Linkedin and Twitter Q1 2014 results

Part of my running a series on linkedin results, updated each quarter, for the purpose of chronicling its eventual collapse.  Predictions from the last article mostly came true. Much of this article was written prior to linkedin's published results because the most relevant data is already known.

Linkedin will likely announce

• 300M members (about 45% yoy growth)
• decline in monthly visitors year over year.
• 10% decline in page views

The above stats are sourced from quantcast, and translate into over 50% year over year decline in member engagment (pageviews per member).  An absolute disaster.

Linkedin actually reported comscore-based results for engagement that show a 7% or so increase in visitors, and 3% increase in page views.  Comscore excludes mobile traffic, while the quantcast includes it.  Last quarter's drop in mobile use continued this quarter.

Financial results 

• a record net income loss ($13.4M) ($0.11)/share.  Trailing 4 quarters are now a net loss.
• First ever operating income loss.
• Continued decelerating revenue of $473M.  A 46% yoy increase.
• A 38% growth forecast for next quarter, along with expected $9M loss
• increase in diluted shares to 124.8M 
• record low corporate solutions customer growth of 42% yoy and 6% qoq. +1400 corporate solutions customers, lowest since +1300 in Q1 2012.
• 28% yoy growth in marketing solutions revenue per 1000 comscore pageviews to $8.27

Conference call admissions

the next few quarters, we expect some year-on-year compression in engagement comps

revenue will continue to be primarily driven by further penetrating the existing customer base (in context of talent solutions

The above admissions confirm the company's relative market saturation, and expected continued growth decline.  The focus on existing customer leveraging suggests that relatively soon (less than 8 quarters) , near 0 growth could occur.  You can upsell a customer once in a while at best.  Certainly, sales productivity declines as you attempt more.  There is also a limit to revenue per 1000 pageviews growth, and all increases generally harm pageview growth.

Further Quantcast data

Quantcast provides traffic statistics for many sites including linkedin. From that site we also know:

• Even further deterioration in April.  About 10% yoy drop in unique visitors.  15% drop in pageviews.
• No lasting apparent engagement impact from press releases of China launch.
• 33% or so decline in mobile pageviews.
• something to keep in mind are that daily active users are over 50x more at facebook

Stock valuation

I previously issued a grossly optimistic price target of $80/share in terms of enterprise value.  This will be lowered in the next paragraphs.  Keep in mind that no one should ever buy linkedin shares as long as there is no possibility of takeover, dividends, and management continues to be empowered to pay themselves the legal maximum.  These cautionary statements also apply to FB, GOOG, TWTR.  Their stocks are worthtless even if they might be relatively close to true enterprise value.

The $80/share optimistic enterprise value ($10B market cap) is based on some reasonable hope that LNKD can sustainably earn $1B in annual net income.

Linkedin has achieved peak sheep

The sheep came to linkedin's pastures with the promise of rams providing them with love and children.  The rams (employers) came because they like sheep.  From its market valuation, linkedin's business model intentions are to power fleese the rams and sheep.  With its sales navigator platform, the apparent intent is to provide access to the sheep for wolves (spam marketers).  With its university program, linkedin has begun letting lambs and goats into the pasture.  (a possible explanation for low engagement new users).  The sheep may be disappointed with the presence of wolves and lambs.  The gate is not locked/closed, and if the rams want to solicit the sheep, they can email without causing any meaningful engagement with the platform.

A major reason for the downgrade in enterprise value is that Monster.com or other job site can offer a platform for just sheep and rams.  The rams may prefer associating with a pasture that is more respectful of the sheep.  We should never value internet companies as if they were a 1980s cable TV monopoly with permanent sheep.  The number of sheep that have filled in signup forms in the last several years is not particularly relevant either.

A $40/share or $5B enterprise value

The extreme sharp drop in engagement raises significant doubt regarding the potential of $1B sustainable annual income.  $500M  may be more realistically optimistic.  There is now certainty that its model will eventually be disrupted, as it moves away from a job matching focus, and decline in engagement should seriously dampen any optimistic model.  

