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So that’s a p/e ratio of around 670. Or a 20-fold increase in the share price valuation over the last two years. It is madness. Yet on flotation yesterday, LinkedIn’s share price rose sharply. The valuation of LinkedIn is utter insanity. Dotcom mania is back, right? Not so fast, I like LinkedIn, and I like what is stands for. In the first quarter of this year, the company’s profit came in at $2.1 million, with revenues of $93.9 million. To be honest, that wasn’t even much of an improvement on 2010, when annual profits were $15 million. It is currently being valued by the markets at around $10bn. With numbers like that, it is not hard to see why the blogosphere is full of talk about dotcom madness.

The first point I would like to make: one of the characteristics of madness of crowds is that there are very few dissenters. The classic study on how we conform to the crowd was carried out by the psychologist Solomon Ashe. In an experiment, he handed his subjects two pieces of paper. On one there was one straight line, on the other were three lines of varying length. Subjects were asked to say which of the lines on the second sheet were the same length as the line on the first. It was an easy question, nearly all got it right. Then, Ashe repeated the experiment, this time putting one of his subjects in with a group of actors. Each actor called out which line they thought matched the first, and every actor called out what was quite obviously the wrong line. On a remarkably high number of occasions the subject agreed with the crowd.

 So that’s the empirical data to back up madness of crowds.

But it only took one actor to dissent, choosing a different line from the others (not necessarily the right one), and Ashe observed a much lower incidence of the subject complying with the crowd.

Such is the din from dissenters on the LinkedIn flotation, that I don’t think you can say we are seeing madness of the crowd. Opinions are too varied for that to be the case. 

My second point, is that I like LinkedIn. This is why:

This is a very scalable business. If revenues were to rise, say ten-fold, I doubt whether overheads would rise by much at all. In 2010 revenues were $243 million, so if they rose, to say $2 billion, I am guessing profits may well pass the billion dollar mark.  All of a sudden, a $10 billion valuation doesn’t look so steep, does it?

So is it realistic? Can revenues really rise that much?

First of all, you need to bear in mind that LinkedIn has 100 million users, and is only just beginning to learn how to monetise this user base. But what the company offers advertisers is the potential of targeting advertising at business to business customers to a degree of accuracy previously impossible.

Lord Leverhulme once famously said: “I know half the money I spend on advertising is wasted. The problem is I do not know which half.” That’s the great problem for advertising. Targeting your ads is a hit or miss affair. That was the beauty of Google key word sponsorship. It offered advertisers the ability to aim their advertisements more accurately than was ever possible before. But social media sites offer advertisers a new level of accuracy in targeting. LinkedIn scores over Facebook because its users are typically business professionals, commanding a much higher worth to an advertiser.  For years, Google didn’t know how to convert its popularity into revenue, but when it cracked the problem, the dollars flooded in. It will be like that with LinkedIn too.

Secondly, LinkedIn is seeing user numbers grow fast. It is putting on a new user a second. At that rate, it will see its user base double every three years. But I suspect this growth will increase.

Thirdly, thanks to the flotation, the company now has oodles of spare cash. It will use this to increase its rate of growth, and to crack the challenge of turning 100 million very valuable customers into dollars.

Fourthly, LinkedIn is becoming a must-be-on service. Kids have to be on Facebook. Increasingly, the view is creeping into business that you have to be on LinkedIn.

Fifthly, barriers to entry and, indeed, exit are high. It will take a lot to persuade a user on LinkedIn to ditch their networks of contacts, and migrate to another service. I know that MySpace and Friends Reunited pretty much imploded, but business users are less fickle.

Sixthly, LinkedIn is like the ultimate business to business database. The problem for those who maintain databases is coping with change – people move, change jobs, change email addresses. With LinkedIn, users change their details for you.

I am not saying LinkedIn isn’t high risk. It is. No doubt Warren Buffet wouldn’t touch it. But the truly exciting companies are all high risk. Thank goodness not all investors follow the Buffett approach, because if they did, innovative dynamic, potential high growth firms would never get the investment they require.

