LinkedIn IPO, Facebook IPO and Concerns About a Future Market Meltdown

LinkedIn's public offering last week saw its shares more than double on opening day in the largest IPO by an Internet company since Google's debut in 2004. In an article by Barrons reporter Andrew Bary on  May 21, 2011, Bary suggests that the LinkedIn IPO evokes images of the dot-com bubble of the late 1990s, when dozens of dubious Internet companies surged following their IPOs, often attaining multibillion-dollar market values, only to crash when they ran out of money or couldn't meet Wall Street's expectations. Bary calls this Bubble 2.0.

This is the first of a two-part series on the wild reception for the LinkedIn IPO and whether that bodes well for future public offerings of social media companies such as Facebook. The issue to be explored in my next blog is the advisability of maintaining the 500-shareholder limit imposed by the SEC on private offerings and advertising constraints that are allegedly encouraging companies to raise private funds outside the U.S. as did Facebook recently. The underlying question is whether the success of LinkedIn and expectations for similar success for social media companies such as Facebook and Twitter when they go IPO raise the specter of an Internet stock-driven bubble similar to the telecommunications stock bubble of the late 1990s and early 2000s.

In case you were asleep on May 18, LinkedIn's IPO was priced at $45 per share up from the previous price range of $32 to $35 apiece. This gave the professional Web networking site a value of $4.25 billion. By May 20, the price had soared to a close of $93. That's more than a doubling of its value in two days. The offering of 7.84 million shares and rapid price increase may be a sign of a new Internet stock bubble. From an ethical perspective, the SEC must be vigilant and get out in front of the possibility that the manipulation of financial results will occur down the road as companies like LinkedIn struggle to reflect the kind of growth in advertising revenues and net income that stock market investors became used to during the telecommunications stock bubble of the late 1990s and early 2000s. We cannot afford another meltdown and the enormous destruction of wealth, job losses and economic pain that we went through in the post-Enron era.

Bary's article points out that LinkedIn "now has a market value of $8.7 billion, based on 94 million shares outstanding—and that doesn't include another 30 million that may be issued to satisfy options and executive stock grants. The market value is equal to 35 times 2010 revenue of $243 million and almost 550 times 2010 profit of 17 cents a share. By contrast, Google is valued at five times revenue and 20 times trailing earnings."

I'm not questioning LinkedIn's business model with its fast-growing membership base of more than 100 million subscribers and three diversified revenue streams: online advertisements sold to businesses; premium subscriptions for individuals; and hiring tools sold to recruiters. Those of us who have followed LinkedIn's rising start have witnessed the doubling of revenue in 2010 from 2009. The company says it adds a member every second. For me it's the greed factor that has infected Wall Street for so long that I fear will take over once again as companies like LinkedIn struggle, on a long-term basis, to meet financial analysts' growing earnings expectations. I'm also concerned about top executives' insatiable appetite for stock options, the motivation to keep share prices rising, and the need to hold on to key executives through lucrative pay packages. The IPO created another Internet billionaire in chairman Reid Hoffman. His 20% stake is worth $1.8 billion.

If we look closer at the numbers, more red flags go up. While LinkedIn's revenue is growing sharply with sales hitting $94 million in the first quarter of 2011, more than double the year-earlier total, the company made just two cents in the first quarter and doesn't expect to be profitable this year, as it "invests for future growth." From an accounting perspective it's not clear how making capital investments for future growth affects the bottom line right now.

In its regulatory filing with the SEC, the company said that a substantial majority of its users don't visit the site regularly. LinkedIn also faces stiff competition from other social networking companies as some users leverage the Facebook platform for recruiting and professional-networking purposes. The bottom line is LinkedIn may be a passing fade as competitors such as Facebook spread their wings and look for additional sources of customers following its expected IPO later this year. In other words, here is a warning to all current and future investors in LinkedIn: caveat emptor.

  Blog by Steven Mintz, aka Ethics Sage, May 23, 2011