LNKD cost structure

Linkedin has no technology.  Meaning its systems are very simple to reproduce.  Every member it adds incurs database storage costs, and "relationship maintenance" costs.  Despite 5x growth since becoming public, it has never generated any material net income, and so the costs per user are not only constant worldwide, but if they provide no engagement, can contribute very little or negatively to the bottom line.  Using cost of revenue and depreciation numbers, it appears as though members cost LNKD $0.38 each per quarter.  Since Q1 2012, depreciation per member has risen almost 100% to 16.8 cents, and cost of revenue per member has risen 50% to 21.1 cents.  Even though technology costs (per storage size and speed) decrease over time, the cost of database operations scales between member growth and member growth squared.

Linkedin's acquisition of Bright is to improve its job matching capabilities.  It may make the service better, but its unclear how it will improve revenues or profitability.

If LNKD has already saturated its main target market of knowledge workers, then that cost per new user can mean very little future benefit to growth, if they will have low engagement and relevance.

The similarities of Twitter

Twitter also makes more sense at a successful $5B instead of its recent $25B.  While it doesn't have dual class shares that doom the stock to worthlessness, it still has concentrated ownership intent on paying itself maximum possible salaries, Delaware law, poison pill provisions to prevent takeovers, and predisposition to refuse takeovers.

The most striking problem with Twitter is cost of revenue and marketing amounting to nearly 80% of sales.  (Its unclear if they include depreciation (which all internet companies should due to recurring computer costs/purchases).  LNKD is a more reasonable (but still high) 58% including depreciation, while facebook is at 40%.  

Not only does twitter have massive losses, those metrics indicate that it needs to raise revenue by 400% before it breaks even.  It may be a great service with significant value to the world, but it may even be more easily disruptable than LNKD, and it has an even greater lack of technology.  

While Twitter claims that its current massive stock based compensation is "only" related to its IPO, and will decrease in the future, Linkedin's executive compensation committee recently provided a generous increase, and we should have every expectation that Twitter will create a similar outcome.

Can Linkedin ever make money for public shareholders?

• It won't be in 2014.
• If it pursued its objective of signing up all 1.5B global workers, (5x growth) It will increase its costs per user (depreciation + cost of revenue) by 5x to 8x to $1.90-$3.  If each user views 30 pages per quarter, and LNKD earns $10 CPM, then its potential marketing revenue is only $0.30 per user.
• The above point casts the most serious doubt over its eventual profitability.  Its stated strategy is guaranteed to lose money.
• Its certain that growing up to that point will take significant sales and R&D effort certain to prolong losses.  The marginal value of those 1.2B new users is certain to be lower than the existing 300M, and so even if sales and R&D are drastically cut after the goal achieved, no obvious prospect of profitability exists.  Sales and Marketing increased 150bp this quarter to 35.2% of revenue.
• More generally, cutting sales and R&D after it has finished growing is going to signal competing ventures to take its share more cheaply than LNKD built it.  For example Mopub (owned by twitter) is competing with google's mobile ad network by not charging publishers anything.  It doesn't matter if there is no hope of profitability if investors are willing to pay Twitter founders so much for the illusion there might be.  Cutting sales and R&D at Linkedin would bring its price multiples down to MWW (Monster Worldwide (which used to be about 10)).
• The only real possibility for Linkedin profitability is a cut in executive compensation.  The prospect of that is the same as Congress voting itself a 94% pay cut based on its 6% approval rating.  Linkedin executives have complete control of the company, and compensation committee, and will continue to pay themselves near the legal maximum.

So, given its strategy and current deterioration, indicative of the saturation of its targetable market, there is a reasonable expectation that it will never be profitable.

We should expect continued deterioration, and in the upcomming quarters it will probably miss its forecast, which will provide market realization of its value and potential.

Linkedin in Q2, 2013 earnings (LNKD)

Linkedin reported Q2 results last night, and the results should be interpreted negatively considering that there is no improvement since the previous quarter.  This is an ongoing series of articles where each quarter I track LNKD's results in an effort to chronicle its eventual collapse.  Here was last quarter's article.

The one positive aspect of their results is that user growth and views was steady, and revenues were a few million higher than they told us to expect.

