Financial Management: LINKEDIN Company Diagnostic based on 2011 10-K

LinkedIn: Company Case Financial Management Class 203a

Alexandra Brooks, !""#!$%#

[email protected]

LinkedIn: Company Case | 2

CONTENTS

A. Overview 3

B. Trend Analysis of Sales and Earnings Growth 5

C. Analysis of Operating Efficiency, Liquidity, and Solvency 7

D. Analysis of Cash Flows 8

E. Own Question 12

Appendix 1 – Calculations and ratios 14


A. Overview 1. Company name and locations

Name: LinkedIn Corporation

Head office: Mountain View, California, USA.

Other primary locations: Amsterdam, The Netherlands; Delhi, India; Dublin, Ireland; Melbourne, Australia; Paris, France;

Stockholm, Sweden; Omaha, New York, Chicago, and San Francisco, USA, Brazil, Germany, Italy, and Spain.

2. Where in the life cycle is LinkedIn?

LinkedIn Corporation is currently in its growth phase, it was co-‐founded in 2003 by former CEO and current chairman Reid

Hoffman. In 2011 the company was the first major social networking company to file an IPO and the biggest internet IPO

since Google. The company used the proceeds for more investment. Having built a competent management team led by

former Yahoo! executive CEO Jeff Weiner, the company has in the last 2 years begun to go through a phase of small

acquisitions, opening new sales office locations internationally as well as continuing to invest in R&D and member

acquisition in order to attain a critical mass of member. More than half of its member base comes from outside the US, and

it offers its services in half a dozen languages.

LinkedIn Corporation is currently in its growth phase, co-‐founded in 2003 by former CEO and current chairman Reid Hoffman. In 2011 the company was the first major social networking company to file an IPO and the biggest internet IPO since Google. The company used the proceeds for more investment. Having built a competent management team led by former Yahoo! executive CEO Jeff Weiner, the company has in the last 2 years begun to go through a phase of acquisitions, opening new sales office locations internationally as well as continuing to invest in R&D. More than half of its member base comes from outside the US, and it offers its services in half a dozen languages.

3. Using its financial report, provide an overview of LinkedIn’s

(a) Core activities:

LinkedIn generates revenues from enterprises and professional organizations by selling its hiring and marketing solutions

both offline, through the company’s field sales organization, and online, through its the website. It also generates revenue

from subscription service fees from members, who are either private individuals or enterprises, subscribing to LinkedIn

premium services.

(b) Primary goal and the main strategies being pursued to achieve the goal(s);

LinkedIn’s mission is to “connect the world’s professionals and make them more productive and successful.” The firm

proposes its solutions benefit professionals and seeks to connect them with enterprises and/or professional organizations


seeking the world’s best talent. The 10-‐K also states the firm’s belief that its members come first and that this long-‐term

approach enables the organization to invest, innovate and pioneer in unexplored segments of the industry in order to

increase the value proposition of its proprietary platform and data.

LinkedIn lists six key points as part of its core strategy. These include: viral growth, serve as the professional profile of

record, be the essential source of professional insights, accessibility for members, increasing monetization while creating

value for members, and also expanding internationally. The company says that it has seen significant growth in the

international member base and has established operations in Australia, Brazil, Canada, France, Germany, India, Ireland,

Italy, Japan, the Netherlands, Singapore, Sweden and the United Kingdom. It adds that it intends to expand sales, technical

and support operations in additional locations, and expanding the member base by supporting local languages.

(c) Primary opportunities and risks associated with the goals and strategies.

• The firm is investing heavily into new technologies in order to deliver consistently high website

performance and new tools and services for members in order to maintain LinkedIn’s brand leader position;

conversely this investment may not result in the level of performance required in order to grow the

membership base and if the security of the website is compromised this may also affect LinkedIn’s business.

• Putting members first is a cornerstone of the company’s philosophy and the management believes this

is the best way to build a critical mass of members that will result in beneficial network effects promoting user

experience, increasing value for all members. The risk however, is that this strategy may conflict with the short-‐

term interests of the business, and the end result may not be the long-‐term benefit envisaged.

