«Equity Valuation LinkedIn Corp José Miguel de Figueiredo Bettencourt Moreira da Silva Student Number: 152414022 Instructor: José Carlos Tudela ...»
1.3 Relative Valuation Relative or Multiples Valuation is, in addition to discounted cash flow models, one of the most popular company valuation tools. As (Baker & Ruback, 1999) state, “it applies the only the most basic concept in economics: perfect substitutes should sell for the same price.” The idea behind this method is exactly that, to reach a company’s value by applying its fundamentals to average industry ratios. Its ease of use and simplicity are the main reasons it is so popular among industry professionals. Furthermore, being easily understood by all levels of financial knowledge has truly consolidated its place in valuation.
In effect, (Suozzo, Cooper, Sutherland, & Deng, 2001) state that the main advantages of multiples valuation are simplicity (easy to calculate and interpret), usefulness (can provide useful information about relative value) and relevance (focuses on main statistics that most investors follow).
Furthermore, as (Goedhart, Koller, & Wessels, 2005) state, “a properly executed multiples analysis can make financial forecasts more accurate.” By combining multiples analysis to an already existing DCF valuation one can check for inconsistencies and could even serve as basis to know the range of values one is expected to reach. Therefore, multiples valuation always adds more value and robustness to a valuation report.
However, as with all models, there are some drawbacks. According to (Suozzo, Cooper, Sutherland, & Deng, 2001) the mains disadvantages are: simplicity (dilution of information), static (“snapshot of where a firm is in time”) and difficult to compare (no two companies are truly the same).
On top of that (Goedhart, Koller, & Wessels, 2005) add another issue, we have to be wary when analyzing multiples as different multiples can present different conclusions about the same company, therefore a more comprehensive analysis of the company is necessary to truly find the relevant multiples.
LinkedIn Corp Equity Valuation (Suozzo, Cooper, Sutherland, & Deng, 2001) separate multiples into two basic groups, enterprise multiples, which are connected to the value of the entire business, and equity multiples, which only values a company’s equity (the shareholder’s claim to the company).
The main multiples of the enterprise group are Enterprise Value (EV) / Sales, which is a very simple multiple but less vulnerable to accounting differences. EV / EBITDA which is the most used enterprise multiple due to being unaffected by both differences in depreciation policy and capital structure. Finally, we have EV / EBIT which is better than EBITDA when capital intensities are different within the industry.
Regarding equity multiples, the main ones are Price / Earnings (PER), which is incredibly popular especially due to the ease of access to the required historical data. Price / Book Value is commonly used when the main source of value generation stems from the business’s tangible assets. To conclude we have Price / Cash Earnings that is usually an addition to existing valuation methods due to the simplified manner in which Cash Earnings are defined that leave out many possible value generation indicators.
Additionally, we can also refer to Transaction Multiples which are taken from actual acquisitions. The idea behind these multiples is that the companies were valued at fair value and therefore are a good estimate for the price at which the company we’re studying would be sold for. With an appropriately sized peer group of relevant (similar) types of acquisitions we reach multiples that should portray the value which the market would be willing to pay for the company.
Finally, we have a specific group of multiples for Social Media and Internet based companies regarding industry specific operating indicators, which can prove relevant in estimating LinkedIn’s true Enterprise Value. These multiples are, among others, Price/Active Monthly Users (MAU).
1.4 Contingent Claim Valuation Contingent Claim Valuation or Option Pricing has two main applications, as presented by (Schwartz, 2013), which are in the natural resources industry (for example mining) and Research and Development (R&D).
In its essence this method strives to fully appraise the different options or decisions within a business. This is clearer in the case of natural resources, as it takes into account the different outcomes regarding output and price fluctuation, even adding the risk of closing the mine by calculating minimum price for production.
However, there are many drawbacks to this method, namely the amount of different variables that are necessary in order to calculate it thoroughly and the difficulty in obtaining said values (namely volatility). Given these conditions and the difference between LinkedIn’s industry and the main businesses where Option Pricing can be effective other methods will be preferred in order to reach its value.
1.5 Liquidation and Accounting Valuation The overall idea of this method is that “the value of a business is the sum of the values of the individual assets owned by the business.”6 This model presents two different approaches: Book Value Based Valuation and Liquidation Valuation.
Book Value Based Valuation is firmly based upon a thorough analysis of a company’s balance sheets and income statements. Various issues arise from this method, namely; do historical accounts present a strong approximation for future cash flows? Can we easily compare market and book values? Yet this hasn’t stopped many investors from calculating underpricing by comparing market values to book values of businesses. The best use of this method is “for mature firms with predominantly fixed assets, little or no growth opportunities and no potential for excess returns”6, which is not the case of LinkedIn.
In regards to Liquidation Valuation, this method is “based upon the presumption that they have to be sold now.”6 The main difference between this model and a DCF method is that it implies a sense of urgency and can lead to either a discount due to a “fire-sale” effect or can lead to a premium depending on demand from potential buyers that might result in and auction situation.
Damodaran, A. (2006). Valuation Approaches and Metrics: A Survey of the Theory and Evidence. Stern School of Business, New York University.
LinkedIn Corp Equity Valuation Overall the main use of this type of valuation is for companies that are in distress and methods which imply terminal values and continuous growth rates are not a realistic approach. Once again it is not the case that best fits with LinkedIn.
1.6 Conclusion After a detailed analysis of the various methods available for the valuation of LinkedIn I believe that the best course of action is to proceed with a combination of 2 of the methods presented in the literature review.