Real earnings vs. Adjusted EBITDA
Real earnings, GAAP net income, was about break even, and the same as last year: $0.03 per share.  The company, and analysts, like to focus on adjusted EBITDA instead of earnings, but depreciation is a real expense for the company as long as it will replace its computers one day, and the even bigger expense they "hide" through adjusted EBITDA is the massive stock based compensation.  Both its compensation program and depreciation are expected to continue, and they affect shareholders.  Only GAAP net income should be considered.

Of note, it had forecast a profit of 0 for the quarter.  With revenue of $16M higher than forecast, it only made $3.7M.  Another reason to consider only net income as relevant is that it is always possible to increase sales without making any money.  Income from operations was down 35% from 1 year ago.

Growth slow down
Year over year revenue growth dropped to 59%.  It was 72% the previous quarter, and 80% the one prior.  This type of slow down should be reason for a drop in stock market price.

Lowered guidance for rest of the year
The high end of its guidance for Q3 is for 48% year over year revenue growth.  The high end of their earnings expectations is a loss of $4M in Q3.  These are poor expectations that should reflect poorly on the stock price.

Linkedin lowered (slightly) its guidance for Q4 compared to guidance at the time of last quarter's results.  Previous top end revenue guidance was $1.46B, but after beating this quarter's revenue estimate by $16M, it raised its full year revenue guidance by "only" $15M to $1.475B.  Its forecast for Q4 is revenues of $413.7M is only 36% YoY growth.  Q4 top end expected profit is (Adjusted EBITDA is expected as $100M) $14.7M, with full year expected profit of $37M.  $14M of that profit will be from special tax rebates from Q1.

These are very poor forecasts compared to its valuation approaching $28B, and a very rapidly declining growth rate.

Under best scenario, LNKD is worth $10B ($90/share) in 10 years
If Linkedin is ever to deserve a market value of $10B, it will need to one day reach net income of $1B.  In 2023, that means 20 to 30 times its 2013 income.  To understand why that would be an exceptional success you have to ignore growth rates.  Using its peak growth rate, we could project that the roman empire would cover earth 20 bazillion times by now.

For Linkedin to triple its sales to $4.5B in 10 years would be a spectacular success.  Not only is that higher than the $3B total recruitment market estimated in 2011, which I addressed last quarter, there is a couple of other reasons to see it as a ceiling.

Jeff Weiner (LNKD CEO) said yesterday that the company has a 600 million user addressable market of knowledge workers.  That is its maximum number of users.  As of this quarter LNKD is already past the 1/3 point with 238M users.

MWW (Monster jobs) reported earnings in the morning, and though its revenue keeps dropping 10% YoY, it made 3 times the earnings of LNKD ($9M).  For what is likely the first time, LNKD's talent solutions revenue has surpassed MWW's revenue.  While its reasonable to hope that LNKD will continue to grow at the expense of MWW, that growth will get even more difficult and expensive.  If it already has half the market share, hoping that it can grow much more than double is too optimistic.

Even if it manages to increase sales 3 times, it would still need to increase profit margins another 6-10 times in order to successfully hit a $10B market value.  It would do so through some price increases, firing sales people, stopping its content purchases, user acquisition costs, server infrastructure, service improvements (development), huge stock compensation, and funding whatever mysterious force keeps their stock price up.

The problem that occurs for LNKD whenever it actually does make money, is that someone else can start a stock hype scam that offers recruitment services without making any money.  The someone else can be fired salespeople, and developers disgruntled they are no longer showered with stock option candy.

Its also possible to get an optimistic 3 times sales rate in 10 years by projecting LNKD's growth rate out.  A flat 30% annual growth from 2013 levels will hit exactly 300% in 10 years.  That is a reasonable projection of its ongoing growth decline.  Because LNKD has been spending so heavily to chase its existing growth profile, its hard to see it achieving these growth levels while also becoming profitable.

Linkedin's sales are almost 7 times what they were in 2010.  Its profitability this quarter was less than in Q2 2010, and its unlikely that next quarter will beat 2010 either.  Its fine to hope that the next 3x in sales growth leads to at least 3x income, but its hard to see LNKD's culture change to stop paying its insiders so much.  It needs to raise income by 30x, not just 3x, in order to justify a $10B market value.

Market reaction to results
All of the issues with LNKD's slowing growth (among others) were apparent last quarter, and the company provided no guidance of any improvement in the next 2 quarters.  After last quarter's results the stock fell to about $170/share.  So, there is no coherent explanation for it to trade near or over $200 after these results.

