LinkedIn May Be About to Disappoint Investors for the First Time

(This is a highly-abbreviated version of a full SumZero report republished with the author's consent)

Contributor: Chris Moreno, CFA.
Firm: Undisclosed.
Location: New York, NY.

Recommendation: Short Shares of LinkedIn (Nasdaq: LNKD)
Timeframe: 1 to 2 Years
Recent Price: $103.79
Target Price: $48.00
Strategy: Special Event

Disclosure: The author of this report had an active position in this security at the time of its posting.

Quick Thesis:
LinkedIn’s valuation is unsupportable—it trades at 17x revenue and 83x EBITDA on a TTM-basis; the firm’s competitive moat is overstated as Silicon Valley is littered with displaced first-movers (e.g. Myspace, Yahoo!, AOL); and even if I assume continued exceptional top-line growth, pricing power, and massive margin expansion, the firm is still trading well above intrinsic value in my most bullish scenario.

But none of this matters until there’s a crack in the growth story as growth stocks can trade well above intrinsic value for a very long time as long as they continue to surpass expectations. I believe we’re about to see LinkedIn’s first crack with 2Q earnings. I expect the firm to report revenue growth in line with its guidance and consensus for the first time in its public history.

Given its past streak of large beats, I believe this will be viewed as a disappointment and will refocus analysts on the firm’s fundamentals. A “miss” has the compounding effect of causing both momentum players and fundamental (but growth-oriented) analysts to reevaluate their investment thesis and could put significant downward pressure on the stock. I estimate the intrinsic value of the stock to be $48 (54% below the current price) and recommend investors initiate a starter short position at current levels.

Central Points
**LinkedIn's Valuation Assumes Long-term Exponential Growth, Massive Margin Expansion, and no Pricing Pressure.
**The Competitive Moat Is Overstated
**Growth Decelerating
**FCF/Shares Estimates Are Overstated
**Insiders Are Selling and Poised to Sell More

*Near-term Catalyst: Revenue Growth Could Disappoint in 2Q for the First Time Since the Company Went Public.
Over its admittedly short history as a public company, LinkedIn has consistently under-promised and over-delivered. Over the last three quarters, the firm has delivered revenue beats ranging from $12mm to $16mm vs the guidance mid-point.

While the Street on average comes in slightly higher than the high end of guidance, analysts seem unwilling to truly make independent estimates that differ from management’s guidance. Over the last few quarters that has produced solid headline top-line beats of $9mm to $16mm and the stock has generally reacted very positively to these beats.

*Investment Technology Group (ITG) Has a Better Track Record of Projecting Revenue & It Sees a Miss Coming
ITG has generally done a much better job at forecasting revenue and three of the last four quarters was within $6mm of the final number. The consensus number has always missed by more than $6m. The firm is currently forecasting $214mm for 2Q12, which is below the high-end of guidance ($215mm) and below current consensus ($216mm). To be fair, ITG’s current estimate only incorporates data through May 31st and is subject to revision post-quarter close and historically, they have generally revised their estimates upwards.

*A Revenue "Miss/Disappointment" Could Reverse the Stock's Positive Momentum
Given that the firm’s valuation is already disconnected from fundamentals, valuation is unlikely to matter until there is a crack in the firm’s growth story. I believe a revenue miss could very well provide that crack and get investors to focus on the firm’s potentially unsupportable valuation. What’s nice about the current situation is that the buy-side has likely grown accustomed to beats and so if I’m wrong, the stock won’t necessarily pop, but if I’m right, we could see a very serious correction in the name, basically an asymmetric risk profile.

*The Final Piece of the Mosaic: Anecdotal Evidence
While I certainly acknowledge this is just anecdotal evidence, as a LinkedIn user, I have received two different emails from LinkedIn asking me to become a premium member for 50%-off. I received both of these emails in the second half of June and while it certainly might be coincidental, I’m inclined to believe that it may be a last-ditch effort by LinkedIn to juice revenue in the last 15 days of the quarter. The fact that the offer expires on June 28th, further deepens my suspicions. Keep in mind that management may have been distracted by the recent security breach, which may have resulted in them taking their eye off the ball.

I further believe that competition poised to accelerate, as apps on FB, direct international competitors, web-based job sites, and micro-specialized career social networks (e.g. SumZero) and traditional job boards are unlikely to yield the career space without a fight.

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