But it seems unlikely. LinkedIn's IPO is obviously about a lot more than LinkedIn. Investors are salivating at the idea of pouring money into, and making money from, new social-networking and dot-com companies. The stream of analysts' notes reacting to the sale mention Groupon and Facebook and Zynga and Twitter just as often as they mention LinkedIn. Relatively few tech companies are planning IPOs, meaning investors are all the more excited about the few that are.
Put simply, LinkedIn's big stock price is in no small part due to the fact that investors are excited about other webby, social companies. If that sounds like irrational exuberance to you, well, that's because it is. But it does not mean that we are returning the big tech bubble that we had in the 1990s. LinkedIn is only one company, and one crazy IPO does not a bubble make.