The social media industry and its ugly stepchild, the sharing economy, could be about to melt down completely and destroy a lot of share value in the process. This is likely to occur because social media stocks, with the fascinating exception of Facebook (NASDAQ: FB), do not make money, but they are grossly overpriced.
Those that do not believe me only need to take a look at what is probably the worst social media stock around: LinkedIn Corporation (NYSE: LNKD). This turkey looks like something right out of the dotcom bubble of the 1990s with financial numbers that have no relation to the share value whatsoever.
For example, on February 17, 2016, LinkedIn was trading at $107.87 a share even though it had reported an earnings per ratio of -1.24, a net income of -$159.24 million, a profit margin of -.98% and a free cash flow of -$679.25 million on December 31, 2015. LinkedIn’s investors were rewarded with a return on equity of -4.04%.
The LinkedIn Bubble Implodes
Now for the truly frightening part LinkedIn, lost more than half of its share value in the last few months yet it was still tremendously overvalued. As recently as December 1, 2015, LinkedIn was trading at $249.82 a share. By February 9, 2016, a little over two months later it had fallen to $100.98 a share.
Now for the truly frightening part: Despite the epic losses, LinkedIn’s market capitalization still exceeded its enterprise value by $2.12 billion! On February 17 the company had an enterprise value of $11.9 billion and a market cap of $14.2 billion.
This is truly frightening because LinkedIn has lost more than half of its market capitalization in the last three months. On December 1, 2015, LinkedIn had $32.75 billion worth of market capitalization. By February 17, 2016, that number had fallen to $14.23 billion, which means LinkedIn shareholders lost $18.52 billion!
Is LinkedIn Making Money?
The truly bothersome thing about LinkedIn is that it is impossible to tell if the company is actually making money or not. Despite its troubles, LinkedIn’s revenue is increasing dramatically.
LinkedIn reported a TTM revenue of $2.219 billion on December 2014 that grew to $2.991 billion a year later. That means LinkedIn’s revenues grew by $772 million during 2015, which is impressive.
Observers will note that the negative free cash flow of -$679.25 million for the fourth quarter nearly equals the amount of revenue growth for the entire year. That indicates all the extra revenue flowing into LinkedIn is going right back out the door. When the free cash flow is subtracted from the revenue, one gets a number of $92.28 million, which is not very impressive.
That sounds bad, but what about the cash? Well, LinkedIn reported $806.98 million in cash from operations for the fourth quarter of 2015. That number has been growing steadily; it reported $568.95 million for the fourth quarter of 2014. That means LinkedIn’s cash from operations grew by $238.03 million in 2015, but the cash is still not keeping up with the negative cash flow.
Interestingly enough, LinkedIn also has some money in the bank. It reported $3.119 billion in cash and short-term investments on December 31, 2015. That number was slightly lower than December 2014 when LinkedIn had $3.443 billion in the bank.
Could LinkedIn Collapse?
This brings us to the obvious question: Could LinkedIn collapse? The answer, unfortunately, is yes because it looks like the share value was propping up the company.
This is the opposite of a value investment, much like another social media giant, Twitter (NYSE: TWTR). The difference between the two is that Twitter seems to be fairly priced by Mr. Market and LinkedIn is not.
Twitter was trading at just $17.11 a share on February 17 even though its numbers were almost identical to LinkedIn’s. That indicates that at some point in the near future, LinkedIn’s shares could fall to the same price as Twitter’s.
Is Twitter Fairly Priced?
On December 31, 2015, Twitter reported a set of numbers very close to LinkedIn. These included the following:
- A TTM revenue of $2.218 billion
- A diluted earnings per share ratio of -.79
- A net income of -$521.03 million
- A profit margin of -12.7%
- A free cash flow of $18.77 million
- $383.07 million in cash from operations
- $3.495 billion in cash and short-term investments.
- A market capitalization of $11.68 billion
- An enterprise value of $9.133 billion
One disturbing aspect of this is that Twitter’s share price was still overvalued. Its market capitalization exceeded the enterprise value by $2.457 billion, a number that is eerily similar to that in LinkedIn’s financial numbers.
Impressive Revenue Growth
This wasn’t the only curious similarity between LinkedIn and Twitter: Twitter’s revenue grew by $815 million in 2015. As I noted above, LinkedIn’s revenue grew by $772 million in 2015. For the record, Twitter reported revenues of $1.403 billion for fourth quarter 2014 and $2.218 billion for fourth quarter 2015.
Both of these companies are delivering impressive revenue growth, but what about the cash? That’s where Twitter really surprised me; it reported a massive increase in cash from operations in 2015.
In December 2014 Twitter reported $81.8 million in cash from operations. That number grew to $383.07 million just 12 months later in December 2014. Therefore Twitter’s cash from operations grew by $301.27 million in 2015!
Is Twitter a Value Investment?
Judging by that number, Twitter could actually be on the verge of becoming a very profitable company and possibly even something of a value investment. Its share price is low, and it is generating a lot of cash right now.
Investors should definitely wait to see if this trend keeps up, but if it does, Twitter could avoid the social media apocalypse and grow into something rivaling Facebook. LinkedIn, unfortunately, looks like it could take the opposite route because its cash does not seem to be keeping up with its revenue growth.
Is the Social Media Bubble Bursting?
Naturally, all this brings up the question of what happens if the social media bubble bursts. That’s hard to answer because I’m not sure that there is a social media bubble, although there is a LinkedIn bubble that is in the process of bursting before our eyes.
Obviously, the effects of such a burst would be nowhere as great as the great dotcom bubble at the turn of the century. The number of publicly-traded social media companies is small, and the amounts invested in them are puny compared to what was put into the Internet back in the day. Nor do these brands have the prominence in our culture that the dotcoms did in their heyday; I cannot remember a single ad for a social media company on this year’s Super Bowl.
A social media burst would not be that bad because most of these companies are already low priced. Yelp (NYSE: YELP) was trading at $17.56 a share on February 17 and Twitter at $17.11 a share. That means LinkedIn is something of an aberration created by Mr. Market’s insanity.
Even if it occurs, a social media apocalypse will not be that devastating. Instead, the major result of it will be consolidation: Twitter buying LinkedIn or perhaps Alphabet or Facebook gobbling up Twitter, LinkedIn and possibly Yelp.
The social media apocalypse will be a nonevent because at the end of the day, social media is nothing but a small niche in the wider Internet. It is a profitable niche but only a small one that exists as a portion of the worldwide web. If investors are interested in social media, they should take a look at Twitter; it could be a bargain.