• The company’s current expansion in international markets opens up the opportunities to successfully

enter new markets and increase the LinkedIn footprint, however, operating in different countries means

different laws and compliance could induce the firm to incur additional costs and change its business practices.

4. What “industry” is LinkedIn in? Is your company an industry leader?

The Internet Information Provider (IIP) industry is populated by customer facing firms that generate their sales by

specializing in creating and / or aggregating content and then attracting visitors to their site through the generally free


provision of such content. Companies that are part of this industry have mass consumer focused Web sites that supply

“neutral” information; supplying information from a variety of sources and generally refrain from selling a proprietary

product to readers – that is, in the main they aren’t selling tangible items like property or services to viewers. Their

customers, in a business model sense, are not visitors. The visitors serve to convince advertisers to buy ad space or

solutions on the site or across their networks.

In comparison to the other players in its industry, LinkedIn’s Market Capitalization is relatively small at $9.6bn; the top

players in the industry include internet and software corporation Google ($200bn), and social media site Facebook (offered

for IPO later in 2012 with some analysts estimating a valuation of $100bn.)1. Job board Taleo acquired recently by Oracle

for $1.3bn competes against LinkedIn’s hiring solutions business, while LinkedIn’s most-‐like social networking public

competitor is German professional networking site Xing (valued at €267.50m/$352m.)2

In relation to its segment, which could be described as “business-‐related social networking” it is the market leader with a

reported 150m members. Competitors include France’s privately owned Viadeo, established in 2004 (with 40m members3),

and German XING (11m members4) established in 2003.

B. Trend Analysis of Sales and Earnings Growth

Table1: LinkedIn - Common Size statement of operations data (redacted) Year Ended December 31 000s$ / % 2011 2010 2009 2008 2007 Net revenue

$522,189

100% $243,099

100% $120,127

100% $78,733

100% $21,486

100%

Cost of revenue

81,488 15.6% 44,826 18.4% 25,857 21.5% 18,589 23.6% 7,384 22.7%

S & Mktg expense

164,703 31.5% 58,978 24.2% 26,847 22.3% 16,986 21.5% 5,037 15.5%

Product develop’ Expense

13,222 25% 65,104 26% 39,444 32% 29,366 37% 11,578 35%

Gross margin

440,751 84.4% 198273 81.6% 94,270 78.5% 60184 76.4% 25102 77.3%

OpEx 496,344 95% 223,523 92% 123,482 102% 84,272 107% 32,918 101% Operating Income

22942 4.3% 18966 7.8% (3125) (2.7%) (4232) (5.3%) 341 1.04%

1 Top Internet Information Providers Companies by Market Cap http://finance.yahoo.com/q/in?s=LNKD accessed 3/13/12 2 Xing AG snapshot http://investing.businessweek.com/research/stocks/snapshot/snapshot.asp?ticker=O1BC:GR acc 3/7/12 3 Viadeo Homepage http://www.viadeo.com accessed 3/13/12 4 XING homepage http://www.xing.com accessed 3/13/12


Net Income

11912 2.3% 15385 6.3% (3973) (3%) (4522) (5.7%) 328 1%

Other income (expense) net

2903 0.55% 610 0.25% 230 0.02 1277 1.62% 773 2.3%

Other data Adj EBITDA 98,713 18.9% 47,959 19.6% 14,651 12.2% 5,461 7% 3,480 11% # members (000s)

144,974 90,437

55,111 32,307 16,712

1. Sales growth

LinkedIn has experienced accelerated revenue growth as the adoption of social media in business enters the mainstream

and infiltrates the professional community. LinkedIn’s corporate webpages report that as of February 9, 2012 the website

has over 150m members (145m members were reported as December 31, 2011), in 200 countries, and that professionals

are signing up to join LinkedIn at a rate that is faster than 2 new members per second.5 The company has shown consistent

growth over period 2008 to 2011 seeing net revenue grow from $78.8m to $522.2m, a compounded annual growth rate of

approximately 88%.

