- LinkedIn stock's drastic drop of 47% following Q4 earnings have left some investors wondering if it has become a value investment.
- I believe the company is still valued above its realistic growth rate.
- I think LinkedIn stock will drop another 22% before hitting its fair value.
LinkedIn stock has dropped almost 50% so far this month and it makes perfectly good sense given the LinkedIn (NYSE:LNKD) inflated valuation. However, if you think that such a drastic drop in LinkedIn stock justifies a buying opportunity, then take a close look at its valuation.
For the trailing twelve months, LinkedIn operating margin was around -5%, which means 2015 is the company’s first net operating loss in a long time. But given the company’s strong growth rate, investors know that patience can often pay off in the long-term. However, LinkedIn’s topline growth is also experiencing a significant slowdown. Finishing 2015 with revenue below $3 billion is an increase of 35% from the year prior, however significantly less than the 45% increase the company saw in 2014. In order for LinkedIn to justify its $13.4 billion market capitalization, they will need to experience double digit growth for the next several years to come.
On the surface LinkedIn’s valuation doesn’t look so bad – 4.5X sales, 3.1X book value – given the industry and growth rate, these multiple valuations aren’t so bad. However, when we get to the bottomline, it distorts the shareholders actual value. Below is my DCF for LinkedIn which uses a 10% discount rate and 5% terminal growth rate. I believe the growth projections are fair, however LinkedIn’s ability to produce positive FCF before 2021 can be possible depending on their operating margin and capital expenditures. But for the model, I am assuming FCF takes off after 2020.
As you can see, I’m valuing LinkedIn’s equity at approximately $10.4 billion, which is 22% below its current market capitalization of $13.25 billion. This represents a price of $78.87 per share. It seems to me as if LinkedIn stock is priced above its realistic growth rate. If the company was able to maintain its historic growth rate then the valuation can be more reasonable, however as growth has slowed the stock price has dropped.
And that is why the LinkedIn stock might look cheap from a sales or book value multiple. If the company can sustain a strong growth rate then 4.5X sales isn’t so bad, however sustaining a growth rate in the low-mid double digits isn’t cheap and that is the reason why I don’t see the same value in LinkedIn stock today.
The $11 billion of LinkedIn’s market cap which was lost in a week may not be the bottom. We’ve seen Wall Street come to the realization of inflated valuations of internet companies before, and that is what I believe happened with LinkedIn. LinkedIn stock was trading above its intrinsic value when it was turning positive earnings with a PE of 900, and it’s doing the same thing now, however, it has come further down to reality. The balance between topline and bottomline growth over the next few years will give us more insight into LinkedIn’s future, but I would stay away from LinkedIn stock until it drops to $78-79 per share and re-evaluate it then.