Finally, I note that one of the early backers of LinkedIn was the Californian VC Sequoia. In my view, this company is a greater miracle worker than any other investment firm in the world. If you look at the firms it once backed at the unquoted stage, it reads like a Who’s Who of stock market superstar performers.

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees


Showing 19 comments

  1. Tony Brooke

    Michael,
    That’s a pretty powerful recommendation. But the problem for me is that it denies any means of logical valuation.
    To buy now, at more than twice the price set by the people running the business, would be too much like saying the longer line is shorter than it really seems. Let the crowd shouting it’s long take their profit if they can, I just can’t take the same leap of faith required to defy my own senses.
    Regards,
    Tony

  2. Garry Hawkins

    LinkedIn is becoming a must-be-on service. Kids have to be on Facebook. Increasingly, the view is creeping into business that you have to be on LinkedIn.

    Really? Anyone been headhunted by a potential employer from their linked in page? Anyone got a job as a result of being on linked in? Anyone sourced a star employee from linkedin?

    No – me neither.

    I can perhaps envisage a future where linkedin sits in the cloud, holding folks professional details – having vanquished employment agencies, headhunters and job websites to the past. It all sounds a bit fanciful and far fetched.

    Combining the wit of Alan Sugar on dot com and the knowledge of Niall Ferguson… exactly what is LinkedIn’s “KILLER APP” that will allow you to “show me the money”?

    With Google, it’s obvious: search linked advertising… but Linked In ???

  3. Interesting piece Michael, and I can see that there actually might be a basis for this stratospheric valuation. It’s certainly got me thinking.

    In response to Garry Hawkins, it has long been said in professional circles in the US that if you’re not on LinkedIn you might as well not exist. And the same has been true in the UK for at least the last year. In fact the first thing I do after meeting someone for the first time is look them up on LinkedIn and connect with them, if appropriate. If they’re not on LinkedIn I do not take them as seriously as I otherwise might.

    OK I was an early adopter of LinkedIn and have always found it very useful and my network (through 3 generations) now contains some 12.5 million people. It is unbelievably useful to be able to keep up to date on what many of my contacts are doing. Beats a drawer full of dog-eared business cards any day … after all how many of them will still be current when you next look at it?

    Again Garry questions whether anyone has ever been head hunted on LinkedIn. If you know anything about the network you will know that just about every head hunter or recruiter worth his or her salt virtually lives on LinkedIn. It is essential to what they do. I suspect that hundreds of thousands, and maybe millions, of people have got jobs as a result of LinkedIn.

    I could only find one Garry Hawkins on LinkedIn. He has a grand total of 17 contacts, and no recommendations. If that is the same Garry Hawkins it’s no wonder he hasn’t been headhunted. He’s all but invisible among the 100 million other LinkedIn users. He will likely never be approached or headhunted until he works at building up his profile, his contacts, his recommendations and demonstrating his expertise, all of which he can do on LinkedIn. For people who do those things, LinkedIn is an unbelievably valuable resource. But it is not something for nothing and, like anything else, it takes dedication and work to make it work for you.

    LinkedIn today is one of the big three social networks, along with Facebook and Twitter. All three are important places to be if you’re in business, but for entirely different reasons. While I thought initially that the LinkedIn IPO might have indicated the start of a bubble around social networking, maybe it isn’t after all.

  4. By the way, it’s not just kids who are on Facebook. With over 30 million accounts in the UK, half of which log on every single day, 60% of the entire UK online population are Facebook users. It is where everyone is. Definitely not just for the kids any more, even if that was where it all started 5 years ago.

  5. Garry Hawkins

    Robert,

    I accept that an awful lot of folks are on Linked in and Facebook, particularly those under 40.

    In future, perhaps even today, folks who aren’t natural networkers will probably have to accept their Darwinian fate and become passe.

    If I accept I’m wrong on recruitment, I’ll try a different tack.

    When was the last time that you purchased a product or service, as a result of advertising on linked in or facebook?

    What I’m getting at, is the fact that LinkedIn/Facebook have blanket advertising to X million or billion enough to sustain the business model?

    Do you foresee Facebook/LinkedIn replacing the traditional media, eg print newspapers and television?