The mix of revenue generation from the firm’s hiring solutions, marketing solutions and online sales of premium

subscriptions has also shifted over the past few years. Since 2008, net revenue from its hiring solutions has increased as a

percent of revenue to 49% at the end of Q1 in 2011 indicating growing market penetration of online hiring solutions.6

Over the next two to three years, we should expect to see sales continuing to grow as the company’s international

operations ramp up, its membership base grows, and the rise in hiring and marketing solutions are adopted by firms

seeking to bypass traditional recruitment and marketing methods in order to access talent. I assess that as the company

has a management team that will be able to manage through the different stages of growth and handle the challenges to

come. Now that membership has passed 100 million members the firm is entering territory where it has enough critical

mass in terms of being part of people’s on-‐line brands it will be difficult for a firm to launch a competing offering –

excepting the entrance of a lower cost substitute into the market.

5 LinkedIn: About Us http://press.linkedin.com/about accessed 3/13/2012 6 LinkedIn Corp Form 424B4 filed 05/09/11


2. Operating income

Operating earnings outpaced sales, although there was some volatility in year-‐over-‐year in this. Over the past five years the

company’s operating earnings have remained volatile as LinkedIn has concentrated on growing its offering and acquiring

members in order to attain critical mass during its start-‐up phase. Looking at the firm’s common size statement it is

evident that as the company is moving into its post-‐IPO phase. Product development spend, sits at quarter of revenues in

2011, trending down from over a third in 2007/2008. On the other hand, sales and marketing expenses have risen

consistently from only 15.5% five years ago to nearly a third of revenue in 2011. Operating costs have fluctuated,

remaining high. Gross margin has consistently improved over the period, while costs for SG&A and Depreciation and

Amortization (not shown in common size statement) have remained relatively constant at around 15% and 8.5%

respectively (averaged over the period 2008-‐2011.)

3. Net income

As with operating income, the firm’s net income has been volatile, emerging from losses incurred in 2009 and 2009, in

2010. As detailed above this is due to the company focusing its resources on developing its products, entering new

markets, and member acquisition. Other income (loss) expense, net over the period has moved from positive to negative.

The firm reports this as primarily of the interest income earned on cash and cash equivalents, investments, foreign

exchange gains and losses, and changes in the fair value of a warrant during 2010 and 2009. Therefore taking into account

the firm’s international expansion, a strengthened dollar since 2009 has impacted net transaction losses on foreign

exchange.

C. Analysis of Operating Efficiency, Liquidity, and Solvency 1. Operating efficiency: Turnover ratios.

LinkedIn’s Asset Turnover ratio is fluctuating around between 1.3 and 0.9, the market average is low around 0.3, the

industry at 0.67 indicating that LinkedIn’s asset turnover is more efficient than its immediate competitors and the IIP

7 Hoovers Corporation Profile: Competitive Landscape -‐ accessed 2/25/2012


industry as a whole. Likewise the increasing Property & Equipment ratio indicates the company improving its effective use

of its fixed assets to generate revenue and is nearing the fixed asset average for the industry. Finally using the 3-‐fiscal data

available, the company’s receivables turnover is fluctuating above the industry average indicating a better than average

ability to extend credit and collect. Other measures that an analyst would rely on would be average time spent on the site

by members, page views, user-‐generated transactions, and percentage of members returning frequently to the site. These

are non-‐financial metrics but indicative of the firm’s business.

2. Liquidity:

Over the past 3-‐fiscal years both LinkedIn’s Current and Quick ratios have hovered above the industry’s average ratio. As

the data is limited no trend was easily discerned for either ratio. The Current ratio sits well above the minimum ratio of 1 to

pay off debts and coupled with a healthy looking receivables turnover ratio the company’s operating cycle looks efficient.

