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The Real Winners of the LinkedIn IPO

On Thursday, May 19th LinkedIn raised U$352.8 million from its initial public offering on the New York Stock Exchange (stock symbol: LNKD). The social network company offered 7.84 million shares (8.3%) of its total 94.5 million shares.

Although the company was initially priced at U$45 per share by its underwriters, the trading opened at U$83 (+84%) and reached as high as U$122 (+173%) during the opening day, making the initial public offering the biggest internet IPO since Google went public in 2004. Two weeks later, LinkedIn stock price stabilized at around U$80 a share and the company had a market cap of U$7.5 billion.

Source: Wall Street Journal [May 20, 2011]

Many financial commentators and investors have mentioned that the valuation is totally out of proportion to be realistic and invoked the previous Dot Com bubble trends to explain their view point. The main argument relies on the fact that the company valuation is around 600 times its 2010 earnings of U$15.4 million, which puts it right next to the infamous theGlobe.com's 1999 IPO.

On the contrary, a handful of analysts advocated that the social network company was undervalued and that the company could be worth U$170 a share in a couple of years, basing their rationale instead on its fantastic, untapped global market potential.

The market will do what it will do.” – LinkedIn CEO Jeff Weiner [May19, 2011]

In reality no one should be surprised that LinkedIn’s IPO with its small share amount (8.3%), affordable price (U$45 per share) and its diluted scheme would delight financial commentators and speculators.

What is LinkedIn?

In its SEC filing, LinkedIn proclaimed itself the “world’s largest professional network on the Internet with more than 100 million members in over 200 countries and territories.” All members publish their online résumé, link in with their professional connections and allow other platform members to see their professional social graph. The social network is used in two ways: by members to reach out to other members or see job postings, and by companies to identify and acquire talent in other organizations or publish job postings.

Source: LinkedIn's SEC filing

Often referred as the “Facebook for professionals”, LinkedIn was founded by Reid Hoffman in 2002. The company was incorporated in Mountain View, CA and had 14 employees and 78,000 users at the end of 2003. Initially appealing to senior executives and mid-level managers in the US, LinkedIn has since then diversified its base to incorporate even graduate students and grown more globally, translating its interface into six languages. Eight years later, with 100 million registered users, the American company is largely ahead of its closest competitors, the French Viadeo (30 million) and the German XING (10 million). Today LinkedIn has over 1,300 employees scattered across three continents (US, Europe, Asia through Australia and India). A new member registers every second, and the platform has 44 million users in the US and 56 million outside the US [March 2011].

Despite the low number of paying members and corporate customers numbering 4.8 million (though +130% since 2008), LinkedIn has managed to increase the number of Page View Per Person Per Month (+25% YtY to 23), Unique Visitors (over 60% over the last 5 quarters), and Time Spent on each page per visit over the years. LinkedIn visitors spend an average of 16 minutes on the site per month, compared with 309 minutes per visitor to Facebook [March 2011, Comscore].

LinkedIn's Revenue
BusinessInsiders [May 18, 2011]

From 2009 to 2010, net revenue increased to U$123 million (102%), net income increased U$19.4 million (487%), and adjusted EBITDA increased to U$33.3 million (227%). In the three months ending in March 31, 2011, net revenue increased to U$49.2 million (110%), net income increased to U$0.3 million, (14%), and adjusted EBITDA increased to U$4.2 million, (46%,) over the same three-month period ending in March 31, 2010.

LinkedIn revenue is split three-ways: [1] the Hiring Solutions (42% in 2010), where companies can post unlimited job postings for a flat U$8,000 a year (compared to the typical professional headhunting services fee, which is 25-33% of the candidate’s base salary), and reach out to potential candidates; [2] the Marketing Solutions (33% in 2010), an ad platform; and [3] the Premium Subscriptions (25% in 2010) for extended features such as email, complete details information or full search capabilities.

Based on its recent first quarter's U$93.9 million revenue (up from U$44.7 million from Q1 2010, or +110%), LinkedIn could generate more than U$500 million for the entire 2011. LinkedIn is today's market leader in online Talent Acquisition, though capturing less than 1% of the U$85 billion total market worldwide [IDC, March 2011].

Who are the Winners of the LinkedIn IPO?

Corporations may choose to go public, and do an IPO to raise more capital and/or pay back early investors. With 1,300 employees, a steady revenue stream and a bright potential growth outside the US, LinkedIn was not seeking new capital to expand but was pressed to cash out by the current shareholders (Employees 30%; VCs, board members and financial institutions 70%). The IPO proposed 7.84 million shares at U$45 per share, for a total of U$352.8 million.

[a] Employees & the Founders
Based on LinkedIn's SEC filing, select employees were allowed to sell some of their shares. U$37.8 million was captured by the 28 lucky eligible employees, ex-employees and founding team members. Among them, it is worth noting that CEO Jeffrey Weiner, and Chairman and Founder Reid Hoffman each made over U$5 million.

[b] Financial Institutions
As part of the IPO, Bain Capital Venture Integral Investors, The McGraw-Hill Companies, Goldman Sachs and SVB Financial Group were also able to divest their share from LinkedIn. The four of them pocketed U$91.4 million in total.

