Be Careful With LinkedIn
Shares of LinkedIn (NYSE:LNKD) bounced on Friday after the company reported revenues and earnings that beat analyst estimates. The company reported double-digit growth in all three business segments, as total revenues increased 35% for the quarter. Talent Solutions (63% of revenues) grew 41% thanks to increased spending from enterprise customers. Marketing Solutions (19% of revenues) increased 29%, reflecting sponsored content growth of 80%. Finally, Premium Subscriptions (18% of revenues) grew 22%, reflecting strong growth in the company’s Sales Navigator platform. With shares up nearly 14%, the company now trades at a forward P/E of 30, compared to 31.3 for Facebook (NASDAQ:FB), and 17.9 for Twitter (NYSE:TWTR). LNKD’s strong performance across each business segment is a testament to the company’s wide economic moat. But while the company’s entrenched competitive advantages reduce certain downside risks, it is difficult for us to recommend LNKD at these levels, particularly when a recession looms on the horizon.
Figure 1: Price Graph
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LNKD benefits from powerful networking effects. With more than 400 million users, LinkedIn is the world’s largest professional social networking site. As the number of user profiles increases, employers spend more on LinkedIn’s Talent Solutions services to find job candidates. Recruiters can more efficiently source candidates using targeted searches that match certain skills or experiences listed on an individual’s profile. Advertising also becomes more valuable as businesses can create targeted ad campaigns thanks to the wealth of user-data available on the website. The greater the number of users on LinkedIn, the more important it is for professionals to join the online network. It is much easier for a candidate to reach out to a recruiter or a fellow professional on LinkedIn than it is to attend a job fair. A LinkedIn profile is now considered to be essential to the advancement of one’s career. We believe the sheer size of LinkedIn’s network makes it unlikely that another firm will be able to compete in the niche professional social networking space.
Figure 2: User and Sales Growth
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Source: Statista
By focusing on the professional worker, LinkedIn has created a wide moat that protects against competition from other social networking sites, namely Facebook and Twitter. Because users like to maintain separate professional identities, competitors will have a difficult time launching professional networking extensions to their core services. While people use Facebook to casually share photos and thoughts about their everyday lives, LinkedIn users carefully mold their profiles to project a professional identity. Since most social networkers are adverse to the idea of blending their professional and social lives, we believe this creates a floor for the number of users on LinkedIn, and makes it highly unlikely that LNKD will lose out to other networks.
LinkedIn’s competitive advantages may shield the firm from other competitors, but they certainly do not make the company recession proof. If anything, LinkedIn is highly exposed to an economic downturn since the company’s revenue depends on business profitability and job creation. LinkedIn is yet to endure a recession, and the US economy is long overdue. The majority of data being released suggests we are on the brink of a recession if not in one already. Only the jobs numbers suggest otherwise. But look beneath the surface, and you realize that the “strong” job numbers are actually weak. Unemployment is low because of record-low labor force participation, and the number of new jobs being added is distorted by the fact that companies are firing full-time workers and replacing them with more part-time workers. This is exactly what businesses do to prepare for recession: they reduce worker hours and refrain from making long-term commitments to full-time employees. Thus, the true nature of the jobs data reinforces, not contradicts, the notion that we are headed for recession. And LinkedIn is particularly at risk. Most of the jobs being added are for minimum wage, service-sector roles such as desk clerks and table bussers, not the white-collar, high-skill office jobs upon which LinkedIn’s network is based.
Since 2009 LinkedIn has grown revenues at a 71% CAGR. Over this period, gross margin improved from 78.5% to 85%, but has contracted in each of the past three years as a result of increased spending on network infrastructure. Operating profitability has fallen in tandem since 2012, and LNKD reported an operating loss equal to 5% of revenues in 2015, the company’s first operating loss since 2009. It will be difficult for LNKD to maintain double-digit top-line growth in a recession, which would radically slow user growth and advertising spending. In such a scenario the company would likely pursue riskier investments to achieve growth, with a greater likelihood of jeopardizing profitability. Thanks to high operating and financial leverage, LinkedIn has significant margin upside potential. But the company will struggle to realize it if revenues do not grow organically. Furthermore, this leverage increases the risks associated with recession and diminishes the pricing power afforded by the company’s wide moat.
At a price of $128.93 and a forward P/E above 30, LinkedIn is too expensive given the uncertainty surrounding the next economic downturn. We like LinkedIn’s business model and believe it has some of the strongest competitive advantages in social media. But we do not like LinkedIn during a recession. Long-term investors purchasing at current levels are playing a dangerous game and ignoring key economic indicators that suggest end-market fundamentals are deteriorating.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.