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