[c] VCs & Board Members
Although no VC investor or board member sold any shares because they were not allowed to (yet), they are still the major beneficiaries of the IPO. Sequoia Capital invested U$4.3 million in a Series A funding in 2003; today at U$80 per share, their 17.3% ownership is worth over U$1.3 billion (a 287 multiple). Greylock Partners invested U$10 million in a Series B funding in 2004; today at U$80 a share, their 14.9% ownership is worth over U$1.1 billion (a 112 multiple). And Bessemer Venture Partners invested U$12.8 million in a Series C funding in 2008; today at U$80 a share, their 4.8% ownership is worth over U$366 million (a 29 multiple). When VCs sell off their combined 37.5%, the profit will generally go to their respective partners (20-30% in management fees), and the remaining proceeds to the fund investors, few will be seen back to the ecosystem.

What is worth mentioning is that the LinkedIn board member Michael Moritz, who is also a Sequoia Capital partner, will cash out twice. First, during the sale of the Sequoia Capital shares (17.8% of LinkedIn) and a second time during the sale of his personal shares (also 17.8%). And same for David Sze, a fellow LinkedIn board member and a partner at Greylock Partners, with his personal 14.9% equity of LinkedIn.

Source: LinkedIn SEC Filing

Since the IPO, LinkedIn has changed some of its shareholder mix, but still the company is majority owned by VCs, board members and financial institutions (61.2%); Founder and Chairman Reid Hoffman (20.1%), other employees and ex-employees (10.1%), and finally by the public market (8.7%).

[d] Day Traders
Shares of LinkedIn opened at U$83 on the NYSE, and went up 84% from its initial public offering price of U$45. By the market's 4 p.m. close, the stock had soared 109% to U$94.25.

LinkedIn Stock Price
Google Finance [June 02, 2011]

LinkedIn chose 5 financial institutions as its underwriters for the IPO. Morgan Stanley, Merrill Lynch (Bank Of America), J.P. Morgan, Allen & Company and UBS were responsible for organizing the sale of the 7.84 million shares and set the price. During an IPO, among other things, underwriters commit to buying all released shares but plan to sell most of them to their biggest institutional clients. By undervaluing LinkedIn’s share price at U$45, while share price immediately soared and then stabilized at U$80, the underwriters gave a U$175 million gift to their best clients, amount not captured by LinkedIn.

Why Is This Important?

Besides the overwhelming noise surrounding this successful IPO, few comments need to be made in order to see the next trends that could prove to be a game changer in the technology industry.

[1] LinkedIn is changed forever.
Becoming a public company impose new rules and responsibilities. LinkedIn will be now scrutinized every quarter and commented on vividly as a new dominant internet company in the executive search market. It will also give a vehicle to current major shareholders (VCs, financial institutions, ex-employees and employees) to offload their shares. Finally it will give LinkedIn the possibility to raise more money later on if needed. One thing for sure, now it will be very difficult (although possible) for any company to acquire LinkedIn and make it private again.

[2] IPOs are back.
After 3 years of low activity in the IPO market, LinkedIn could be the kick-starter of a new era of the social media IPO tsunami. Looking at the buzz surrounding the most stable and less risky of all “Big Five” IPO contenders (LinkedIn, Facebook, Twitter, Groupon and Zynga), public investors are eager to jump on the next band wagon. Today investors prefer remembering Google and Apple stock prices rather than the Dot Com bubble to make their decisions. Groupon is officially the next in line for IPO (June 02), Zynga will follow later this year, then Twitter and “inevitably” Facebook.
Nο one іѕ buying us, wе are going public.” – Facebook COO, Sheryl Sandberg [May19, 2011]

[3] LinkedIn set a precedent.
The American company has set a precedent for followers not only in the share offering (less than 10%), but also with the high valuation that followed the successful public introduction on the market. Many doubted the outcome of the offering as well as the large valuation mentioned in the press, but these numbers reflect the market reality. Prior to the IPO, LinkedIn was estimated to be worth around U$4 billion, compared to today's market cap nearing U$8 billion. Groupon (U$25 billion), Twitter (U$7.7 billion), Zynga (close to U$10 billion), and the crown prince Facebook (U$100 billion) will all be the beneficiaries of LinkedIn's IPO success.

[4] VCs need cash.
LinkedIn was forced to go public by its shareholders. After many years of dry outcome for its VCs, it was their time to cash out. Since there is only a handful of potential companies that could be monetized with a tremendous growth opportunity, VC firms are looking for big bets. However the main concern today is the same one as during past boom-bust cycles: too much money choosing too few deals will drive up prices. VCs will need to avoid making the same mistake as before in giving too much money in too many companies in similar spaces, which could potentially take margins out, creating a massive and rapid sector devaluation, called bubble bursting.

[5] Secondary market should be ignored for pricing.
One year ago you could have bought LinkedIn stock for U$17 a share on SecondMarket, a platform for buying and selling private company stock. Today they are worth close to U$80 a share.

LinkedIn Share Price on SecondMarket
SecondMarket [May 19, 2011]

It is now evident that the small amount of volume traded on secondary platforms such as SecondMarket or Sharespost has negatively impacted the valuation of LinkedIn. For future IPOs these second market numbers should only be viewed as a reference but certainly not seriously incorporated for a public offering valuation.

[6] Many more IPOs will come soon.
At a risk of fueling a new technology bubble, most VCs from the Silicon Valley will divest their portfolio companies through IPOs as soon as possible. The rhythm to which the best and brightest,VC backed-technology companies will IPO in the future will accelerate, leading to a strong competition for public investments.

The next wave of IPO will arrive soon and it will be big. It might be a good time to read up on the theGlobe.com story again.

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