LinkedIn Stock A Risky Bet Going Into Q4 Earnings

  • LinkedIn is due to report Q4 2015 earnings on 4 Feb 2016 after markets close.
  • Wall Street expects LinkedIn to report upbeat results for the quarter.
  • LinkedIn continues to be faced with a lot of problems, most notably slowing top line growth and spiralling losses.
  • Will an earnings beat lift LinkedIn stock?

Professional networking site LinkedIn (NYSE:LNKD) is slated to report Q4 2015 earnings on 4 Feb 2016. During its third quarter earnings call, LinkedIn said that it expects fourth-quarter revenue of $845M-$850M, the mid-point representing year-over-year growth of 31.8% while projected non-GAAP EPS of $0.74 is 21.3% higher than Q4 2014 EPS. Meanwhile, Wall Street and other analysts are more sanguine about LinkedIn’s upcoming call and expect the company to report revenue of $857.59M and non-GAAP EPS of $0.78. There is an earnings whisper that LinkedIn might exceed earnings projections by reporting non-GAAP EPS of $0.84.

LinkedIn has soundly beaten earnings projections in three out of four preceding quarters.

LinkedIn Earnings Quarterly Surprise History

Fiscal
Quarter End
Date
Reported
Earnings
Per Share
Consensus
EPS* Forecast
%
Surprise
Sep2015 10/29/2015 -0.06 -0.32 81.25
Jun2015 07/30/2015 -0.3 -0.52 42.31
Mar2015 04/30/2015 -0.18 -0.03 -500
Dec2014 02/05/2015 0.12 0.03 300

Source: NASDAQ

However, that does not guarantee that LinkedIn stock will recover from its deep slumber even if the company does manage to beat earnings estimates for a third consecutive quarter. LinkedIn and social media peer Twitter (NYSE:TWTR) have hit a brick wall, even as they continue to draw unfavorable comparisons with sector leader Facebook (NASDAQ:FB). In theory, LinkedIn appears to have an attractive business model which is pretty well diversified. Unlike FB and Twitter which rely very heavily on ad revenue to drive their top lines, LinkedIn sports a more diversified model that depends more on subscriptions than ad revenue. 64% of LinkedIn Q3 2015 revenue came from subscription-based Talent Solutions with Marketing Solutions (ad-based revenue) contributing just 18% to the company’s top line.

LNKD-1

Source: LinkedIn Investor Presentation

Although a subscription-based revenue model provides better future revenue visibility, and should give investors some reason to cheer, the investing universe has been more concerned about LinkedIn’s low revenue ceiling compared to Facebook due to its role as a niche player, while Facebook appeals to a much wider user base.

A larger user base is the biggest reason Facebook has been doing much better than both LinkedIn and Twitter, especially in the current era of programmatic advertising. Marketers have increasingly been opting for programmatic advertising as opposed to traditional display ads, due to their better ROI and lower CPM rates. Facebook has been successful at vastly improving its ad targeting methods, thus allowing its ads to yield better returns for marketers. This is one of the main reasons why Facebook’s ad revenue surged 57% to $5,637M during Q4 2015. In sharp contrast, LinkedIn’s Marketing revenue grew only half as fast during Q3 2015, with 28% Y/Y growth, to touch $140M. Notice how Facebook’s ad revenue is growing at twice LinkedIn’s rate despite being more than 40 times bigger.

LinkedIn has been trying to grow by expanding into international markets. Only about 38% of LinkedIn’s revenue comes from international markets, with the rest coming from the U.S. LinkedIn’s international expansion efforts have unfortunately led to ballooning product development as well as sales and marketing expenses. This has placed the company’s bottom line under a lot of pressure and led to an unfortunate trend of a string of losses. During Q3 2015, LinkedIn spent $468.1M on product development + Sales & Marketing expenses, which works out to a whopping 60% of revenue. What’s worrying is that the two line items grew 40% Y/Y, ~300 basis points faster than LinkedIn's top line growth. With such huge cost items expanding faster than the top line, LinkedIn might find itself in an ongoing conundrum of spiralling losses.

Meanwhile, LinkedIn has been unable to bring down its executive stock-based compensation to more reasonable levels. During the last quarter, the company spent $126.9M, or 16.3% of its revenue, on stock-based compensation. An average tech company spends 3%-5% of revenue on this line item. Moreover, LinkedIn’s stock-based compensation during the quarter increased 53%, 1600 basis points faster than top line growth.

Young tech companies such as LinkedIn have to compete fiercely for top talent in Silicon Valley against well-heeled rivals with much deeper pockets. This frequently means doling out huge amounts of stock as executive compensation. Unfortunately, this also means that many of these companies are unable to become profitable for years. LinkedIn happens to be one of them.

LinkedIn Stock Is Pricey

LinkedIn stock still looks pricey even after falling 30% over the past 12 months, trading at 130 times free cash flow and 75 times non-GAAP earnings (the metric looks much worse when calculated on a GAAP basis). In comparison, the sector average is a PE of 20. That valuation looks stretched even after factoring in LinkedIn’s still-impressive top line growth.

The investing world usually tolerates losses in a company as long as top line growth remains brisk enough. But with LinkedIn’s Marketing Solutions business facing severe competition from Facebook, the company will be hard pressed to maintain strong revenue growth. LinkedIn has projected revenue to grow just 31.8% during Q4 2015, considerably slower than the 37% growth posted by the company during Q3 2015. Against this backdrop of slowing growth, investors tend to be quite intolerant of poor bottom line performances. It, therefore, won’t really come as a surprise if LinkedIn stock sells off post Q4 earnings especially if the company’s top line growth drops to the projected level.

At this juncture, LinkedIn is faced with many headwinds which make the LinkedIn stock a risky long-term bet. That could, however, change if the company is able to record much better growth for its ad business, and also figures a way to rein in on its ballooning costs. But right now it’s hard to see this happening soon enough.

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