    Will LinkedIn/Facebook need to do a google and add a whole lot more services to its portfolio to maintain its user base and drive revenues – thus perhaps avoiding the fate of myspace, yahoo, microsoft et al and becoming another internet dinosaur?

  6. Garry, traditional media is in steep decline. Facebook, in particular, is in the process of completely rewriting the rules of business engagement. It is not a matter of blanket advertising. It is a matter of being able to target your advertising even down to a single individual level. That has never been possible before.

    You need to start by reading these pieces to get a better understanding:

    http://marketingwizdom.com/archives/3510

    http://www.businessinsider.com/chart-of-the-day-newspapers-classified-ads-revenue-2011-3

    http://thenextweb.com/media/files/2011/01/TNW_BreakingNews_Infographic-1.jpg

    http://www.marketingpilgrim.com/2010/12/online-ad-spending-beats-newspapers-by-year-end.html

    http://www.designdamage.com/3-ways-to-capitalize-on-the-destruction-of-traditional-media-and-embrace-social-media/

    http://www.inc.com/news/articles/2010/04/how-social-media-helps-small-business.html

    http://designdamage.com/blog/index.php/201002/the-long-tail-of-trust-in-new-media-marketing/

    http://www.designdamage.com/how-social-media-is-transforming-business/

    http://mashable.com/2010/11/08/comscore-display-ads/

    http://tech.fortune.cnn.com/2010/11/22/how-facebook-fixed-the-social-advertising-problem/

    http://blogs.webtrends.com/blog/2011/01/31/facebook-advertising-analysis/

    http://www.insidefacebook.com/2011/05/03/sponsored-stories-ctr-cost-per-fa/

    http://www.internetretailer.com/2011/03/30/no-two-consumers-have-same-facebook-experience

    http://www.marketing-startups.com/facebook-marketing/why-you-need-a-facebook-page-more-than-it-needs-you/

    Most of these pieces don’t deal with LinkedIn specifically, but you can be sure that with its new found £ millions LinkedIn will be adapting many of the ideas used by the Facebooks of this world to their marketplace, where they haven’t already done so. These are rich, multi-faceted ecosystems that have sprung up in the last few years, yet many people still oblivious.

    If that’s not enough for you I can share a few thousand more links with you …

  7. Tony Brooke

    I recall my own first tentative encounter with PC computer networks, when they were first introduced into the offshore workplace in the 90′s. The rig ET, being assumed to understand all such things automatically, was delegated to the task of installing and keeping the network running, alongside all the other electrical stuff that goes with a 24hour non stop drilling operation. Human nature being what it is, the computers slowly drew on more and more of our time, as new applications evolved and their “potential” was discovered by each newly networked departmental head.
    Drilling Managers were the worst, taking the view that anyone else sat down could not possibly be working, they generally hated the new technology and by forced association we ET’s took the brunt of their wrath. So all computer work, apart from total breakdowns, had to be done after the normal 12 hour shift. You might think such Luddite judgement was narrow minded and wrong, but with hindsight, I’m more inclined to think they were right to resist such change until they fully understood it. The number of productive man hours wasted due to profligate computer use in the average workplace must be truly mind boggling, all in the name of improved communications. Sure, it’s a revolution all right, one that’s still ongoing and evolving, but the good side and bad side of total involvement, the advantages and disadvantages, are still highly questionable. I’ve been involved with technology all my working life and know just how attractive change for it’s own sake is, but the “off switch” is still a very precious thing. Being LinkedIn is one thing, but can you get LinkedOut when you’ve had enough? If not I’m out.

  8. Garry Hawkins

    Tony,

    You raise some interesting points… one wonders exactly how much ‘productive work’ is done on social/professional networking sites during company time?

    No doubt business owners and shareholders for that matter, would be alarmed if they realised how much productivity is lost through employees accessing online media during work time.

    Some obviously employ online filters, whilst others tolerate a ‘reasonable’ amount of use provided that specified tasks are completed on time. With the advent of mobile online media you can waste company time anywhere – such things are difficult to police – assuming of course, policing is in itself desirable.

    On a different note: there appears to be a race for quantity, rather than quality, within the social networking arena.

    It’s all very well having 250 contacts within your social network, but when it comes to the crunch – how many of them are actually have sufficient authority to actually to employ you as an individual?

