Monday, June 16, 2014

Is LinkedIn's Business Model Already In Need of Repair?

Above are two charts of stock.  The weekly chart (top chart) shows that prices topped at 257 about a year ago, but have since been moving lower.  The daily chart (bottom chart) shows the last year's price action in more detail.  This is a classic bear marker chart of lower lows and lower highs.  Stock holders overwhelm the market, sending the price lower.  At some price level, buyers see the stock as attractive and bid it higher but can never attain sufficient bullish momentum.  Key to the top chart is that prices are now below the long-term EMAs.  Key to the lower chart is that prices are below the 200 day EMA which is also moving lower. 

Clearly, the markets have determined that a high price for this company is not warranted, and they are thereby sending prices lower.  The question now is, what have the markets figured out?  The answer is simple: despite the glitz of the website, LinkedIn is really nothing more than a glorified  And while their user base is now growing and will continue to grow as they expand throughout the world, the website will eventually saturate the HR job search market and be unable to print solid earnings growth.

First, like most professionals, I have a profile on LinkedIn (you can see it here).  And I've had several conversations over the last few years where I have been asked to send people a link to my profile, largely for validation.  This behavior is encouraged by the company which says it has three goals for users: 

1.) Managing and sharing who they are through their digital professional identity;
2.) Engaging and expanding who they know through their professional network; and
3.) Discovering professional knowledge and insights making them better at what they do.

I, like many other people, have done number 1 and found it a pretty valuable service, although not central to my business development.  I've also expanded my contacts a bit through the network, but probably not to the degree the company had hoped.   I've personally heard mixed results from other professionals on this topic; some say their contacts have increased, others not.  As for discovering new knowledge, I belong to over 40 groups, but there are really only 3-5 that are meaningful; the rest just don't add much to what I already know.

However, also note a key point of the above three activities: LinkedIn derives no revenue from them.  So, in using their platform the way they want me to use it, I'm not helping them make any money. 

The company earns revenue from three sources:

1.) Talent Solutions: We provide access to our professional database of both active and passive job candidates with LinkedIn Recruiter, which allows corporate recruiting teams to identify candidates based on industry, job function, geography, experience/education, and other specifications. 

Translation: LinkedIn has created a series of algorithms that allow talent recruiters to search through their users to find "active" and "passive" job candidates.  Top line revenue from this service increased from $261 million in 2011 to $860 million in 2013.  This is a good increase.  However, a large percentage of that comes from the US market, which accounted for 67% of gross revenues in 2011 and 61% in 2013.  But the number of US users is already at 94.1 million.  According to the latest BLS employment report, the US civilian, non-institutional population was 155 million.  That means 60% of the US labor force is already on LinkedIn.  You've got to wonder if the company is already near saturation in the US market, as the other 40% may not be in an industry that requires a LinkedIn profile.  And assuming that to be the case, the company needs to expand into other markets.

Looking at Europe, according to Eurostat, the euro area 17 has a total population of 331 million, 67% who are employed, bringing the total employed population to about 221 million.  LinkedIn Currently has 85 million members in the EU region, so there is the potential for growth.  But the efficacy of this platform is in question with an unemployment rate at 11.8% and growth close to 0% growth.  And then there are the much more stringent EU employment laws to deal with, which could hinder LinkedIn's overall efficacy.  This explains why the EU region has only accounted for 21% of Linked in revenue from 2011 and 23% in 2013.

And the Asian market only accounted for 5.5% of revenue in 2011, increasing to 7.7% in 2013. 

Either LinkedIn needs to figure out how to increase their revenue penetration in the EU and Asia, or they're looking at some revenue containment within 3-5 years based on simple demographics.

There are two other ways the company earns revenue -- add placement and premium subscriptions.  However, ads have provided a declining amount of revenue as it was responsible for 30% of earnings in 2011 and 24% in 2013.  This could become a much more fertile revenue source if properly developed, especially considering the large number of users.  However, the company hasn't really developed this yet.  Premium subscriptions consistently account for 20% of earnings.

So, from a business model standpoint, the market has probably figured out the company may be approaching saturation in the US with little help for additional market development from the EU or Asia.  While there is the possibility of ad revenue, the company hasn't really developed this in a significant way.

Financially, the company is in fine shape.  Cash generated by operations has increased from $134 million in 2011 to $436 million in 2013.  This cash burn more than pays for PPE expansion, which accounts for 46% to 66% of net cash.  This means the company has been putting its funds to use in investments to earn a higher return.  The company is extremely liquid, and has a book value of $2 billion. 

In short, the company has the financial capabilities to change direction or try different ideas out in order to keep revenue growth going.  As mentioned above, the best option here is to really up their ad revenue in some way.  But, until they do, the market will probably question the company's long-term viability given their near saturation of the US market and the different and perhaps harder to develop international markets.