LinkedIn Corp (LNKD), a leading provider of social networking for working professionals, saw its share price plummet 43% after it reported fourth-quarter earnings. The drop was sudden and dramatic, with LinkedIn stock falling 84 points to $108 per share in a single day.
LinkedIn stock has recently settled around $118 — a far cry from its 52-week high of close to $270. There were many overly ambitious buy ratings in the mid-$200 range, and patience appears to have paid off for those waiting for a more compelling entry point.
That point may be here as LinkedIn’s best days are ahead of it — cash flow is soaring and should for many years to come. The adverse reaction to the earnings release easily qualifies as an overreaction.
Sales growth is decelerating, but it’s still high enough and well above what investors are likely to find elsewhere. The firm also has multiple revenue streams — this is unique among social media firms that rely solely on advertising for sales. It is also a rare, publicly traded pure play in the growing online recruiting market.
The Overreaction to LinkedIn Earnings
LinkedIn’s Q4 sales jumped 34% to $862 million, beating analyst projections. Earnings per share also handily beat expectations, jumping 54% to 94 cents per share. Yet, LNKD plummeted because management lowered its Q1 sales and profit projections.
The negative reaction by investors was way too short-sighted. The absolute level of overall growth continues to impress, but the market is worried that the trend is slowing.
Indeed, it was running at over 100% per quarter back in 2011, dipped to the 34% mentioned, and is projected to run at about 20% annually in the coming two years. Slowing sales yes, but cash flow trends are as robust as ever.
LinkedIn stock has three revenue streams to keep growth at a decent enough clip to propel the stock forward. And 20% is very respectable, especially considering earnings growth for the S&P 500 as a whole is projected by Goldman Sachs to be negative this year, which jives with what other market prognosticators are expecting.
Talent Solutions helps recruiters find and hire talented employees. This is essentially LinkedIn’s main business — it accounted for 63% of sales last year and grew 45% year-over-year. The namesake website’s network effect is a competitive advantage; the scale it has developed gives employers the ability to sift through millions of potential recruits and search their profiles, contact recruits and track important candidate activity. Divisional growth has been great: last year it grew 42%, down only slightly from 46% growth between 2013 and 2014, well above average industry growth.
Marketing Solutions lets companies and individuals market to LinkedIn’s user base. Advertising is the name of the game in this segment, with selling services and products key. The unit accounted for 21% of last year’s sales and grew 24% on a constant currency basis. As users stay engaged and increase in number, this segment will continue to do well.
Premium Subscriptions made up the remaining roughly 18% of sales and helps users market themselves to make professional contacts for their existing jobs, as well as seek new employment elsewhere. The top line grew 22% last year and is targeted for more investment to boost it further.
Three Heads are Better than One
LinkedIn stock counts Alphabet Inc’s (GOOG, GOOGL) Google, Facebook Inc (FB), Twitter Inc (TWTR), and Microsoft Corporation (MSFT) as key competitors. With the exception of Microsoft, which has a diversified software revenue stream and significant sales of its Xbox video game console, these rivals rely on online advertising revenue.
Don’t get me wrong — online advertising is growing rapidly. Consulting firm PwC expects it to grow 12.1% annually through 2019 to reach $240 billion. LinkedIn stock will benefit from this in the company’s marketing solutions segment.
But the majority of sales relate to online recruiting, which happens to be LinkedIn’s forte. Its growth is second only to Glassdoor. Indeed, Monster and CareerBuilder are other large players, but there is no way to directly invest in them. LinkedIn stock is a pure play, and it’s public.
Online employment market growth has been running slightly higher than advertising at closer to 15%. As I mentioned, as one of the leaders in the space, LinkedIn has been growing much faster than the overall industry and should continue to do so.
LinkedIn Stock: The Financial Picture
LinkedIn’s stellar sales growth should remain elevated for some time, but the income side isn’t the whole story. On a GAAP basis, LinkedIn lost $1.29 per share in 2015, its second consecutive year of operating in the red. Management touts EBITDA as a more accurate measure of profits, but there is a better one.
Cash flow is soaring.
Operating cash flow was $807 million last year, nearly double the 2013 total of $436.5 million. Spending to grow and maintain the business is hefty (but will decrease over time) and totaled $507 million last year. This left a little over $300 million in free cash flow, a clearer indication of a firm’s profit generation for shareholders.
On a per-share basis for 2015, this works out to free cash flow of $2.33. If I plug this into my discounted cash flow model and project it grows 35% annually for the next four years (an admittedly ambitious level, but it did just double over a two-year span), I calculate an intrinsic value of $130 per share, or 14% ahead of the current stock price.
My other inputs to the model include a 15% cost of equity, 3% terminal growth rate and expectations that growth slows from the 30%-plus rate to that terminal rate over 10 years, which is a rather standard rate for a company to see growth mature.
LinkedIn is a leader in its space, growing the top line respectably, and should see rapid cash flow growth. The share dip since February puts it in very reasonable territory to consider hiring some shares for your portfolio.
As of this writing, Ryan Fuhrmann was long shares of LinkedIn, Facebook and Twitter but did not hold a position in any of the other aforementioned securities.