The first method I will use is Relative Valuation, since it provides a good basis for further valuation methods and gives more robustness to a valuation report. The main multiples I will use are PER and EV/EBITDA given that they are the most commonly used multiples in valuation and complement the analysis with others to increase the robustness of the results. My goal with this step is to reach values that can provide guidelines for the rest of the process, with the intent of setting a base value of comparison. I will then compliment these base multiples with more specific and industry specific indicators such as MAU users and Transaction Multiples.
Finally, I will perform an APV valuation, I choose this method over WACC or ECF due to LinkedIn’s recent capital structure changes due to continued acquisition and investment strategies which are expected to continue. It is stated in the company’s annual report that LinkedIn intends to continue its acquisition strategy and R&D expenses and will look to finance them with more equity issues and debt if necessary. Adding to this information the issued convertible senior notes and employee stock-based compensation plans up until 2021 it is guaranteed that the company will experience capital structure shifts in the coming years.
LinkedIn Corp Equity Valuation
2 Industry Overview To fully evaluate LinkedIn, it is necessary to consider the industry where the company operates and which sectors it influences. Moreover, the analysis of historical data and the features of its market will allow making educated predictions about future perspectives as well as understand its evolution.
On the other hand, it is fundamental to, after having studied the industry overall, analyze LinkedIn in particular in terms of evolution, strategy and the actions that allowed the company to be so successful as it is.
Finally, data from the US market will be very relevant, since the company is North American and it has the highest per-capita rate of users (close to 30%), despite United Kingdom and Canada having very high rates as well (around 22 and 26%, respectively).
2.1 Global Overview LinkedIn is included in the Social Network Market, which is an Industry of close to $25 Billion Dollars (in 2015) in terms of revenues, encompassing advertising revenues as well as other sources and it is predicted to keep growing exponentially, reaching $80 Billion Dollars by 2020 worldwide. Moreover, the number of users has also increased throughout the years, from 2.177 Billion in 2015, to an expected 2.5 Billion in 2017, with North America having the most users, and Asian-Pacific the highest increasing market. Besides being a very attractive market, due to its exponential growth (in terms of revenues and users) over the course of the last decade and its future expectations, Social Networks provide benefits for both individuals and companies, which reinforce the Industry’s importance and assure present (and future) investment of both time and financial resources into developing and customizing the different social media platforms to people’s goals and objectives.
For companies, benefits include: the increased knowledge and familiarity with organizations/products/services (which can translate into more visits to the company’s website for instance), feedback about hypothetical future products/services, customer appreciation and suggestions for improvement, better focused marketing campaigns, understanding the positive and negative comments and where products/services are struggling or being successful and why, improve a company’s external perception,
LinkedIn Corp Equity Valuation
identify new opportunities and allow companies to find suitable talent for available positions. As for individuals, it can increase one’s technological understanding and make them feel more comfortable with it; it helps bring people closer to one another and the opportunity to meet people that in regular circumstances would not be possible; increase knowledge about subject matters that users might not be initially interested or simply did not know about; it helps individuals present themselves by referring personal achievements, features and preferences; it can help people launch businesses, part-time hobbies or have companies/organizations seeing their profile and increasing their chances to be hired.
In summary, the Social Network Industry has been increasingly growing in terms of revenues, importance and number of users worldwide, benefitting both individuals and companies in professional and personal aspects. The next sub-topic will address the Porter’s Five Forces analysis to further understand the industry’s features and attractiveness.
2.2 Porter’s Five Forces Analysis2.2.1 Rivalry between competitors
When considering Professional/Business-oriented networks, LinkedIn is the leader, being ahead of companies such as Viadeo and XING, by having a global database of skilled and/or experienced individuals as well as being available in more than 24 languages, and more than 200 countries, leading to a more internationalized strategy and be more globally expanded. On the other hand, LinkedIn was able to keep a strong position as a leader in the hiring industry, by fulfilling companies’ needs. Moreover, LinkedIn also operates as a SNS (Social Networking Service) where it provides the possibility for clients to engage and view people’s profiles, based on general professional interests. This leads to the ability to find suitable opportunities for job seekers, while keeping a social interactivity, meaning that companies can address candidates primarily, before, and decide to hire the best candidate afterwards.
Although LinkedIn has been able to maintain a position of leadership in the Professional Networking Service (PNS), while competing with organizations such as Monster and CareerBuilder, it also ends up entering the market and suffering competition from Social Networking Services, such as Facebook and Twitter. On the other hand, although LinkedIn Corp Equity Valuation LinkedIn is a leader in the PNS environment, the market is very volatile, jeopardizing its position, and the fact that consumer preferences can change very unexpectedly. Finally, although LinkedIn offers a wide variety of features and options (free and premium) attract a lot of different segments (organizations, professionals and marketing agencies), there is not much product differentiation that allows LinkedIn to breathe comfortably in this type of environment. Having stated this, the competition and rivalry in the industry is moderate.
2.2.2 Threat of Substitutes
The threat of new substitutes is always related to the appearance of new Professional Networking Services features in existing websites and Social Networking Services (either new, or existing ones evolving into this segment too). Having said that, individuals can also search job offers in other platforms such as Facebook, for example, if the company involved does not use PNS. Other substitutes include the traditional hiring channels and online job advertisement. Due to possible entrance of new service substitutes and the existing ones in the market, the threat of substitutes can be considered moderate.
2.2.3 Threat of New Entrants