The first major social media company to go public this year was LinkedIn. This offering was a major event in the stock market, because it created a reference point against which other social media companies to could be valued. Specifically, people are always interested in trying to figure out how to properly estimate the value of Facebook.
While I’m not going to go into the complexities of valuing Facebook against LinkedIn here, I would like to clarify how it is that Linkedin creates value for shareholders. Specifically, I want to describe how it is that Linkedin generates returns on a cost-per-click basis, which it then converts into shareholder value through cash flow.
Remembering our mantra of ‘cashflow is king’, valuing a company like Linkedin is going to provide us with an excellent framework for valuing a vendor of online ad-space. Specifically, we’re going to be able to look at the returns that Linkedin generates from people purchasing ads on the site, and evaluate what kind of opportunities there are for growth in this company.
Remember, we want to look for growth, because personal investors need to assume that a stock is fairly valued at any given time. This means that we need to look for things like a low cost-per-click value, a quickly growing user base, or an ability to greatly increase functionality.
In the case of Linkedin, the initial hopes of investors were that the company would be able to increase the volume of ads that were sold, and therefore increase the revenue generated for each user of the website. Unfortunately, compared to some other venues out there, it was found that Linkedin advertising did not provide the ideal solution for high-volume advertisers.
However, it did provide an adequate solution for smaller companies (ie. Headhunters) to advertise on at a higher cost-per-click. The end result has been a situation where Linkedin has found a space in the market as a low-volume, high expense ad venue for niche purchasers. Unfortunately, this was not what investors were expecting, and the stock has performed appropriately.
As the stock begins to flounder downwards to reflect a difference in expectations and operations, Linkedin needs to be able to reengage its shareholders by setting realistic goals for growth, and delivering through sustainable implementation. Until then, it simply remains as a benchmark for valuing companies like Facebook as they come to market.
