Thursday, May 19, 2011

Valuing young growth companies: A postscript on Linkedin

So, that was quite an opening for Linkedin.. The stock opened in the mid-80s, almost double the offer price. I know that some of you have used the model that I attached to my last post to value Linkedin on your own and that was exactly my point. None of us has a crystal ball that shows us the future and your estimates are as good as mine.

However, since we are on the topic of young growth companies, here is what I see in the base year numbers for Linkedin, as contrasted with Skype:
a. Linkedin is at an earlier stage in the life cycle that Skype. It revenue growth is more explosive (100% growth last year: Revenues grew from $120 million in 2009 to $243 million in 2010) than Skype's revenue growth in 2010 (20%).
b. Linkedin is already profitable. It reported pre-tax operating income of about $20 million in 2010. In contrast, Skype is still losing money.

Now, here's where the subjective component comes into play in the forecasts:
a. Revenue growth: You may disagree with me on this one but I see a smaller potential market for Linkedin than I do for Skype. While at least in theory, Skype could compete for the much larger wireless telecom market, Linkedin has a narrower focus. To provide perspective, Yahoo's total revenues in 2010 were $ 6 billion and I have a tough time seeing Linkedin generate revenues as large, even ten years from now.
My projection: 50% compounded revenue growth for the next 5 years, scaling down to 3.5% in stable growth. Revenues in 2021 will be about $ 5 billion.

b. Operating margins: I see margins falling somewhere in the middle of the range for companies in this space: Google at the top end and Yahoo towards the bottom. Competition in this space is much fiercer and the barriers to entry seem small.
My projection: Pre-tax operating margin of 15% in 2021, rising from the current margin of 8.23%.

c. Survival: The company has little debt ($2 million), enough cash on the balance sheet ($92 million) with more coming in from the IPO.
My projection: I am going to assume that there is a 100% chance that the firm will survive, though I am not sure how successful it will be.

The valuation, with these inputs, yields a value per share of $47 and I think that that number is at the upper end of the spectrum. So, the original offer price of $43 does not sound unreasonable... As for the current price in the mid-80s, I am glad I don't have it in my portfolio. (Update: It gets worse. There are two classes of shares outstanding and if you incorporate both, the value per share that I estimate drops into the twenties.. I have updated the spreadsheet as well..)

As with the Skype valuation, here is my Linkedin spreadsheet. Make your own best estimates.... and good luck...


26 comments:

M Miller said...

thanks for posting this. Is your share count (43.31) correct? The 2 shr classes make it confusing, but i was thinking it was 94.5mm?

Rafa Tudela said...

Prof. Damodaran,

Many thanks for posting this, indeed.

I believe that one added benefit from the IPO (or a qualitative analysis of the optimistic figures) is that going public underpins the 'brand'.

Facebook, LinkedIn, Google ... are somewhat natural monopolies imho.

So once these companies are public, they benefit from the first moving advantage: brand awareness, lower cost of capital, economies of scale... and make it harder for competitors to rival with them.

... but this is already reflected in the valuation (sustained margin, etc.

Thanks again Prof.
cheers everyone

Mike said...

Prof, thank you for the post.

Are you a proponent of rational market?

I am sure the Linkedin share price will fall. If I short this stock, do you think the price will come down before I become insolvent?

richard tucker said...

thank you Professor (even with your spreadsheet I couldnt have done this... its the thinking and rationale behind the inputs which obviously key... and why i have more to learn).

Anil Bains said...

Hi Professor,

I had a problem knowing the exact no of shares outstanding, I know equity value is relevant no though but still. Can you please explain how you took the number 94 million. It's a serious problem I have encountered in lot of IPOs.Please explain it sir!!
Regards
Anil Bains

Aswath Damodaran said...

The number of shares was a little murky until yesterday. It was specified in the prospectus, but the public sites (Yahoo! Finance, for example) were reporting only the number in one class. Lesson learned. Always go to the source.

Aswath Damodaran said...

