«Equity Valuation LinkedIn Corp José Miguel de Figueiredo Bettencourt Moreira da Silva Student Number: 152414022 Instructor: José Carlos Tudela ...»
In the Base Case it is expected that LinkedIn become a market leader in the Talent Solutions market and a relevant player in the remaining markets. Learning shows a lower level than Sales due to being a very recent and unproven market. Marketing Solution has proven a difficult market for LinkedIn to take a part of, and with the strong competition of other social networks will be difficult to become a leading player.
Talent Solutions Marketing Solutions Premium Subscriptions
3.1.2 Operating Expenses These costs are divided, within LinkedIn, in two: General and Administrative and Sales and Marketing. An analysis of past results shows these values to be at a comparatively high percentage of total revenues when compared to peers. This is due to high costs of training, sales and marketing for the implementation and market penetration phase of LinkedIn.
LinkedIn Corp Equity Valuation
General and Administrative includes all employee compensations, except marketing and sales departments, as well as outside consulting, legal and accounting services. It is expected to remain in line with revenue for 2015 and in this scenario expected to increase with revenue albeit with a lower margin.
Sales and Marketing include employee compensations for all marketing and sales departments. Furthermore, includes costs with branding, public relations and advertising commissions payed to outside agencies in order to increase global footprint of the company, a major focus for the future. Growth in line with General and Administrative.
Another key driver of these costs is employee stock-based compensation, a very common expense given the maturity level of the company. This compensation scheme is scheduled to end by 2021 and from that point onwards it is expected to see a compensation in the work remuneration to make up the difference.
In steady state it is an industry standard to aim for a total margin of around 38% so it is visible through the model a gradual shift from the current 48% of revenues towards that much lower value around stabilization.
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Chart 3 - Operating Expenses in millions of dollars, and percentage of revenues 3.1.3 Capex and Property, Plant and Equipment (PP&E) In regards to Capex, this variable was calculated as the difference between current year PP&E minus current accumulated depreciations and previous year PP&E minus previous year depreciations. In effect Capex is the increase in PP&E from one year to the other minus accumulated depreciations.
LinkedIn Corp Equity Valuation PP&E increase was estimated as a constant percentage of revenues, as it was believed to be the necessary investment in fixed assets to ensure growth and a certain level of revenues. This conclusion was derived from the constant growth rate in PP&E of the last few years for LinkedIn, which were in line with its revenues.
Similarly, depreciation was calculated on a percentage base given the values and growth rate of past years in these values.
3.1.4 Debt LinkedIn has very little debt consisting solely of bonds issued in 2014 maturing in 2019.
For the purposes of this model it is assumed that LinkedIn will strive to always hold the optimal level of debt, as a function of interest tax shields gain and probability of default incurred with each level of debt, in order to maximize firm value.
Given the market rating towards the current bonds LinkedIn has issued it is not beneficial for LinkedIn to incur in more debt until the bonds mature in November 2019. This model assumes that LinkedIn only increases its debt to optimal levels in 2020, when the rating is a synthetic rating given by LinkedIn’s ratio between EBIT and Interest Expense (interest coverage ratio).
3.1.5 Working Capital Working Capital is the difference between current assets and current liabilities of a company and is an important figure to value a company’s health and to compute its DCF.
It is explained in the company’s annual report that all historical changes in working capital were a result of increased sales and operations. Therefore, for the purpose of this forecast, it was established that this value would increase accordingly with the company’s revenues.
We look at current assets (current liabilities) in terms of days of sales (days of costs) which are based on total revenues (cost of sales) divided by 365 days. This value is then taken and we divide the different constituents of current assets (current liabilities) by it and it gives you the average amount of days it takes for the company to receive (pay) its rights (obligations).
In the case of LinkedIn, the values of the past 2 years have rather stabilized and in regards to current assets it is close to peers such as Microsoft and Facebook, standing at 92 days compared to 100-110. Therefore, in total current assets it was estimated that this ratio would maintain in perpetuity.
However, in the case of current liabilities the value, although also stable for the past 2 years, is almost double the figures presented by Microsoft and Facebook. In the end it was decided that given LinkedIn’s specific revenue sources and operating characteristics (and since the values have recently stabilized) it was also assumed that these values would maintain in perpetuity.
3.1.6 Margins A company’s operating and gross margins are of the utmost importance in forecasting cash flows and future earnings. In the case of LinkedIn, it is expected to suffer some shifts in these margins as it matures.
In regards to gross margin, by 2014 it was around 87% which is in line with more mature companies and, as stated in the company’s report, is not expected to suffer large shifts.
Contrarily, LinkedIn’s EBITDA margin of 12.3% it is quite low in comparison to its peers. As stated by the company and other specialists we can expect this value to shift
towards the market standard of around 27% in maturity, as a result of decreasing operating expenses.
3.1.7 Taxes Although LinkedIn operates at a multinational level with operations and offices across the globe, in order to simplify (and also due to the volatility of the company’s effective tax rate over the past few years) for the purpose of the model the tax rate was set at 35% which is the corporate tax rate faced in the United States where the headquarters are located.
3.1.8 General Assumptions
All values up to 2014 are retrieved from the company’s annual reports and Thomson Reuters Eikon. 2015 values are based on the company’s estimates for the end of the year from their third quarter report. Finally, all values from 2016 to 2025 are forecasts based on the model’s assumptions and calculations.
Given that LinkedIn has a no-dividend policy no pay-outs are included in the estimations and net income transitions towards retained earnings of the following year.
