Wednesday, February 20, 2013

Linkedin valuation issues

I've posted a couple of articles this week about the dangers of investing in companies where management holds a controlling interest and no dividends are ever likely to be paid.

In one of the articles, I highlighted specific concerns about Linkedin (LNKD), and that perhaps financial analysts, stock promoters, and the company face liability for promoting the stock considering the fact that there is no possibility for a minority shareholder to get any return without selling their stock to a greater fool.

Linkedin, though has published (in its 10k regulatory form) really the same warnings that I have made for it.  So, it responsibly acknowledges the risks of investment in it.  I am copying the relevant portion below (with some additonal bolding+underlining).

Risks Related to Our Class A Common Stock
The dual class structure of our common stock as contained in our charter documents has the effect of concentrating voting control with those stockholders who held our stock prior to our initial public offering, including our founders and our executive officers, employees and directors and their affiliates, and limiting our other stockholders' ability to influence corporate matters.
Our Class B common stock has 10 votes per share, and our Class A common stock has one vote per share. Stockholders who hold shares of Class B common stock, including our founders, and our executive officers, employees and directors and their affiliates, together held approximately 69.1% of the voting power of our outstanding capital stock as of December 31, 2012. Our co-founder and Chair, Reid Hoffman, controlled approximately 16.3% of our outstanding shares of Class A and Class B common stock, representing approximately 61.5% of the voting power of our outstanding capital stock as of December 31, 2012. Therefore, Mr. Hoffman has significant influence over the management and affairs of the company and over all matters requiring stockholder approval, including election of directors and significant corporate transactions, such as a merger or other sale of our company or its assets. Mr. Hoffman will continue to have significant influence over these matters for the foreseeable future.

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In addition, the holders of Class B common stock collectively will continue to be able to control all matters submitted to our stockholders for approval even if their stock holdings represent less than 50% of the outstanding shares of our common stock. Because of the 10-to-1 voting ratio between our Class B and Class A common stock, the holders of our Class B common stock collectively will continue to control a majority of the combined voting power of our common stock even when the shares of Class B common stock represent as little as 10% of the combined voting power of all outstanding shares of our Class A and Class B common stock. This concentrated control will limit the ability of our Class A stockholders to influence corporate matters for the foreseeable future, and, as a result, the market price of our Class A common stock could be adversely affected.
Future transfers by holders of Class B common stock will generally result in those shares converting to Class A common stock, which will have the effect, over time, of increasing the relative voting power of those holders of Class B common stock who retain their shares in the long term. If, for example, Mr. Hoffman retains a significant portion of his holdings of Class B common stock for an extended period of time, he could, in the future, control a majority of the combined voting power of our Class A and Class B common stock. As a board member, Mr. Hoffman owes a fiduciary duty to our stockholders and must act in good faith in a manner he reasonably believes to be in the best interests of our stockholders. As a stockholder, even a controlling stockholder, Mr. Hoffman is entitled to vote his shares in his own interests, which may not always be in the interests of our stockholders generally.

Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of us more difficult, limit attempts by our stockholders to replace or remove our current management and limit the market price of our Class A common stock.
Provisions in our amended and restated certificate of incorporation and amended and restated bylaws, may have the effect of delaying or preventing a change of control or changes in our management. Our certificate of incorporation and bylaws include provisions that:
authorize our board of directors to issue, without further action by the stockholders, up to 100,000,000 shares of undesignated preferred stock;
require that any action to be taken by our stockholders be effected at a duly called annual or special meeting and not by written consent;
specify that special meetings of our stockholders can be called only by our board of directors, the Chair of our board of directors, or our Chief Executive Officer;
establish an advance notice procedure for stockholder proposals to be brought before an annual meeting, including proposed nominations of persons for election to our board of directors;
establish that our board of directors is divided into three classes, Class I, Class II and Class III, with each class serving three-year staggered terms;

prohibit cumulative voting in the election of directors;
provide that our directors may be removed only for cause;

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provide that vacancies on our board of directors may be filled only by a majority of directors then in office, even though less than a quorum;
require the approval of our board of directors or the holders of a supermajority of our outstanding shares of capital stock to amend our bylaws and certain provisions of our certificate of incorporation; and

reflect two classes of common stock, as discussed above.
These provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management. In addition, institutional shareholder representative groups, shareholder activists and others may disagree with our corporate governance provisions or other practices, including our dual class structure and the other anti-takeover provisions, such as those listed above. We generally will consider recommendations of institutional shareholder representative groups, but we will make decisions based on what our board and management believe to be in the best long term interests of our company and stockholders. Our dual class structure concentrates the voting power of our stock in a small group of stockholders who would have the ability to control the outcome of a stockholder vote. Additionally, these groups could make recommendations to our stockholders against our practices or our board members if they disagree with our positions. Finally, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any “interested” stockholder for a period of three years following the date on which the stockholder became an “interested” stockholder.

We do not intend to pay dividends for the foreseeable future.
We have never declared or paid any cash dividends on our common stock and do not intend to pay any cash dividends in the foreseeable future. We anticipate that we will retain all of our future earnings for use in the development of our business and for general corporate purposes. Any determination to pay dividends in the future will be at the discretion of our board of directors. Accordingly, investors must rely on sales of their Class A common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investments.

The other issue I brought up in my analysis of Linkedin is a limit to the total recruiting market.  This is a similar concern to the analysis of OPENtable I provided 2 years ago (which dropped in value dramatically since that time).  The online job recruitment market has been estimated at $3B annually as recently as 2 years ago.  There is an irresponsible report out today that suggests it will grow to $369B in 2014, but it is necessarily irresponsible because it is not measuring recruitment fees, and likely estimating total salaries hired.  At a $500 fee rate, to earn $4B, LNKD would need to place 8M jobs per year.  At a $200/job fee rate, it would need to place 20M jobs per year.  Simple competition for LNKD is from which offers (including free) job search listings and postings.  The other reason I mention is that they list the current total US online job listings as 2.2M.  Assuming the world is 3 times the size of the US, and extremely optimistically assuming that the rest of the world pays as much in recruiting fees as the US, then if Linkedin were to get nearly the entire online jobs market and place 6M jobs per year at $500 fee per job, that would cap its recruitment revenues at $3B.  This is well below any possibility of justifying a current valuation near $18B.


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