LinkedIn Plans To Scrap Its Ad Network Business

  • LinkedIn plans to scrap its ad network business as it lacks sufficient resources to scale it out.
  • LinkedIn plans to channel more resources to grow its Sponsored Content business which grew 85% during the last quarter.
  • How is this move likely to impact on the company's marketing business and on LinkedIn stock?

After LinkedIn stock cratered 45% in a single day of trading post Q4 2015 earnings, trying to say anything bearish about the company right now might sound like flogging a dead horse. But LinkedIn (NYSE:LNKD) is an intriguing tech company because it sports a rather unusual business model that is worth a second look. Unlike other leading social media powerhouses such as Facebook (NASDAQ:FB) and Twitter (NYSE:TWTR) who rely very heavily on ad revenue to drive their top lines, LinkedIn’s ad business, Marketing Solutions, is just a small part of the company since it contributes just 21% to the company’s revenue. In sharp contrast, ad revenue contributes more than 90% to Facebook’s and Twitter’s top lines. LinkedIn’s subscription-based Talent Solutions business is the company’s main lifeline contributing 65% of its revenue.

Despite being much smaller than the company’s subscription-based business, LinkedIn’s Marketing Solutions has traditionally played an important role for the company due to its robust growth. About a year ago, the business was growing at a rapid clip of more than 60% and was easily LinkedIn’s fastest growing segment. But the business has lately come under a lot of pressure from Facebook and has as a result seen its growth slow down to just 20% during Q4 2015.

I explained in my LinkedIn earnings review that Facebook embraced the industrywide shift to programmatic advertising earlier than many other media companies including LinkedIn. Additionally, Facebook enjoys natural advantages over other social media companies due to its much bigger userbase which makes it a marketing magnet. Facebook’s ad business has as a result been witnessing a resurgence lately, growing 57% during the last quarter despite being more than 40 times bigger than LinkedIn’s ad business.

Marketers increasingly prefer to use programmatic ads in the place of traditional display ads because they sport better ROI and lower CPM rates. Publishers such as LinkedIn have been avoiding programmatic ads due to their low CPM rates. Meanwhile, Facebook has well developed programmatic display tools that companies such as LinkedIn lack. FB owns Audience Network, a mobile ad network that syndicates mobile ads that companies can buy from Facebook across diverse third-party apps. Facebook also has a strong presence in the private ad marketplace courtesy of its LiveRail acquisition about two years ago. Private ad marketplaces are all the rage in the world of programmatic advertising because they allow publishers such as Facebook to exercise tight control over who buys their ads.

LinkedIn started selling its ad inventory on programmatic ad exchanges just last quarter. As a result of being so late to the party, LinkedIn’s display ads tumbled a massive 30% Y/Y during the fourth quarter.

LinkedIn Scraps Its Ad Network

Although the current situation appears rather bleak for LinkedIn, there is some light at the end of the tunnel. LinkedIn recently announced that it was planning to scrap its ad network business just one year after it acquired the business from Bizo, a B2B advertising company, in July of 2014. LinkedIn says that it will shutter its popular Lead Accelerator B2B ad product during the first half of 2016 because the company realized that growing and scaling out the network requires much more resources than the company had anticipated. LinkedIn CFO Steve Sordello had this to say about scrapping the ad unit during the company’s latest earnings call:

“As a result, we will phase out selling Lead Accelerator in the first half and incorporate the key technology into Sponsored Content throughout 2016. We will also deprecate Network Display through this process. In the short-term, the trade-off is roughly $50 million in potential revenue, but we believe this is the best long-term decision.”

LinkedIn’s ad network is a clever ad technology that leverages data from LinkedIn users to target them with relevant ads outside LinkedIn’s walls. The technology is commonly used by Alphabet Inc-C (NASDAQ:GOOG), Facebook and Twitter. Clearly LinkedIn lacks the financial wherewithal to build an ad network competitive enough to compete with the industry heavyweights. This appears to be the right thing to do considering that LinkedIn’s free cash flow during the fourth quarter entered red territory due to heavy CapEx in data centers.

LinkedIn says that it will instead focus on building its Sponsored Content business, a business it says grew 85% during the fourth quarter and one that now accounts for more than 50% of its ad revenue.

Scrapping Lead Accelerator will, therefore, lead to an immediate shortfall of ~$50M in ad revenue for LinkedIn. That perhaps explains why the company issued Q1 2016 guidance that came in below expectations. LinkedIn finished the quarter with ad revenue of $183M, which implies the scrapped unit will nick at least 27% off from its ad revenue. You can expect the market will react negatively towards this development, at least in the short-term.

Investor Takeaway

LinkedIn lacks the resources to grow its ad network business to a scale big enough to compete with the industry titans. The company’s decision to instead channel its resources to build its more promising Sponsored Content business appears well-informed. LinkedIn stock is likely to remain range-bound for at least a couple of quarters due to the weakness in its ad business. Luckily the company’s core products remain healthy with some such as Lynda having good growth potential. Perhaps long-term investors should wait until the company has scrapped its ad network business then buy the shares for the long haul once the dust has settled.

Brian Wu Brian Wu   on Amigobulls :
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LinkedIn is the best network for B2B Business
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