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LinkdIn Earnings Miss Heralds Worse To Come

By: InvestorsObserver
Posted: 2/10/2014 8:00:00 AM
Referenced Stocks: LNKD

Julian Close 02/10/2014

LinkdIn ( LNKD ), the Internet's only credible network of professional people dedicated to discussing professional things, reported its fourth quarter 2013 earnings numbers, and they were not what the Street was hoping for. The company earned $0.05 per share during the quarter, instead of the consensus estimate of $0.08. Worse, the profit was less than half of what the company had earned in the year-ago quarter. LinkedIn's revenue was ahead of the Street's expectations, but its guidance was not. Rounding out the bad news, the company's profit margin fell to 3.5% from 9.8% in the year-ago quarter.

LinkdIn can still report large increases in total membership, which rose 37% from the year-ago quarter to 277 million, but the number is largely irrelevant, as it says nothing about how or even whether any of those people are using the site. That wasn't lost on the Street, which sold LNKD shares on the report, causing them to fall by 7% to $208 per share. When a well-known company drops suddenly, even on an earnings miss, it can suggest a buying opportunity, especially if the company's business model is still sound. Which, in this case, it isn't.

LinkdIn is intimidating to most new users, especially the young who have not yet racked up the sort of credentials everyone else seems to have on display. Many people set up profiles only to let them languish after determining, probably correctly, that the service is not likely to be their route to employment. It feels worthwhile to be part of the network if you are an employer, because you have something everyone wants; it feels worthwhile to be part of the network if you are a prospective employee with incredible skills and credentials, because you are always in demand and can field multiple offers.

For everyone else, trying to use the site just feels like work. Few are disciplined enough to work diligently for long in the absence of reward, and almost none in the absence of hope. It is easy to see why hope might die quickly for job seekers at the site; they are, for the most part, beset by the same sort of spammy recruiters that destroyed the credibility of employment sites such as Monster.com. My sense has always been that the network would simply crumble from the bottom up.

But that's not even the worst of it. Though the company has an essentially untested business model, as well as a thin and narrowing profit margin, it has, up until now, been given the same sort of valuations seen so frequently in social networking sites, and seen so rarely anywhere else. As the company is just in the process of becoming profitable, pointing to its P/E of 939 is a bit misleading, but even based on analyst forecasts for the end of 2014, the leading P/E ratio is 62, a number unsupported by the 20% revenue growth the company is predicting during that time.

It will take one more slip on profit margin-a slip less than half as bad as the one the company just reported-for LinkdIn to become an unprofitable company, something I doubt is part of their long-term strategy. Still, the company has, for now, retained the greater portion of its social media valuation-cushion. Based on this long-term, system weakness, the chance of any significant near-term rise in the price of LNKD stock appears remote.


Chart courtesy of stockcharts.com

I seek to capitalize on this weakness with a bear-call credit spread. Look at the May 230/235 bear-call spread for at least a $1.00 credit. Use limit orders. This trade has a target return of 25% over 96 days, which is an annualized return of 95.1%, (for comparison purposes only). The stock has to rise 10.5% to cause a problem. Be aware that this is an aggressive trade, best undertaken by investors with diverse portfolios and high tolerance for risk. In addition to other risks, the trade includes the risk of what might be called "market error," which is to say that if the company does poorly, because LNKD is a social media stock, it may rise for purely irrational reasons. Fortunately, that possibility means this is a higher yielding spread than most.