    Alternatively, assuming you have such authority yourself, how many of your contacts would you actually employ if it came to the crunch?

    How many such people with recruitment or headhunting authority avoid the ‘riff-raff’ and choose to remain anonymous?

    It’s worth pointing out that, while of course it goes on… such employment practices are at worst illegal (ie against most companies HR policies) and at best unethical.

  9. Garry,

    Your only take on social networking seems to be around seeking employment. While that is certainly a use for social networks it is FAR from the only use, and not something I have personally ever had any interest in.

    There is much more to them than you seem to realise. I have shared some links to give you a better perspective in an earlier response, but that response is still awaiting moderation, it seems.

  10. Garry Hawkins

    Robert,

    Of course I’m aware that traditional print media is in decline: that is why I brought the subject up. A lot of folks no longer read print media – or perhaps more importantly – they no longer pay for it.

    This is the point I was making regarding quality and quantity… just because it is free and there’s lot of it – doesn’t necessarily mean you’re getting improved quality. For example: do you envisage improved standards of investigative journalism in the free online media world?

    Referring to LinkedIn: I wasn’t only talking about job seeking, but also job filling… and of course there are lots of other social networks apart from Facebook and LinkedIn all no doubt marketing to their own specialist interest groups.

    But as an investor, perhaps interested in getting a return on my investment having purchased shares in the likes of LinkedIn… Do I see them making sufficient profits from investing my hard earned cash in new targeted services and advertising to bring in sufficient revenues?

    Er… no I don’t.

    I see great business for the investment banks peddling their shares on Wall Street.

    It makes you wonder why the likes of Warren Buffet bought a shedload of Goldman Sachs shares through his Berkshire Hathaway investment vehicle.

    He may not understand social networking – but he sure knows where the real money is being made.

  11. Tony Brooke

    Robert,
    For a nation of shop-keepers that’s fine. I know that marketing is seen as the crucial element for business success and that almost instant communication via the web has made the Earth a more accessible and understandable place. But no addiction (and computers are highly addictive and most of us clearly are addicts, as quick replies here testify) no addiction is without downside risks. Like dehumanising future generations by saturating kids in virtual worlds without rules, porn and unverifiable information, extreme opinions and outrageous, highly organised scams. All addicts have a vested interest in their drug of choice, and that worries me.
    So what else, apart from marketing and better communication, can LinkedIn offer an argumentative OAP like me that might improve my quality of life? (Apart from an escalating share price).

  12. Tony Brooke

    Sorry Gary, You beat me to the send button again, and have already said much the same thing as I intended.

  13. Garry, you asked “Do you foresee Facebook/LinkedIn replacing the traditional media, eg print newspapers and television?” It wasn’t clear earlier that you understood that traditional media was in decline, and that’s why I provided links to stats charting the decline of traditional media.

    My answer to that question is that social networks including LinkedIn/Facebook will definitely have their part to play. I am sure there will also be lots of developments to come which will also play their part in accelerating this change. So in short, yes I see electronic media replacing traditional print media very rapidly indeed, and undoubtedly in an evolved form.

    As to whether an investment in LinkedIn will yield a good return, I’m not the one to judge. The market has valued the company very richly, and I have no idea whether it justifies such a valuation. But, as Michael says in the article, it could work, just as Google did, and just as Apple did and is still doing. I don’t disagree with your comment about it being great business for the investment banks peddling their shares on Wall Street. That’s probably so.

    Social media is a phenomenon that has had incredible uptake globally because it facilitates the communication process dramatically. It is certainly not a fad, although I accept that it in turn may give way to something even more advanced that we don’t know about yet.

    As for Tony’s comment about social media maybe being OK for a nation of shopkeepers, I would take issue with that terminology. A nation of shopkeepers, to me, is a somewhat derogatory term that suggests, in the American parlance, nickel and dime businesses, and no way are shopkeepers at the centre of this communications revolution.

    Far from being suited to shopkeepers, LinkedIn is a network for businesses and professionals who do business with other businesses and professionals. It is B2B, not B2C. In my own case, no more than 10% of my clients over the past decade or so have been in retail.

