Looking at the basics
As frequent readers of TNL.net know, I have to a tendency to try to run some numbers before passing judgement. Oftentimes, I discover that my hunch are correct but, almost as often, I find some interesting and surprising nugget of information in the data. Ultimately, though, it’s a question of gathering the information, something that too few people seem willing to spend time on.
So for this IPO, I decided to investigate how some fundamentals may be working either for or against the success of the LinkedIn IPO. My instinct was telling me that the fundamentals may be different now but I needed the data to assert which way things went. A lot of searching through both the web (and, as I mentioned last week, getting historical data can be hard on the web) and through paper record (books and magazines I still keep in my library), I was able to come up with the following chart:
|IPO Date||August 9, 1995||May 19,2011||August 19, 2004|
|Amount Raised||$9.5 million||$353 million||$1.67 billion|
|# of shares issued||339,285||7. 84 million||19.6 million|
|Value based on strike price||$1.39 billion||$4.3 billion||$23 billion|
|First day high||$75||$122.69||$104.06|
|End of day price||$58.25||$94.25||$100.33|
|Market Cap. First Day Close||$2.9 billion||$8.4 billion||$27.1 billion|
|Revenue||$696,000||$243 million||$1.4 billion|
|Profit (Loss)||($8 million)||$15 million||$250 million|
One of the things that become apparent at first glance is that we are talking about totally different scales of business. Netscape was a company operating at a loss ($8 million) with very small revenue (not even a million dollars) when it went public. By comparison, LinkedIn seems to be a relatively healthy business with profits of $15 million on almost a quarter billion in revenue. On the other hand, that business paled in comparison to Google, which was generating profits of a quarter billion dollars on revenues of $1.4 billion in the run-up to its IPO.
Adding to the challenge in comparing them was the fact that they were all looking to raise different amounts so I decided to play “what if” with the different stocks.
What if LinkedIn had launched as Netscape?
I decided to normalize the data based on a revenue, assuming that LinkedIn would try to get a market capitalization equivalent to that of Netscape based on revenue:
|Value based on strike price||$1.39 billion||$4.3 billion|
|Market cap / revenue||1997||17.69|
|Linkedin value assuming Netscape marketcap / revenue||$485 billion|
|Netscape value assuming LinkedIn marketcap / revenue||$12.312 million|
So, already here, we see some fundamental differences. Netscape would not even be allowed to go public today based on the paltry revenue they were generating at the time of their IPO and LinkedIn would turn into the largest corporation in the world if the same logic had been applied to its revenue stream.
What if LinkedIn had launched as Google?
But the irrational exuberance around the Netscape IPO should not serve as a way to give LinkedIn a clean pass. In order to do so, I decided to compare the company to Google at the time of its IPO. People who were around then will remember that the Google IPO happened at a time when internet stocks were mostly out of favor but Google was garnering a very strong following. In a lot of ways, Google had the media presence of a Netscape in its time but with real revenue and earnings.
As price to earning ratio are a valuable way to evaluate companies, I decided to base my comparisons between LinkedIn and Google on it. So here goes:
|First Day Close||$94.25||$100.33|
|Profit||$15 million||$250 million|
|P/E ratio at opening||286.66||92|
|P/E ratio at close||560||108.4|The difference largely comes down to the number of shares outstanding but ultimately, it looks like LinkedIn P/E ratio are not that wild and while IPO Opening day are too small a data set to really make wild generalization, it seems that the LinkedIn IPO was one that basked largely in relatively rational behavior.
If the LinkedIn IPO is an example of what this boom cycle is going to look like, we may be in luck as the markets seem to be acting a much more rational, profit-focused manner than they have in the past. My read is that there may even be some level of conservatism to the way markets are approaching internet stocks and a healthy skepticism that will benefit real companies by weeding out the ones which wouldn’t make the cut under normal conditions.
Update: Some of my calculations were wrong and, thanks to many commenters, I finally have the P/E numbers corrected. Based on the new number, the conclusion can be vastly different as the P/E ratio for LinkedIn today seems to be much higher than it was for a company like Google. Can LinkedIn be 5 times as successful as Google has been since its IPO? I don’t know. Is there some inflation due to a more optimistic market outlook? Absolutely.
At the end of the day, it looks like LinkedIn is overpriced, when compared to Google, and underpriced, when compared to Netscape. What that means in terms of investment strategy is something I’ll leave to people smarter than me to figure out.