2013 may reach close to triple 2011 sales for LNKD.  Excluding the Q1 tax breaks it received, LNKD is projecting full year net income below that of 2011.  Just because it may beat low expectations doesn't mean its stock price should be rewarded when they are set that low, and fundamentally, we need to wonder what sales levels might lead to profitability.

DICE holdings
DICE (DHX) is also in the online professional communities business with a focus on recruitment.  It is about 1/7th the size of LNKD, but its Q2 profit was more than double that of LNKD ($8M).

The stock based compensation issue
LNKD had expected $49M this quarter, and came in just under that by less than $1M.  It expects Q3 stock compensation of $49M and Q4 of $52M.

The headline (non-gaap) earnings exclude these expenses and look better because of it.  But it is a cost paid by existing shareholders.  The $10B optimistic future market valuation worked out to $100/share just last year, when there were 100M shares outstanding.  Current shares outstanding are near 117M.  If somehow shares stop growing past 120M (around the end of this year), a $10B total value would mean $83/share.

There is reason to believe that stock based compensation will never come down.  Linkedin has a dual-class share ownership structure where only the insiders have voting power.  There is strong incentive to award themselves extra stock.  While the company is projecting stock compensation to grow slowly, this is still growth in stock compensation while the company's sales growth is rapidly declining.  The best we can expect from Linkedin's management is for stock compensation to plateau.

Linked in Q1, 2013 earnings (LNKD)

Linkedin reported earnings last night, and I plan to write an article after each quarter for now on as a diary tracking how an impossibly valued company adjusts to its real valuation, and how the financial industry may attempt to distort and manipulate that valuation.

Core maximum future value remains below current price
The total recruitment market was last measured 2 years ago, at $3B.  Even if that grows to $4B, linkedin is suited to only the higher end job portion of that market.  If it is paid $200 per job, it needs to place 15M jobs per year in order to generate $3B in sales.  A couple of months ago (end of article), I estimated worldwide online job postings at below 8M with many of the postings having fees much lower than $200 including free.

So it is hard to understand how LNKD could ever reach as high as $3B in core sales, and $1B in annual profits, and so a maximum corporate future value of $10B, which is a maximum future share price of below $90.  Considering the risk of failing to reach that maximum, a $45/share or below current price is appropriate.

The lack of takeover or dividend potential
The true value of a share of stock can only be measured by the payments that share is entitled to receive:  Dividends and takeover bids.  If a company is too large, and too highly valued, with no real cashflow stream then it cannot be taken over at a price near its current value.  Similarly if its structure discourages ever paying a dividend, its stock value can only be measured based on significant deterioration in stock price that is necessary before management considers selling or issuing a dividend, and a price that buyers can rationally consider the whole company based on cashflow.

LNKD meets all of these overvaluation criteria, as it has tightly controlled dual class shares.  A related issue is that it uses that concentrated control to issue extremely generous stock compensation to itself (and employees).  Its irresponsible for the financial analyst and media industries to ignore that compensation in its results.  That compensation has a real effect on the valuation of shares for both takeout and dividend purposes as well.  The below $90/share ($86.65 = 10B / 115.4M shares) maximum future value is based on current shares outstanding of 115.4M.  Just 18 months ago, that same $10B maximum total future value translated to over $100/share because the shares outstanding were 98.8M.

Linkedin estimates that it will award its insiders $195M in shares this year, and that number excludes the 512k shares it is giving out for its acquisition of Pulse.  The share issues are the main reason it has never been profitable, and there is no reason for it ever to stop issuing nearly all operating profit to insiders, because it has complete insider control of the company, the support of the financial analyst community, and the support of state of Delaware.  That future stream of insider share giveaways further reduces any maximum future share value estimate.  There is no reason for LNKD's management to ever pay all shareholders through a dividend when it can be applauded by the analyst community for paying itself.

Linkedin forecasts
For the next quarter, Linked in is forecasting year over year sales growth of about 55%, and core (after depreciation and stock compensation) earnings ranging  from a loss -$6M to 0.  For the next 3 quarters, it is also forecasting year over year sales growth of 55%, and core earnings range of $-21M to $4M.  A significant slowdown in growth is occurring in non-US markets.