    Yes all of these networks have applications in retail. But that is hardly the main group of users.

    Certainly, Tony, marketing and better communication are key facets of the social media revolution, and are changing the world before our very eyes. As you correctly state there are also downsides to these developments. But the examples you cite are, in my view, overblown. It’s amazing how savvy or streetwise kids and adults alike become to the potential downsides as they become proficient in using this new media, and that certainly reduces the problem.

    I could give you hundreds of uses for these networks, but I’ve already shared plenty of links that will point you in the right direction. Social media, together with technologies like smartphones, are changing the world we live in. And the evidence is all around us. Do I really need to say any more?

    Have a great weekend both of you.

  14. Garry Hawkins

    Tony,

    To answer your previous question: maybe LinkedIn is the wrong social network for you? Try:-

    http://www.gransnet.com/info/join

    :)

    More seriously… while Napoleon accused us of being a nation of shopkeepers… we should be careful what we wish for… if the retail future is internet then town and city centres are no longer fit for purpose: we might end up with downtown Johannesbourg or Detroit – which I for one wouldn’t welcome.

    Robert: I must confess I hadn’t thought of LinkedIn as a B2B application (apart from being a glorified online filofax), rather B2C or C2B… perhaps they’ll be adding an Alibaba style trading addendum in due course.

  15. Tony Brooke

    Guys,
    Thanks for all your enlightening comments. Nothing derogatory intended in Napoleons old insult, Robert, I have friends in retail just as good as any hot shots, despite their small change size. And the thought of learning more will probably induce me to spend a further hour or so of my invaluable quality time! investigating both your kindly sent links further, for educations sake, which vanity knows no bounds of either age or past experience.
    Have a great weekend yourselves.
    Tony

    (B2B & B2C! must make a note of that! not that I need it,Hell, I don’t even qualify for CnC or GFF cards any more).

  16. Tony Brooke

    http://link.ft.com/r/YIQXNN/RNJYJI/X8L1W/RNQB3T/PREK2Z/6C/h?a1=2011&a2=5&a3=22

    If this mornings FT report about short sellers targeting LinkedIn is true, late buyers could be in for a bumpy ride.

  17. Michael Baxter

    The backlash against LinkedIn probably does mean the share price will fall back. Just last weekend, we saw the Independent’s cover story suggest we are seeing a new dotcom bubble. This anti LinkedIn sentiment provides evidence we are not seeing a bubble, we are certainly not seeing madness of crowds, because there are too many dissenters for that.

    However, I stick by the view that many critics of the product and its valuation have failed to grasp its significance. LinkedIn is the only serious B2B network on the Internet. As such, its potential is enormous. There are two big risks, as far as I can see. Risk one, it fails to fully monetise this potential. Risk two, a new B2B network becomes the new market leader.

    As far as the first risk is concerned, the real danger relates to privacy concerns, and whether LinkedIn users will object to the information they produce about themselves being using as marketing collateral. How big a problem this will be is anybody’s guess.

    As for the second risk, as stated in the article, I think there are significant barriers to entry for this product, and a new entrant will have to come up with an extremely impressive product to knock LinkedIn off its perch.

    However, strictly speaking, a company’s valuation should be based on an estimate of future dividends discounted to give a net current value. Producing such a valuation is very difficult, and only in hindsight will we be able to say whether a valuation today is justified. I suspect that in 30 years’ time, if we were to look back on companies listed on the stock market in 2011, we would find a significant percentage were too expensive based on that calculation. Many techs, including Google and Apple, may eventually fail on this criterion. We will only be able to say for sure that the 2011 valuation was justified when cumulative dividends, subject to a compound interest calculation, exceed current valuations.

  18. Tony Brooke

    Michael,
    Thanks for that valuable reminder of a companies true valuation. I’m probably not alone in frequently losing sight of it when buying. Being blinded by wild promises and vain hopes is best left to adolescents, it’s inappropriate in the elderly, who too easily assume ourselves to be either wiser than we are or much more foolish, while our unknowable, ‘true value’ might be anywhere between at any point in time.

  19. I wound up your place a little while ago and I absolutely cannot get
    enough! Please keep writing!

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