The Quick (or Acid Test) ratio again indicates that the company can and has been able to cover its immediate liabilities. The

higher values indicate that the company is more liquid than the industry as a whole. The CFO turnover ratio deals with the

company’s ability to cover current liabilities from the firm’s own operations. This ratio is >1 and is slowly trending upwards.

This ties in with the company’s reliance on investor capital during its start up phase, giving it the firm its ability to cover its

liabilities and remain relatively liquid.

3. Solvency:

The company does not have any debt of material capital lease obligations. The company reported no off balance sheet

arrangements for 2011, 2010, or 2009. In terms of liability, the firm’s debt to equity ratio (total liabilities/total SE) is

trending down indicating that the company’s liability position is moving back from a position where LinkedIn’s creditors had

more money in the company than its equity holders, even more so considering the 2011 IPO. The firm’s ROA has for the

past 4-‐fiscal fluctuated slightly above the market average of 0.88% indicating above average manageme

D. Analysis of Cash Flows 1. What were LinkedIn’s 2 largest sources of cash? The 2 largest uses of cash?


a) During the past 3 fiscal years the two largest sources of cash to the company was the Initial Public Offering in 2011 that

raised $248.8 million and its follow on offering later that year which raised $177.7 million. These are recorded on the

company’s 2011 consolidated statement of cash flows.

b) LinkedIn’s two largest uses of cash were the purchase of investments at $251.1 million in 2011, and purchases of

property and equipment totaling $152.2 million between the period 2009 and 2011. These are recorded on the company’s

2011 consolidated statement of cash flows.

2. For the past 3-fiscal years, has LinkedIn’s cash flows from operations (CFOs) been adequate to fund its growth initiatives? How has LinkedIn funded the CFO’s shortfalls to fund growth?

Over the years 2009 and 2010 the company’s CFOs were not adequate to fund its growth initiatives, therefore it is apparent

that the company has been reliant upon early investment from venture capital firms. Investors of the company include 5%

stockholders founder Reid Hoffman, Sequoia Capital, Greylock Partners, and Bessemer Venture partners.8 In 2011 the

company closed its IPO and follow on offerings unlocking capital for the organization.

3. Based on your review of the cash flow statement, has LinkedIn’s growth been driven by organic growth or acquisitions?

Although positive throughout 2012 peaking at $17.9m following the firm’s IPO, the company’s Free Cash Flow (FCF) ended

2011 relatively low at $3.57m. In prior FYs 2008 through 2010 the FCF oscillated from -‐$10.42m (Q4 2008) to $8.09m (Q4

2010). The lack of free cash can be explained by the company’s significant investments into technology infrastructure,

product development, and sales and marketing in order to maintain is competitive advantage and stay ahead of the

competition.

Since starting in 2003m LinkedIn’s growth has been driven by a organic growth, since 2010 the company has begun to make

acquisitions, a number of small companies, although in comparison to the increase in revenues, this is still limited –

members are not being purchased, it is likely more technology and talent. The annual report states its aim that in 2012, it

will continue to invest in product, engineering, and sales infrastructure in order to capitalize on the long-‐term opportunity.

8 LinkedIn Press Pages: Investors http://press.linkedin.com/investors accessed 3/17/12.


4. If LinkedIn continues to grow at its recent historic rate, does it appear that its CFOs can fund this growth? How might it fund future growth?

As of December 31, 2011 the company reported having cash and cash equivalents of $339.0 million and short-‐term

investments of $238.5 million. It is likely that the existing cash and cash equivalents and short-‐term investment balances,

together with cash generated from operations, will be sufficient to meet working capital expenditure requirements for at

least the next 12 months.

If however, the company is unable to fund the costs of growth internally then the company’s management and board will

have to decide whether or not to incur debt from a bank or the bond market, (if they are able to find terms that are

acceptable to them) or to sell more stock which will be dilutive to the current stockholders.

5. During the past 3-‐fiscal years, what dollar amount of common stock did LinkedIn repurchase and what dollar amount of dividends did it pay?

