LinkedIn accepts Microsoft"s networking request
SummaryAfter LinkedIn"s (NYSE: LNKD) share price plummeted in February the share price has risen steadily. LinkedIn also reported OK Q1 numbers at the end of April. However, current share price implies that LinkedIn needs to execute better than the relatively demanding consensus forecast. This also is due to their seemingly generous stock compensation plan. That is, LinkedIn is relatively expensive at these levels.
BackgroundLinkedIn is the biggest business-oriented online social networking service. More information about LinkedIn on their Investor Homepage. The below chart from YCharts shows the number of shares outstanding.
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Number of shares outstanding have been increasing with about 5% each year.
Forecast assumptionsI will create a forecast based on LinkedIn"s historical financial performance and current consensus forecast. I have used the Equity Analysis Model from SimulationFinance.com to generate this analysis. I have copied historical financial data from LinkedIn"s Interactive Analyst Center. The below image shows the historical financial data copied from LinkedIn"s spreadsheet and pasted into the Equity Analysis Model. Important! I have used reported adjusted EBITDA.
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I then clicked the Generate forecast button to create an analysis based on extrapolation of the historical development. This will create forecast assumptions based on the most recent quarter and the historical trends. It also will calculate historical standard deviations and correlations used in the analysis to create fan charts and distribution charts. I will change some of the forecast assumptions further down in this analysis.
The below image shows the extrapolation assumptions chosen.
After having automatically generated forecast assumptions based on the historical development I then manually change some forecast assumptions to reflect the consensus forecast.
The below image shows LinkedIn consensus forecast from 4-traders.com.
The below image from the Equity Analysis Model shows the forecast assumptions used in the calculation. The forecast assumptions are generated from the historical development and manually adjusted to reflect current consensus forecast.
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I have assumed a quarterly revenue growth of 4.8% and a quarterly cost growth of 4.4% to reflect consensus forecast. The total depreciation rate is calculated to 37% to cover depreciation of fixed assets, amortization of goodwill and intangibles, and to cover the non-cash effect from the stock-based compensation. In this analysis, all the long-term assets are input as fixed assets in the Equity Analysis Model. I have assumed a flat tax rate of 30%. I have assumed capital expenditures to be more like consensus forecast.
Important! I have used adjusted EBITDA to reflect that stock-based compensation is not a cash cost. In my forecast the negative balance sheet effect from stock-based compensation appears as shrinking long-term assets instead of as accrued liabilities. I have not included an increase in the number of shares outstanding as a result of the stock-based compensation.
ForecastAll the statements and charts below are calculated in the Equity Analysis Model and based on the assumptions above. The below statements summarizes the forecast.
The below chart shows the historical and the assumed future revenues. Historical data with dark blue columns and the forecasted data with light blue columns.
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The below chart shows the historical and assumed future adjusted EBITDA.
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The below chart shows the historical and the assumed future earnings per share and cash earnings per share, assuming unchanged number of shares outstanding.
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ValuationBased on the discounted cash flow valuation method, assuming a weighted cost of capital of 8% and perpetual growth of 4% from the end of 2018. The below image shows the calculated fair value per share based on the assumptions above, and assuming 132.8 million shares. That is, the fair value per share is about $114 (the column to the right). Current share price is about $126.
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Confidence AnalysisThe Equity Analysis Model allows to include uncertainty assumptions in the forecast, that is, standard deviations and correlations. In this example, they are automatically calculated based on the historical financial data. Calculated historical standard deviation in revenues is 4.38%. Calculated historical standard deviation in costs is 3.15%. The Equity Analysis Model calculates multiple scenarios based on these standard deviations. The below image shows the historical and the assumed future adjusted EBITDA with uncertainty assumptions.
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The black line shows the historical development and the dotted line shows the main case assumed future development. The darkest blue area shows the range containing 75% of the calculated outcomes. The two darkest blue areas combined shows the range containing 90% and the total blue area shows the range containing 95% of the calculated outcomes.
The below image shows the historical and the assumed future net profit with uncertainty assumptions. Important! This assumes a fixed stock compensation cost.
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There"s a striking difference with the calculated historical adjusted EBITDA and the reported historical net profit. Calculated historical adjusted EBITDA which does not include stock compensation costs has increased, but reported net profit which includes stock compensation costs has fallen.
The below image shows the calculated fair value per share range. Assuming 132.8 million shares and a fixed stock compensation cost. That is, fair value per share range is between $64 and $200 per share.
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The horizontal axis shows the distribution of calculated fair value per share and the vertical axis shows the probability of each outcome. The percentages on top of the bars have been chosen to show the accumulated probability, starting from the left. That is, it is calculated to be about 55% probability that the fair value per share is below $118.92.
Historically, the number of shares outstanding has been increasing with about 4%-5% each. Historically, the number of shares outstanding has increased by about 4%-5% each year. If I assume that the numbers of shares outstanding increases by 4% each year then the number of shares in 2020 will be about 160 million.The below image shows the calculated fair value per share range assuming 160 million shares outstanding. I still assume a fixed stock compensation cost. That is, fair value per share range is between $46 and $172 per share. It is about 89% probability that the fair value per share is below $121.97. Current share price is about $126.
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SummaryLinkedIn is a good company with good products in a long-term growth market. However, a long-term growth market will attract other behemoths such as Facebook (NASDAQ: FB) as mentioned in the article by Dana Blankenhorn. This may limit both the revenue growth and the margin potential for LinkedIn.The threat of other players entering this market combined with LinkedIn"s seemingly generous stock-based compensation makes the risk-return seem unattractive.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Source: http://seekingalpha.com/article/3977073-linkedin-share-price-stock-based-compensation-trap
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