Declining sales growth
Even if LNKD beats its own estimates considerably and achieves 60% growth, it would be a significant drop from 2012's year over year growth of 81%, and this quarter's 72% yoy growth.  It would also make the most reasonable optimistic estimate for 2014 growth to be 45%, and 2015 growth nearing 30%, even if you make the mistaken assumption of an infinite addressable targetable sales market for Linked in, instead of it approaching its potential penetration cap.

With declining sales growth and no real earnings, even with the mistake of assuming an infinite potential market, valuing the company at over 14 times 2013 sales ($202/share) is not close to reasonable.

Comscore vs. Alexa metrics
Another peculiarity of Linked in results is that it reported a healthy 13% quarter over quarter increase in comscore internet metrics for use and pageviews, but Alexa's more transparent internet monitoring service shows no change in the last 6 months for Linked in's pageviews, time spent on site, and reach.

I can't explain the difference, but someone should be explaining it.

The future of employment and robotics
Relevant to linked in's value 10 years from now, and so its real value today, is how robotics might transform employment.  General purpose personal robots are closer than we think, and it not only ends many types of employment, it ends the need for most types of factories.  The main reason personal robots will arrive soon is that they are cost effective if they can be transformed into self-driving electric cars as one of many potential transformations, and widespread adoption of standardized components makes programming and sharing the programming of the robots cost effective and easier, much like computer and phone apps are easier and cheaper because there is a large market available to share them.

Institutions that invest in stock market - extreme liability

Institutions that invest client and members funds in the stock market are very likely investing in pyramid schemes and thus very likely to be defrauding those clients/members by investing in instruments that are known to have no intrinsic value.  The intrinsic/inherent value of a share of stock is the future value of dividends and the future company buyout price.

Most large public companies trade at a value far higher than a reasonable estimate of their stock's inherent value to minority shareholders.  Any institutional fund or analyst that recommends or invests client funds at inflated market prices has a conflict of interest of participating in a pyramid scheme even if they have a genuine speculative belief that for the next few months collective market exhuberance/hysteria/mispricing will maintains a stock's price.

A valuable company with a worthless stock
A company that cannot be taken over either because it is too big, or because it is controlled by insiders who can block any takeover attempt, necessarily has a stock that is relatively worthless (to outside minority shareholders) compared to the value of the company.  For such a stock to have value as a piece of paper, it must be paid dividends or have the reasonable prospect of high future dividends. (Proof of this statement)  For a stock to be worth what it was bought for the company must either be bought out at a higher price or the sum of all dividends to be paid must be high enough.

A reasonable hoped minimum stock return of 7.2%
The concept of a reasonable hoped return is relevant as a threshold for establishing liability when influencing other people's money.  A 7.2% return per year on a company that cannot be bought out, and doesn't pay a dividend, means an expectation that its price will double in 10 years, or quadruple in 20 years.  After those 10 or 20 years, there should be an expectation of a continued healthy company, and an expectation of say a 3.6% dividend yield instituted in that future, and expected dividend growth that accompanies the company's continued health and prosperity.

The key part in the above analysis is the continued healthy future prospects.  If you believe the company's health will be deteriorated in 20 or 50 years, then its stock must pay significant dividends prior to its deterioration in order to compensate for its purchase price.  While I've said that all companies pay too little in dividends today, the big dividing line between reasonable disagreement on dividend policy is the division between sustainably hopefully permanent companies and those destined to eventual deterioration.  It is excusable to tolerate low dividend payout ratios from companies with sustainable growth, because there is a theoretical possibility of proper shareholder compensation in the future.

My previous article delves into the math behind this in more detail

The problem with social media companies
The core problem with investing in social media stocks is that the companies have no unique technology.  Its unlikely that the generation 10 or 20 years from now will want to use the same social networks as their parents, teachers and grandparents.  Its hard to maintain a sustainable value of 10s of billions, when competition can be created easily/cheaply, and necessarily provide better value to members by monetizing them less.

The core misunderstanding of social media company valuation is that their member/subscribers are equivalent to 1990s cable company subscribers with the assumption that they can be infinitely milked as a captive audience.  Social media members are in fact more sensitive to excessive monetization efforts, and likely to move to a new platform that buys growth.

