Work and Play on the Web: a Look at LinkedIn and Facebook. Valuation and Prospects

Twitter filed an S-1 form at the Securities and Exchange Commission and became public a week ago. It will list on the New York Stock exchange and its IPO estimated to net around $1.5 billion, sources familiar to the matter say. This changes the situation in the stock market for other social/professional networking companies. The other two big players in the Western World are Facebook Inc. (NASDAQ:FB) and LinkedIn Corp. (NYSE:LNKD). Trading at considerably high valuations, do these stocks still stand as good investment options? Let’s take a look at them:

It´s All About the Valuation

Although Facebook has been laying the foundations for a huge online advertising business, most analysts and investors seem to be worried about its valuation. Trading at about 212 times its earnings, more than six times its industry’s average, a lot of growth is priced in this stock. In order to catch up with its peers, Facebook’s earnings should have to increase at least by 500%.

However, it is unfair, in some ways, to compare Facebook with the internet content and information industry, since there are few companies that can compete with it. But, if compared to Google (NASDAQ:GOOG), for example, Facebook’s valuation is more than 8 times higher. In addition, Google’s advertising income is considerably larger and more effective. Nevertheless, Facebook’s publicity income continues to rise, quarter after quarter. Furthermore, several initiatives within the company point towards changing the ways that users interact with its website.

“It has recently added a feature called Graph Search which allows users to perform similar queries that they would perform in Google Search. It also allows them to perform queries that Google is unable to do such as ‘which hotel did my friends stay at in Mexico?’ (…) These kinds of queries would have a lot more user engagement resulting in Google-like click-through, and it could take a slice of several different industries such as dating, job search and property listings, just for starters” (SeekingAplha).

Another piece of news that alters the landscape for Facebook’s advertising business is the recent announcement of the incorporation of publicity to its photo sharing service, Instagram. The company acquired the service/application last year for $1 billion in cash and equity. And this is just one of the many initiatives that Facebook is carrying out in order to augment its advertising revenue.

Despite the good prospects, this is not a time to buy in, as the valuation is no bargain. On the other hand, if you already hold Facebook stock, keep it! It is not a time to short, but rather to wait for further upside.

Valuation and Fundamentals Don´t Look Linked at LinkedIn

LinkedIn is the largest professional social networking website in the world, with more than 200 million users. However, its stock still looks overvalued; even more than Facebook’s! Trading at 625 times its earnings, more than 20 times its industry average, while offering returns and margins way below its peers’ means, this doesn’t look like a very attractive stock at the time, even though analysts expect average EPS growth rates of more than 50% per year for the next five.

The stock has almost doubled its price since the beginning of the year and the valuation doesn’t seem justified, neither by its fundamentals, nor by its growth prospects. However, its Talent Solution segment (which provides recruiters with access to LinkedIn’s database in exchange of a subscription fee), its main source of its revenue, continues to grow along with the trend of hirihng through social media.

Then again, many investors are worried about competition in developing and high-growth countries, like China and India. For instance, Viadeo has a wider user base in China than LinkedIn does. Moreover, Facebook´s competition in the professional networking segment could increase in the future. Given this situation, one most reassess the potential of the Talent Solution business. Furthermore, “heavy investments in activities unrelated to professional networking and career search may be unsuccessful and generate unacceptable returns on capital” (Morningstar).

Final Comments

Calling Facebook and LinkedIn bubbles might be too farfetched. However, investors should be aware of their overvaluations. Although both companies offer compelling growth prospects, wide user bases, strong fundamentals, and even stronger brand names, their stock prices do not match their realities. Apparently, both Tom Russo (Gardner Russo & Gardner) and Jim Simmons (Renaissance Technologies LLC) have recognized this, since they recently sold out their stakes on both these companies. [size=13px; ][/size]

If I were to invest in the social media segment, I would wait for Twitter´s IPO and see how it impacts on LinkedIn and Facebook´s valuations. However, if you need to put your money down now, my bet would still be on Facebook, not only in account of its more reasonable valuation, but also in account of its prospects going forward.

Disclosure: Damian Illia holds no position in any stocks mentioned

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