Looking at the quote for career-minded social networking site LinkedIn (LNKD) today might convince you the company is in serious trouble. However, if you read the company 2015 financial results press release you will see that revenue hit $3 billion in 2015, double 2013 levels. Operating cash flow rose 42% to $800 million and the company forecast 2016 revenue of $3.6 billion, up 20% versus last year. So how on earth is the stock down nearly 50% today after releasing their results?
Valuation. Valuation. Valuation. Yesterday the company’s equity was valued by the market at $25 billion. Investors were willing to pay 8 times annual sales, more than 30 times operating cash flow, and more than 80 times annual free cash flow. That price was, to put it mildly, quite rich. The result was a bar that was set so high that it was quite likely LinkedIn could not jump over it. And then the stock gets crushed as investors realize they too can (and will) stumble relative to high expectations.
So should investors go out and back up the truck on companies like LinkedIn? Here’s the problem. The price was so high before today that even after a 45% decline, it is still not cheap. For example, LinkedIn reported $300 million of free cash flow in 2015. If you assume that figure will grow in-line with sales in 2016, it would reach $360 million this year. Not only does the stock still trade at 40 times free cash flow after today’s decline, but as a fast-growing technology company LinkedIn issues a very large amount of stock-based compensation. In 2015 it amounted to a whopping $510 million. In other words, if the company paid their employees with cash only, rather than cash and stock, the company would generate negative free cash flow. Accordingly, it is difficult to ague that investors are getting a bargain even with LinkedIn trading at $106 per share, down from a high of $276 within the last 12 months.
As is usually the case, sky-high valuations set companies and investors up for big problems down the road. High-flyer buyer beware.
Full Disclosure: No position in LNKD at the time of writing, but positions may change at any time