Over the period 2009 – 2011 the company repurchased $953,000 of its common stock related to unvested stock options, at

the original exercise price due to the termination of employees. The company has not repurchased stock for any other

reason, as reinvesting capital into the company would yield a higher return. The company has not issued, and has no future

plans to issue a dividend, opting to retain all future earnings for use in the development of the business or for general

corporate purposes. The company does not have any debt or material capital lease obligations.

E. Accounting Policies 1. Identify and describe three of LinkedIn’s significant accounting policies/issues.

(a) Accounting issues (b) How does LinkedIn handle this accounting issue? (c) Appropriateness

1: Allowance for doubtful accounts

The firm maintains an allowance for doubtful accounts receivable based on historic loss patterns, the number of days that billings are past due, and an evaluation of potential risk of loss associated with delinquent accounts. The allowance is the company’s best estimate. As at December 31, 2011 the allowance for doubtful accounts represents approximately 5% of accounts receivable (around $5.5m.)

I think the treatment of this accounting issue as a whole is appropriate, however, the treatment does not specify if credit-‐worthiness and current economic trends would also be taken in account.


2: Determining the fair value of assets acquired from purchased businesses and liabilities assumed especially with respect to intangible assets (including goodwill).

Estimates intangible assets such as goodwill are based on information obtained from management of acquired companies and historical experience. These parameters include but are not limited to: a) the time and expenses that would necessary to recreate the asset; b) the profit margin a market participant would receive; c) cash flows that an asset is expected to generate in the future; and d) discount rates. Testing for goodwill impairment was adopted during the third quarter of 2011 in line with FASB guideline 420.

There are no mentions of any analytical tests, or how management’s experience complies with the guidelines set out in ASC-‐350. Due to the inherently uncertain and unpredictable nature of intangible assets such as goodwill, an analyst would need to assess the competency of management in depth before deciding.

3: Management decision to lease office facilities under operating leases as opposed to capital leases.

The accounting policy lays down specific criteria as to what constitutes a capital (ownership for accounting purposes) or an operating (off balance sheet, rental expense) lease. The company’s most significant estimates used by management in accounting for property leases are: a) Expected lease term; b) Incremental borrowing rate; c) Fair market value of leased asset

The company is currently undergoing considerable growth and has just floated, using operating leases will reduce any Debt to Equity ratio and increase ROA allowing it appear more liquid and maintain investor interest.

2. In light of LinkedIn’s core activities, goals and strategies, discuss why each of the accounting policies/issues identified is significant: • Allowance for doubtful accounts – as the company is undergoing rapid expansion of its operations and

growth ensuring that potential cash flow issues are warded off is important. This fiscal conservatism allows the

company a cushion. Furthermore assuming the company has made sufficient provision in its allowance for

doubtful accounts, reported earnings will not be penalized by bad debts when bad debts occur. The company’s

bad-‐debt expense ratio to revenues has declined from 1.2% in 2008 to 0.4% in 2011.

• Valuation for goodwill and intangible assets – the company has made several acquisitions of small,

private companies, primarily to acquire talent and technology. Such legal and competitive intangibles include

developed technology, non-‐compete agreements, workforce in place, in-‐process research and development and

a patent. The company’s goal in 2012 is to continue expending substantial financial and other resources on five

main areas, including technology infrastructure and product development, potential sources of intangible assets

and goodwill.

• Office facility leases – the company has all of its office leases structured as operating leases, by adopting

this accounting treatment, this means potentially smoother time-‐series of Reported Earnings, higher net income


and times interest earned ratios towards the start of the contract. Because the operating leases will be

expensed this also will assist with cash flow by not tying up cash, allowing “off balance” sheet financing resulting

in lower debt to equity ratio, and higher ROA.

3. In general, do you think LinkedIn does a satisfactory job of discussing its accounting policies?

The disclosures describe the company’s accounting, explains its estimates, quantifying how different estimates could

impact the business. The accounting policies put forward by the firm allow the reader to gain a reasonable understanding of

the business’s condition of its operations. The use of plain English and layout of the discussion is also helpful for the reader.

