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Profit on Facebook’s IPO By Shorting LinkedIn: $FB, $LNKD

As two of the most popular social networking sites in the world, Facebook, Inc. (NASDAQ: FB) and LinkedIn Corp. (NASDAQ: LNKD) allow users to be a part of an immersive community of their peers, though each is unique in its own way.  LNKD is geared toward professionals and aspiring jobseekers through its innovative ‘degrees of separation’ system, and even allows employers to post jobs on its platform.  Mark Zuckerberg’s brainchild, on the other hand, is predominantly a leisure-based network that can be adapted by its users to fulfill a variety of needs.  Aside from their basic differences, both company’s stocks are surrounded by a similar hype.  Although it’s a little over two weeks until shares of Facebook hit the secondary markets, investors are already lining up to buy FB stock.  Additionally, LNKD has been public since last May and has already surpassed $100 a share.  This year, investors have seen the stock appreciate 73.6 percent, though this growth may be overblown by bullish expectations.  After comparing both social networking companies’ fundamental characteristics, it seems that it may be a good idea to use a pairs trading strategy – which includes shorting LNKD – after Facebook’s IPO.

Facebook Inc (NASDAQ:FB), LinkedIn Corp (NYSE:LNKD)

A popular metric used by all Internet-based companies is ‘total users’, and in the case of Facebook, the numbers are staggering.  As of this April, FB’s user base eclipsed the 900 million mark, easily making it the largest site of its kind in the U.S.  In recent years, however, growth rates have slowed noticeably, falling from 38.6 percent in 2010 to 13.4 percent last year.  By 2014, analysts expect this rate to stabilize at just over 3 percent.  Even though this is a dramatic decrease, FB’s user base will be in the 1.5 billion range by this time – still significantly higher than any of its competitors.  Speaking of which, LinkedIn currently has over 120 million users, and it is still growing quite swiftly.  The professional networking site’s user base expanded by 60 percent last year, and corporate clients grew at an even quicker rate of 140 percent.

In fact, it is LNKD’s focus on career-oriented users that allows it to have a more diversified income stream than Facebook.  While around 85 percent of FB’s revenue comes from advertising, LNKD’s ad sales only make up 30 percent of its top-line.  The other 70 percent is split almost evenly between ‘premium subscriptions’ and ‘job listings’.  Last week, LNKD reported Q1 revenue of $188.5 million, more than double the company’s first quarter figures in 2011.  These totals still dwarf in comparison to Facebook, which reported over $1 billion in Q1 revenue this year.  It was just three years ago when FB’s earnings abilities were in the ballpark of LNKD – but the original social network has skyrocketed since then, as it has placed a bigger focus on charging companies for the usage of its services.  The most notable of these companies is Zynga, Inc. (NASDAQ: ZNGA).  Most widely known as the developer of ‘FarmVille’, ZNGA is charged a fee to integrate its games into the Facebook platform; these fees now account for 12 percent of FB’s top-line.  In total, FB’s revenues from this arena have doubled in the past year, and the future looks bright.  One potential cash cow that has gone untapped is the iconic ‘connect through Facebook’ option that appears on every site from ESPN to Vimeo.  While there is currently no charge for this synch feature, it is possible that FB may consider such a fee in an effort to diversify its income stream further.  This potential ‘connectivity fee’ is a clear advantage that the company has over LNKD, as most users do not want to mix their professional profiles with leisure sites.

A final advantage that FB may have over LNKD lies with its IPO valuation.  Wall Street estimates that shares of FB will cost between $28 and $35 a share, meaning that the stock’s P/E ratio would between 80 and 100 times earnings.  While a multiple this high seems steep, consider the fact that LNKD currently trades at a P/E north of 1,000X.  Now it is obvious that investors are trading on LinkedIn’s future earnings, but Forward P/E analysis tells the same story.  Based on earnings estimates over the next 12 months, LNKD’s Forward P/E is 108.3X.  Based on average estimates of FB’s future earnings, its stock will be valued at a Forward P/E of 60X.  Heck, even if the company’s earnings stay flat – which would be about as likely as the Mayan calendar being correct – FB stock would still be undervalued compared to LNKD.

While it should be noted that at these valuations, FB’s earnings would be more expensive than mainstream tech stocks like Google, Inc. (NASDAQ: GOOG), Apple, Inc. (NASDAQ: APPL), and Yahoo! Inc. (NASDAQ: YHOO), investors can profit by using pairs trading.  As mentioned above, this strategy would prove successful if LNKD’s valuation metrics are higher than those of FB.  Hedge fund and insider activity seem to validate this conclusion, as managers like Steve Cohen have been buying FB in bulk, while LinkedIn’s CEO Jeff Weiner and VP Erika Rottenberg have been selling LNKD since the stock eclipsed $100 a share.  Come May 18th, it may be wise for individual investors to go long FB/short LNKD for a solid profit.

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