The problem with high sales growth and no profit
Any company should be able to increase sales by $100M by increasing sales expenses by the same amount. Marketing rebates, bribes or "hookers and blow" can create the sales increase.  Financial reporting and auditing is not designed to inform investors whether the spending is legitimate or not, but even if legitimate, it is never an effective marketing program if its costs match the increased sales revenues.  There's no reason for investors to be impressed by unprofitable high sales growth, because it never includes evidence of sustainability.

Facebook (FB)
The majority of Facebook's shares are owned by its main founder.  Because facebook has a dual class share system, its founder can compensate himself by awarding and selling non voting shares without the possibility of diluting his ownership.  For that reason, and because of current dividend tax treatment rules, there is no possibility that FB will ever declare a dividend until the founder retires.  Because FB is currently worth $60B it is too large to be bought out.  It is also impossible for it to be bought out because the owner/founder doesn't want it to be.  The owner enjoys the surplus privilege to his shares of being able to control the FB empire.  Only significant deterioration in the company could change the outlook on a takeover.

So, even if FB as a company can be optimistically valued at $60B or even $100B, hoping that it has sustainable longevity, its shares cannot be worth more than $10B because minority shareholders rely on deterioration in the company to ever see compensation on those shares.

Linkedin (LNKD)
Linkedin shares FB's dual class share structure.  That means that its difficult for outsiders to buy out the company, and insiders that control the company strongly prefer issuing themselves additional shares over the prospect of ever paying out a dividend.  The other issue that makes a takeover impossible is that LNKD shares are grossly overvalued, and not something that informed investors using their own money would buy hoping to replicate current management's performance.  Its more sensible to launch a new job recruitment platform instead.

Linkedin's main problem as a company is that it pays its management and employees too well, has no real profitability this past year, forecasts no growth in the next quarter, and forecasts no real profitability for all of 2013 either.  The addressable market for its core recruitment services is saturating, as it has approximately the same recruitment revenue as Monster worldwide, and it has spent so much to gain that revenue.  I don't believe that users will ever value the social aspects of Linkedin, and may be turned off by constant sales communications.  For all of its sales growth, it has stagnated in page views even though it is buying high profile blog content, and investing heavily in redesigns.

With a current value over $16B, and the criteria outlined before, we could ask if it is reasonable that LNKD could be worth $32B in 10 years.  However, because LNKD pays its management and employess with a large amount of stock compensation, its shares oustanding grow about 5% per year.  We should be evaluating, as a criteria to justify a $16B valuation today, whether LNKD will be worth $50B+ in 10 years, if we take into account expected future issued shares.  I don't think it is possible or reasonable to expect LNKD to make more than $1B or so in annual profit in 10 or 20 years, and so would not understand a company future value of beyond $10B (and so max $5B in today's value).

There is substantial competitive risk to the company, because while it does the heavy lifting to penetrate international markets, it is simple to duplicate the useful aspects of the platform, and offer it with a cheaper self-serve model for recruitment.  It would seem impossible for LNKD to maintain a sustainable $10B+ value as a company, if easily formed competition is content with sustainable valuation under $1B.

Bigger issues than the value of LNKD as a company, is the value to external shareholders.  Will LNKD ever repay shareholders $50B before it deteriorates?  Will it ever even repay $16B or $5B?

Liability of ratings firms
When analysts announce a target value of $175/share ($19B) for LNKD, I have to wonder about their crack addiction based on Linkedin's own projections of sales and profitability growth.  It becomes blatantly irresponsible when you factor in the company's limited addressable market, dual class share structure, and its impossibility of being bought out or offering dividends, as well as its nearly assured eventual deterioration.

If it is indeed irresponsible for analysts to confirm a stock's current high valuation, or for institutions to invest client/member money in such stocks, then there is liability for investor losses both for short sellers that might suffer from a short term price hike, and buyers/members who suffer eventual losses from long term deterioration of that stock price.

The defense that investors have a short term horizon, and hope to flip out of the stock prior to any collapse, is invalid.  If it is irresponsible to view the piece of paper that is a stock as having any real long term value (possibility of receiving sufficient compensation through buyouts or dividends), then it is irresponsible to participate in the short term hype and greed manipulation surrounding that stock.