Marketable securities are considered by the company to be extremely liquid and therefore they treat them internally as Cash and equivalents. The company justifies their increase in Cash and marketable securities due to a certain ratio towards the working capital requirements, therefore in the model these figures are calculated based on this ratio compensated by the increase in retained earnings.
Additional paid-in capital and goodwill are expected to remain at last levels reported by the company due to the uncertainty of their shifts and changes.
4.1 Multiples Approach As stated in the Literature Review, Multiples is the most commonly used valuation method by analysts. However, further research showed that very few analysts used this approach for LinkedIn. The reasons for this became quite clear as this approach was further developed.
The key to a robust multiples valuation resides in selecting the right peer group. Not only do you need to find companies within the same sector, preferably competitors, but also that have similar operating and financial results.
This, however, proved impossible for the particular case of LinkedIn. On the one hand LinkedIn is considered a Social Networking Service (SNS) in the likeness of Facebook, Twitter and even Alphabet’s Google+, however its revenue source and general operating strategy is completely different.
Whereas other SNS rely on advertising for their revenues, capitalizing on unique visitors and website traffic, LinkedIn’s Marketing Solutions account for less than a third of revenues. On the other hand, as a Professional Networking Service (PNS) such as Viadeo or Xing, most of its revenues stem from direct sales to companies interested in the Talent Solutions product, yet LinkedIn’s completely different market position and positioning place make its results not comparable to either of these two companies.
In order to show a broad range of results of using multiples as an approach to value LinkedIn I will present 4 tables with the summary results for Equity Multiples, Enterprise Value Multiples, Transaction Multiples and Monthly Active Users (MAU) Multiples.
These values where reached by choosing a combined peer group of SNS and PNS companies: Alphabet, Facebook, Twitter, Xing, Viadeo, Monster Worldwide and Salesforce.com.
Alphabet, Facebook and Twitter where chosen given their focus on advertising (LinkedIn’s Marketing Solutions) and capitalize well on their member base as social networks by converting them into operating results (a characteristic in common with LinkedIn).
Xing, Viadeo, Monster Worldwide and Salesforce.com where chosen due to representing (besides LinkedIn) the most mature and developed companies in the PNS and Talent Solutions market and therefore to give some weight to LinkedIn’s major source of income for this approach.
Equity Multiples provide the largest disparity within multiples classes. PER which is usually a reliable multiple here shows a large disparity towards LinkedIn’s value due mostly to low earnings expectations in comparison to its peers.
In contrast EV Multiples have a much lower dispersion in terms of values, however LinkedIn’s EBITDA, Sales and EBIT values are not in line with any of its peers and therefore the validity of these results is questionable.
This multiple is a great example of the disparity towards some of LinkedIn’s “peers”.
Although classified as a SNS, LinkedIn’s P/MAU is around 2.43 whereas other SNS companies from the peer group range close to 0.06. Which just shows that LinkedIn’s value as an SNS does not stem from traditional sources.
LinkedIn Corp Equity Valuation
To summarize the results, given LinkedIn’s stock price as of the 1st of December 2015 of $249.82, all multiples point towards it being overpriced. However, as previously stated, the discrepancies in terms of fundamental operations, revenue sources, strategies and operational and financial results do not provide a peer group robust enough for a truly comparable multiples valuation.
4.2 Adjusted Present Value Approach In this section the steps and results of the DCF approach through the APV method will be presented. As stated before, the main reason APV was chosen over WACC was due to the company’s commitment to pursue its investment and acquisition strategy through equity issues and debt. Therefore, shifts in capital structure are expected although difficult to forecast with precision.
4.2.1 Unlevered Cost of Equity
The first step is to reach LinkedIn’s unlevered firm value. Hence, we must start by finding what the discount rate applicable is. The method used to calculate the unlevered cost of equity is CAPM. Therefore, we needed three key inputs: risk-free rate, unlevered Beta and market risk premium.
The risk-free rate chosen is the 10 year US Treasury Bond which, as of the 1st of December 2015, was trading at 2,15%.
For the unlevered beta the method chosen was to run a regression between LinkedIn’s stock price variations and corresponding returns of the S&P. The regression yielded a levered beta of 1,61. In order to reach the unlevered value we had to apply the following
Where t represents the effective tax rate, which we assume to be equal to the corporate tax rate of 35%. Lastly D/E represents the debt-to-equity ratio of the firm. Running this equation leads us to an unlevered beta for LinkedIn of 1,54.
Lastly, market risk premium was based on the average return of the S&P for the past 10 years deducted by the risk-free value which lead do a market risk premium of 4,99%.
LinkedIn Corp Equity Valuation Running the CAPM with all the variables yielded an unlevered cost of equity of 9.82%.
4.2.2 Discounted Cash Flows In order to reach the unlevered firm value, we had to take the discount factor and apply it to the FCFF forecasted for LinkedIn up to 2025 and subsequently add the terminal value of the company at steady state.
The main factor in the growth of FCFF, as can be seen in the Appendix, is due to increasing operating results. Since NWC isn’t expected to suffer major changes, and Capex and other factors are linked to growth in revenues, the growth is therefore sustained on the increase of the EBITDA and, subsequently, the EBIT margin.
4.2.3 Terminal Value
The company’s terminal value represents the value a company has in perpetuity after reaching steady state (constant and close to GDP growth rate). The value is obtained by applying the growth rate in perpetuity to the FCFF of the last year in analysis and taking the constant growth rate in consideration in the discount factor with the following
Given LinkedIn’s global spectrum of operations the value used to represent growth in perpetuity was the average global GDP growth rate of the past 5 years of 2.8%.
4.2.4 Unlevered Firm Value