Are investors nuts for LinkedIn?

May 20, 2011

By Kathleen Brooks

Who would have thought that LinkedIn — the business social networking site launched in 2003 — would at one point be worth more than $90 a share on its first day of trading, within minutes doubling its $45 opening price?

Not the banks who managed the IPO or analysts who priced the stock prior to the listing. Neither did the naysayers who thought $45 (the equivalent to 17 times 2010 earnings of just over $243m) was way too high a price to list at in the first place.

LinkedIn raised its guide price for the stock by $10 earlier this week, but the sharp appreciation of the stock warrants some close attention. Firstly, why wasn’t the pre-IPO guide price a better indication of where the stock would actually trade once it went live on the market? Secondly, why are so many people interested in LinkedIn? Lastly, will LinkedIn continue to trade at these lofty levels.

Looking at the first point, we don’t know why the $42-$45 guide price was so far off the actual trading price. Within the first two hours of trading in New York more than 11.5 million shares had changed hands. So how did the underwriters and the company massively under-estimate demand?

In fairness to them the market doesn’t have much experience of trading social networks. Renren – a Chinese type of Facebook – listed on the New York Stock Exchange earlier this month. Volume was a little over 9 million on the first day of trading and the stock jumped from $14 to $18. Using this as a benchmark, however tentative, means that while a bounce was expected a 100 percent premium on the opening price surpassed even the most ambitious expectations.

The proceeds from the LinkedIn listing were to fund existing operations and expand its business, possibly through acquisitions. Its management may well be kicking themselves that they hadn’t placed more shares and raised more money especially since the price of its rivals are likely to soar on the back of its success in the stock market.

All of this suggests that analysts, underwriters and even the management of these companies have no real way of predicting how well a social or business network will perform in the markets. After all these companies are the new-wave of tech stocks and little is known about their earnings stream and how sustainable the business model is.

What is known is that the internet is likely to continue to be a major force in the global economy and combined with this people have become accustomed to free access to the net (Facebook is totally free, while Linkedin charges for a premium service alongside its free service). Combining free access with revenue streams is the Holy Grail, which makes LinkedIn so enticing.

So if the experts haven’t convinced anyone they know how to price these companies, how can regular investors know whether or not it is a good deal? Worryingly, there must be some people who are using LinkedIn as a proxy for other social networking sites that are yet to come to market like Facebook, so this IPO is a bit like an experiment for the entire industry.

The difficulty in analysing these firms levels the playing field for the institutional big guys and the individual investor. Both types need to take a leap of faith that social networks will continue to thrive. While there may be some fatigue around social networks and the torrent of status updates and likes, LinkedIn is a useful tool for anyone who works – after all, it’s a good way to connect with recruiters and most people need a job.

No one expects this frenzied trading of LinkedIn shares to last indefinitely and a cooling off period is to be expected in the coming days and weeks. But whether or not these companies will thrive in the long term depends on the ability of Facebook, LinkedIn etc. to help advertisers sell stuff to their growing base of users. This is a tall order but it is the only way to fuel the share price going forward.

Kathleen Brooks is research director at forex.com. The opinions expressed are her own.

Image — A banner announcing Linkedin Inc. listing on the New York Stock Exchange hangs on the face of the building in New York, May 19, 2011. REUTERS/Mike Segar

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