Friday, August 2, 2013

Linkedin in Q2, 2013 earnings (LNKD)

Linkedin reported Q2 results last night, and the results should be interpreted negatively considering that there is no improvement since the previous quarter.  This is an ongoing series of articles where each quarter I track LNKD's results in an effort to chronicle its eventual collapse.  Here was last quarter's article.

The one positive aspect of their results is that user growth and views was steady, and revenues were a few million higher than they told us to expect.

Real earnings vs. Adjusted EBITDA
Real earnings, GAAP net income, was about break even, and the same as last year: $0.03 per share.  The company, and analysts, like to focus on adjusted EBITDA instead of earnings, but depreciation is a real expense for the company as long as it will replace its computers one day, and the even bigger expense they "hide" through adjusted EBITDA is the massive stock based compensation.  Both its compensation program and depreciation are expected to continue, and they affect shareholders.  Only GAAP net income should be considered.

Of note, it had forecast a profit of 0 for the quarter.  With revenue of $16M higher than forecast, it only made $3.7M.  Another reason to consider only net income as relevant is that it is always possible to increase sales without making any money.  Income from operations was down 35% from 1 year ago.

Growth slow down
Year over year revenue growth dropped to 59%.  It was 72% the previous quarter, and 80% the one prior.  This type of slow down should be reason for a drop in stock market price.

Lowered guidance for rest of the year
The high end of its guidance for Q3 is for 48% year over year revenue growth.  The high end of their earnings expectations is a loss of $4M in Q3.  These are poor expectations that should reflect poorly on the stock price.

Linkedin lowered (slightly) its guidance for Q4 compared to guidance at the time of last quarter's results.  Previous top end revenue guidance was $1.46B, but after beating this quarter's revenue estimate by $16M, it raised its full year revenue guidance by "only" $15M to $1.475B.  Its forecast for Q4 is revenues of $413.7M is only 36% YoY growth.  Q4 top end expected profit is (Adjusted EBITDA is expected as $100M) $14.7M, with full year expected profit of $37M.  $14M of that profit will be from special tax rebates from Q1.

These are very poor forecasts compared to its valuation approaching $28B, and a very rapidly declining growth rate.

Under best scenario, LNKD is worth $10B ($90/share) in 10 years
If Linkedin is ever to deserve a market value of $10B, it will need to one day reach net income of $1B.  In 2023, that means 20 to 30 times its 2013 income.  To understand why that would be an exceptional success you have to ignore growth rates.  Using its peak growth rate, we could project that the roman empire would cover earth 20 bazillion times by now.

For Linkedin to triple its sales to $4.5B in 10 years would be a spectacular success.  Not only is that higher than the $3B total recruitment market estimated in 2011, which I addressed last quarter, there is a couple of other reasons to see it as a ceiling.

Jeff Weiner (LNKD CEO) said yesterday that the company has a 600 million user addressable market of knowledge workers.  That is its maximum number of users.  As of this quarter LNKD is already past the 1/3 point with 238M users.

MWW (Monster jobs) reported earnings in the morning, and though its revenue keeps dropping 10% YoY, it made 3 times the earnings of LNKD ($9M).  For what is likely the first time, LNKD's talent solutions revenue has surpassed MWW's revenue.  While its reasonable to hope that LNKD will continue to grow at the expense of MWW, that growth will get even more difficult and expensive.  If it already has half the market share, hoping that it can grow much more than double is too optimistic.

Even if it manages to increase sales 3 times, it would still need to increase profit margins another 6-10 times in order to successfully hit a $10B market value.  It would do so through some price increases, firing sales people, stopping its content purchases, user acquisition costs, server infrastructure, service improvements (development), huge stock compensation, and funding whatever mysterious force keeps their stock price up.

The problem that occurs for LNKD whenever it actually does make money, is that someone else can start a stock hype scam that offers recruitment services without making any money.  The someone else can be fired salespeople, and developers disgruntled they are no longer showered with stock option candy.

Its also possible to get an optimistic 3 times sales rate in 10 years by projecting LNKD's growth rate out.  A flat 30% annual growth from 2013 levels will hit exactly 300% in 10 years.  That is a reasonable projection of its ongoing growth decline.  Because LNKD has been spending so heavily to chase its existing growth profile, its hard to see it achieving these growth levels while also becoming profitable.

Linkedin's sales are almost 7 times what they were in 2010.  Its profitability this quarter was less than in Q2 2010, and its unlikely that next quarter will beat 2010 either.  Its fine to hope that the next 3x in sales growth leads to at least 3x income, but its hard to see LNKD's culture change to stop paying its insiders so much.  It needs to raise income by 30x, not just 3x, in order to justify a $10B market value.

Market reaction to results
All of the issues with LNKD's slowing growth (among others) were apparent last quarter, and the company provided no guidance of any improvement in the next 2 quarters.  After last quarter's results the stock fell to about $170/share.  So, there is no coherent explanation for it to trade near or over $200 after these results.

2013 may reach close to triple 2011 sales for LNKD.  Excluding the Q1 tax breaks it received, LNKD is projecting full year net income below that of 2011.  Just because it may beat low expectations doesn't mean its stock price should be rewarded when they are set that low, and fundamentally, we need to wonder what sales levels might lead to profitability.

DICE holdings
DICE (DHX) is also in the online professional communities business with a focus on recruitment.  It is about 1/7th the size of LNKD, but its Q2 profit was more than double that of LNKD ($8M).

The stock based compensation issue
LNKD had expected $49M this quarter, and came in just under that by less than $1M.  It expects Q3 stock compensation of $49M and Q4 of $52M.

The headline (non-gaap) earnings exclude these expenses and look better because of it.  But it is a cost paid by existing shareholders.  The $10B optimistic future market valuation worked out to $100/share just last year, when there were 100M shares outstanding.  Current shares outstanding are near 117M.  If somehow shares stop growing past 120M (around the end of this year), a $10B total value would mean $83/share.

There is reason to believe that stock based compensation will never come down.  Linkedin has a dual-class share ownership structure where only the insiders have voting power.  There is strong incentive to award themselves extra stock.  While the company is projecting stock compensation to grow slowly, this is still growth in stock compensation while the company's sales growth is rapidly declining.  The best we can expect from Linkedin's management is for stock compensation to plateau.