05.17.11

LinkedIn's Big Ripoff

With Facebook and Twitter still privately held, investors are hot for the next best thing with the networking site's public offering. But once the banks and insiders get their fill, Gary Rivlin asks, will mom and pop investors get burned?

Thinking of buying shares of LinkedIn, the social networking company scheduled to make its stock market debut on Thursday? You might want to reconsider after listening to David Menlow and other investment pros who spend their days monitoring the market for initial public offerings.

Sure, buying shares in LinkedIn makes sense if you’re a favored client of Morgan Stanley, JPMorgan Chase, Bank of America, or any of the other big banks putting together the LinkedIn deal and have access to the inside price, says Menlow, president of IPOfinancial.com, an independent research company. But for those purchasing shares once LinkedIn starts trading on the New York Stock Exchange and the price soars?

“I’d put those people on suicide watch,” Menlow says. He anticipates those buyers will wind up paying “tree-top tall prices—and then finding the limb they’re out on breaking."

LinkedIn might be more of a niche player in social media than its better-known counterparts like Facebook and Twitter, but it’s the first big social media company to hit the stock market—and therefore its public offering is promising to be the hottest tech IPO since Google went public in 2004. “The mentality that’s out there is, ‘We can’t get into Facebook, we can’t get into Twitter or Groupon or whatever, so we’ll pay whatever it takes to get into this uncorrelated proxy for those offerings,” Menlow says.

Menlow is hardly alone in his skepticism. On Tuesday, the big banks behind the LinkedIn deal bumped the anticipated price for the LinkedIn public offering by $10—from an already sky-high $32 to $35 a share to $42 to $45 a share. The demand among their favored customers has been that high. That’s prompted Fred Hickey, editor of the Hi-Tech Strategist newsletter, to conclude that an investor would be “crazy” to buy a piece of LinkedIn at that price.

When LinkedIn goes public, it’s expected to have a market value exceeding $4 billion, which will make it worth—presto!—more than RiteAid, Goodyear Tire, Kodak, or Office Depot. Yet LinkedIn’s profit margin last year was a meager 6 percent—“pennies on the dollar,” Hickey says, and hardly the kind of bottom-line that would justify so steep a stock price.

Money manager Barry Randall is inclined to agree. Randall, who runs the small, tech-centric Crabtree Fund, sees LinkedIn as a “very solid player with a very solid brand name.” But he also won’t be scooping up shares in LinkedIn when the company makes its stock market debut. Maybe in a few weeks when the stock stabilizes, but not now.

“Some might say the company is overpriced,” Randall says. “I’d say it’s ‘premium valued,’ which is just a ten-dollar Wall Street phrase for the same thing.”

“Some might say the company is overpriced,” Randall says. “I’d say it’s ‘premium valued,’ which is just a ten-dollar Wall Street phrase for the same thing.”

These are hardly the madcap days of the dot-com boom. LinkedIn, which launched in May of 2003, booked $243 million in revenue last year. The company has been profitable five quarters in a row. Not great, but also not Pets.com. LinkedIn earns about one-third of its money via advertising and another quarter comes from the sale of premium subscriptions to those seeking a broader range of services from this professional networking company. The remaining 42 percent of its revenue comes from what the company calls its “hiring solutions” business—in English, the fees it charges corporations, head hunters, and others to search for potential job candidates.

In the prospectus that every company must publish before going public, LinkedIn boasts that it’s “the world’s largest professional network on the Internet” with more than 100 million members. Except LinkedIn then confesses in the same document that it can’t be sure how many members it has:

“The number of registered members in our network is higher than the number of actual members because some members have multiple registrations, other members have died or become incapacitated, and others may have registered under fictitious names. Given the challenges inherent in identifying these accounts, we do not have a reliable system to accurately identify the number of actual members.”

And then there’s the question of how many of those registered users, dead or alive, actually use the site. “A substantial majority of our members do not visit our website on a monthly basis, and a substantial majority of our page views are generated by a minority of our members,” the prospectus reads.

In other words, LinkedIn has tens of millions of users scattered in 200 countries around the globe. The problem is that only a small fraction of them even visit the LinkedIn site in a given month.

Yet there’s also no denying that the demand for LinkedIn is huge. It’s rare, David Menlow says, for a stock to see a 30 percent bump in price in the days leading up to a public offering. But that’s what happened when the bankers hiked the price by $10 a share on Tuesday, which tells him that the price of LinkedIn is likely to soar. “I think the opening is going to be substantially higher than $50,” he says. Much higher, he says, when pressed.

That’s why Menlow thinks LinkedIn at the insider’s price is attractive—and why Scott Sweet of IPO Boutique, a company that runs an IPO rating service, has been recommending the stock to his high net-worth clients.

Sweet, who has 38 years in the business, is buying LinkedIn at the insider’s price. So, too, is practically every last one of his clients. But don’t expect them to hold on to their LinkedIn shares for very long.

”I think they’re thinking they’ll capitalize on the euphoria and will probably sell quickly,” Sweet says. Here the comparison to the dot-com era is spot on, when the greater fool theory of stock investing reigned.

“People don’t have to care about the fundamentals of a stock,” says Hickey. “So long as they think the stock is going to go higher, they know there’ll be the greater fool out there willing to buy if the story is a good one.” And with LinkedIn able to sell itself as a hot social media company, its story is sizzling right now.

Journalist Gary Rivlin is the author of five books, including Broke, USA: From Pawnshops to Poverty, Inc.—How the Working Poor Became Big Business. He has worked as a staff reporter for The New York Times, where his beats included Silicon Valley and New Orleans after Hurricane Katrina. He is a special correspondent for Newsweek and The Daily Beast.