The bad news about LinkedIn's good fortuneAugust 12, 2013: 5:00 AM ET
The safe-haven social stock has some stiff competition.
By Kevin Kelleher, contributor
FORTUNE -- Everything seems to be going right for LinkedIn (LNKD) these days. Except for maybe one thing: Everyone and their dog knows that everything is going right for LinkedIn.
That's not necessarily a problem for LinkedIn's business. In fact, it could help. As the company broadens into international markets, as it pushes toward new goals like being a clearinghouse for realtime business news, and as it partners with companies and developers on its LinkedIn Platform, positive-word-of mouth can only help these efforts gain traction.
Few things offer better word of mouth than a rocketing stock price. And that may present LinkedIn a problem. During the past few years, investors were skeptical about web companies that listed on public markets. Some, like Groupon (GRPN), went public with fast growth but big losses. Others, like Zynga (ZNGA), listed with a business model that soon ran into headwinds. LinkedIn was always the exception disproving the rule, the star pupil in a less-than-impressive class.
In May 2011, LinkedIn planned to go public at $32 a share before the offering price to $45 a share. Then In 26 months on the market, the price of those shares have risen more than five times over, rising to a record high of $237.96 a share earlier this week. By contrast, Groupon is 47% below its offering price, and Zynga is 71% below.
Even after Facebook's (FB) problematic IPO last summer dampened interest further in web IPOs, LinkedIn thrived. The company's focus on the professional market made it seem more like an enterprise play rather than a consumer social network trying to sell mostly ads.
Now that Facebook's strong earnings report has reignited its own stock rally, LinkedIn's continues to rise. Investors who harbored their social-media money in LinkedIn during the dog days of Facebook's first year as a public company aren't selling now that Facebook is trading above its own offering price of $38 a share. LinkedIn is up 18% in the past two weeks, propelled in good part by its own strong growth last quarter.
But unlike Facebook, LinkedIn's report was seen as a mixed bag. Yes, revenue grew 59% on year, but the company forecast revenue in the current quarter to be around $370 million, below the $384 million analysts had been modeling.
Much of this reaction has to do with the view that Wall Street has taken of LinkedIn. The company delivered quarter after quarter of robust revenue growth and operating profits at a time when many wondered how social media sites could be monetized. LinkedIn relied heavily on its hiring solutions, a service built upon the business network at its core. Each quarter, the company guided expectations low, then hopped easily over the bar once it came time to announce results.
So the weak revenue guidance was seen as one more attempt to lowball Wall Street's expectations rather than a warning. After all, LinkedIn was transitioning to new ad-revenue models like Sponsored Updates, ads inserted into the LinkedIn feed that some advertisers said generated five times as many leads as banner ads and other paid channels.
There are, however, a couple of risks involved with the game of guiding investor expectations low. One is that after a couple of years of this people begin to expect it of you. As we saw in the post-earnings rally of LinkedIn shares, the market shrugged off disappointing guidance for this very reason. The trick begins to lose its impact. Great things are expected of you each quarter, whether you downplay them or not.
Once, Intel (INTC) and Microsoft (MSFT) were very good at this game. Ebay (EBAY), in its glory days, was too. More recently, Apple (AAPL) played it during the years when the iPhone and iPad were delivering growth that exceeded almost everyone's expectations. Then, in all of those companies, the growth began to cool. Not disappear or even slow significantly, but simply to not meet the heightened expectations that the low-guidance game had perversely created in the market.
New growth areas are what investors are essentially betting on when they bid LinkedIn shares higher. That's what makes them especially crucial to the future of LinkedIn's stock. LinkedIn called Sponsored Updates "a more sustainable and scalable content marketing model." The company is trying to supplement a business model dependent on job searches to also become a site where people share news and information of interest to their work lives. LinkedIn's ad-driven marketing solutions unit made up 24% of revenue last quarter, down from 33% two years earlier.
Even with more ads in LinkedIn feeds, with LinkedIn pushing into overseas markets and with it opening up its platform to well-known writers, it's hard to justify the optimism bulls have about the company's growth prospects. The stock is trading at 17 times its estimated revenue and 150 times its earnings for 2013. It's trading at 106 times earnings. Which means that even if Linked stayed flat for a year and a half, it would still be priced at 100 times its current profit.
It's a paradox of success: Sometimes companies do so well their expectations can become hard to meet. It may be that's starting to be the case with LinkedIn. Good word about the company has priced the stock for perfection. As history has shown, priced to perfection often means, in time, priced to disappoint.