Rafa,
There are no natural monopolies in this business. Only a period of advantages that fades. Think back. At one time, Yahoo! was considered in the same vein as Google. As for Linkedin, way too early to make any judgments about monopoly power.

Anil Bains said...

Dear Prof,

Still didn't get it..what's the source for indian retail investor in the case of linkedIn (perhaps S-1)??
But I couldn't derive the number (94 mn from S-1)

Regards

M Miller said...

Anil, it's in the S-1, on page 8:

"Total Class A and Class B common stock to be outstanding after this offering
94,498,627 shares "

Anil Bains said...

Miller, pls correct me if i am missing something...

Total Reedemable Convertible Preferred Stock=10.9mn(C+D)
Convertible Preferred Stock=34.6 mn
Common Stock=42.8mn
Total stock= 88.3mn

M Miller said...

anil, the numbers u posted are the pre-IPO share classes/amounts. The post-IPO (pro-forma as adjusted) share counts = 94mm (class a, class b). compare the 'actual' vs. 'pro-forma as adjustd' on page 36 of the s1

richard tucker said...

@MIke and perhaps an interesting observation on non availability of shorts and put options on LNKD price: http://blogs.wsj.com/marketbeat/2011/05/19/linkedin-helped-by-lack-of-shorting-put-options/

Maarten said...

Thank you professor for the posting. One question: The amount of 90m of cash seems to me a bit low as their target was to raise around 175m. I know that especially in the light of the current market valuation it does not really make a difference to the conclusions one can draw from your valuation. But when valuing a company in an IPO setting what method do you use in assessing this cash number.

Regards,

Maarten

Aswath Damodaran said...

The cash balance is prior to the IPO. The cash raised on the IPO will augment this amount. They will have a lot more than $175 million when all is said and done.

Shruti said...

Can someone please clarify the calculation for the terminal 'Reinvestment' number (M7).

ETFGuru said...

I am looking for guest lecturers to take a session on fundamental analysis and valuation. The ideas is to cover one valuation example in the first half of the session. This will be followed by an overview of the equity research process, latest developments, news or recent trends in the industry.

ntss2000 said...

Hi Professor,

LinkedIn's S-1 mentioned that it will offer 7.8million class A stock and there are 86million class B stock which will be kept.

How did you get 43.31 as the initial # of shares? I thought it should be 7.8million?

Aswath Damodaran said...

You cannot divide the value by just the shares offered, but by the total number of shares outstanding... The initial number of 43.31 has been replaced by the 94.5 million shares outstanding.
The terminal reinvestment is a computed number, based upon the growth rate forever and an assumed (high) return on capital forever.

Bogus Person said...

While we're on the subject, did you see the report from Jarrow et. al. at Cornell? Their model showed $LNKD in a "bubble" based on real-time data.

http://meb.tw/loYBD3

presentvalue said...

What is the rationale for multiplying EBIT by 1-t when allowances for on past and future investment will likely result in no taxes being paid for some time?

Aswath Damodaran said...

Linkedin claims to be making money and paying taxes.. Unless they are lying, any operating income that they generate will be taxed.

Paulo said...

Hi professor, were you able to take a look at most of the sell side research, which initated today (BofAML, JPM and MS). They are quoting PTs in the range of $85-90/share, based of multiples of ~50x EBITDA. Even adjusting them for growth, they are quite high... or would I say expensive. Do you think a company like LNKD deserves such high EBITDA multiples for 2013??

Alice said...

Can you please explain how you took the number 94 million. It's a serious problem I have encountered in lot of IPOs.Please explain it sir!!
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navaneedh said...

interesting blog. It would be great if you can provide more details about it. Thanks you





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Anonymous said...

LinkedIn closes at $235.58 on August 2, 2013.

Where did you go wrong, Professor?

Anonymous said...

It would be a good exercise if prof. give us un update on LNKD valuation.

Stock is going to correct until 140, close to the value I got wih prof model.

Thanks