4. MD&A: Do you think LinkedIn does an adequate job of discussing its operations, financial position, and cash flow issues?

I believe that LinkedIn’s MD&A section does an adequate job of covering the firm’s operations, financial position, and cash

flow issues. The report is succinctly written, in plain English and gives an adequate “top down” assessment based on the

previous years’ activities, it gives the reader an indication of the management’s stance and style. It also sets out the

company’s plans for the coming year highlighting the risks and additional interpretive considerations that need to be borne

in mind when making an assessment. The messaging within the MD&A generally matches the rest of the audited 10-‐K.

One area that could be improved in the discussion is the Revenue Recognition section, which clearly states the different

revenue models but does not discuss at what point revenue is recognized/payment made, although this is laid out in

another part of the document.

The company also refers to the use of Adjusted EBITDA as an important measure used by the management and board of

directors. The use of what is essentially a measure of profitability, not a measure of actual cash earnings could be window

dressing by the company of its earnings, although the company clearly states that other measures should be referred to

when assessing the company.

E. Own Question 1. Is LinkedIn’s internal proxy non-‐GAAP Adjusted EBITDA really the important indicator the firm’s 10-‐K says it is, or this just window dressing the company’s earnings?


Why it’s important to ask: LinkedIn’s Q4 earnings announcement caused an 18% spike in the company’s stock price in February; some might argue the firm’s healthy looking Adjusted EBITDA ($34m) was partially responsible. It’s apparent that other social Internet information provider companies are also using their own versions of the EBITDA metric to ‘tweak’ earnings figures and transform net losses in previous years. LinkedIn’s adjusted EBITDA differs from standard EBITDA by its inclusion of stock-‐based compensation. Is the stock-‐based compensation component relevant?

Attempt at answering: First in order to see the difference in the numbers I compared the traditionally calculated EBITDA with LinkedIn’s adjusted EBITDA and the percentage difference between the two:

2011 2010 2009* 2008* 2007 Std. EBITDA 68,945 39,127 8,499 856 1805 Adj. EBITDA 98,713 47,959 14,651 5461 3480 % difference 35.5% 20.3% 53.7% 145.8% 63.4%

*Net income loss recorded for company in this year.

The difference over time is that the earnings of the company look better by a fifth in 2010 to nearly 150% in 2008 (a year when the company recorded a net income loss of $4,552,000) using the adjusted figures. Researching this deeper it appears that other social network related businesses use variations of this metric, like Groupon, Zynga and Overstock.com. Each has its own version of non-‐GAAP “adjusted“ EBITDA. Interestingly Facebook’s IPO prospectus has bucked the trend with no mention of EBITDA or adjusted EBITDA or any non-‐GAAP measures included.9

One could assume that the company's reliance on attracting and retaining talent through its issuance of stock-‐based compensation could be a relevant expenditure that affects profitability. Also stock-‐based compensation is a non-‐cash item -‐ the shares are not free. It is a mixed bag, because it aligns the management or employee’s interests with shareholders to see a rising share price but also incentivizes risk taking. ]

It appears that the use of positive-‐adjusted EBITDA is the organization’s way of glossing over the firm’s difficulty in achieving profits during its pre-‐IP0 growth phase.

In order to gain further insight I looked to see if there is a Q&A dealing with the use of Adjusted EBITDA on the LinkedIn

investor relations website in order to understand the inclusion of stock-‐based compensation, there was none. If I were to

research this further I would contact the investor relations department at LinkedIn for a background brief.

9 Facebook’s biggest surprise – no funny numbers, Gary Weiss, Forbes http://www.forbes.com/sites/thestreet/2012/02/15/facebooks-‐biggest-‐surprise-‐no-‐funny-‐numbers Accessed 3/18/12

Business

Financial Management: LINKEDIN Company Diagnostic based on 2011 10-K