Is LinkedIn worth $1bn? Yes. Why? Because Bain Capital says it is. The stock is not public, so you and I cannot trade it. The whole notion of the average punter trading tech stocks (or the average punter's pension fund trading it on your behalf) seems rather quaint, from some bygone era. But why has the public market for tech stocks disappeared? Where has it disappeared to? Will it ever return? The LinkedIn financing offers some clues to these questions.
LinkedIn has a dominant market position, their revenues are growing like a weed, they are profitable and they have growth ambitions that require lots of capital. For the last hundred years or so that has meant a company is ready for an IPO. LinkedIn management did say something about private financing being better, due to the "distractions" of quarterly reporting. I have seldom known people refuse the IPO "golden ticket" because of "distractions". What we are really witnessing is a strange reversal of normal market rules.
The rules used to be:
- The real stars went for IPO, where you got the highest valuation. Management also got to keep some independence and could use their public currency to make acquisitions. Everything else was second best.
- Next best was to get bought by a public company with a mix of cash and stock, the idea being that the public company's stock would do well and you would get wealthy from that. If the public company acquiring you had an inflated "bubble" currency, the trick was how to get quickly to cash - ask Mark Cuban how to do that.
- Next best was to get an all cash deal from a private company. As these companies usually don't have too much cash and hoard it carefully, these deals are smaller. But if you showed some strategic value you could do well.
- If you grew slowly and made some profits you fell into a category that VCs call "the living dead". Not dead, as the business is profitably self-sustaining. But not hot enough for deals 1,2 or 3. This was where a very unfashionable firm called a Private Equity (PE) Fund stepped in. They had lots of spreadsheets showing net present value, all of which are designed to show you that your business is worth an awful lot less than you thought.
These rules determined valuation. IPO got you the highest multiple. If you have real profit growth you could get a PE multiple of 60 to 100. If your profits were growing at 60% that PE of 60 would be a PEG of 1.0 and that is viewed as a bargain. In the Private Equity world, an EBITDA multiple of 6 is bargain time and 10 is considered "frothy". EBITDA is not quite the same as PE, but it is good enough to show that these worlds (public and private) used to have 10x factor difference in valuation.
Clearly these rules no longer apply. Bain Capital is a Private Equity Fund, a rather special example of the breed and sharing some characteristics with VC Funds, but still a Private Equity Fund. And they appear to have given LinkedIn a multiple that is in the 60 to 100 range. (My calculation is based on LinkedIn statements that revenue in 2008 will be in the range $80m to $100m and an assumption that profits are in the 10% range i.e. $8m to $10m.) In other words, a Private Equity Fund is giving a public market valuation.
In which case, LinkedIn management got a good deal. They got the valuation premium normally associated with a public market without any of the hassles and uncertainties of a public market. Given the big tasks ahead for management (more on that later) that seems like a smart move.
Which begs the question, did Bain Capital get a good deal? This was Series C, so earlier investors - all of whom are top tier VC - got a paper increase in value and probably put in more cash to maintain their % ("re-upping" in deal terms). So the earlier investors did well on paper. What about Bain Capital?
Bain Capital has a first class reputation. They are separate from Bain Consulting but grew out of that strategic consulting stable. So they are not passive investors, they really look for ways to build a ton of value and historically they have done that. So it is reasonable to assume they looked at this very carefully and have a shot at making a lot of money from this investment.
However, these are clearly strange times and the strangeness is reflected in what PE Hub called the " late night infomercial", where all the investors are on YouTube proclaiming over and over again that $1bn was a screaming bargain.
So, did Bain Capital get a bargain? Well, it all depends on what management does with the money. LinkedIn is the dominant business networking site in America. That is a hugely valuable asset as switching costs are high. You could argue, correctly that LinkedIn misses key features and they are still learning how to monetize fully. But those are execution issues and they have a strong management team who can fix those issues. The simple fact of switching costs makes LinkedIn a valuable asset that, if properly managed, will generate a lot of profits.
LinkedIn dominates in America and other English-speaking markets. But we live in global markets and LinkedIn has an equivalent in Europe - Xing - that on some metrics is stronger than LinkedIn, as we have outlined here.
And the huge Asian markets are still up for grabs, with no obvious pan-Asian champion.
Using private financing for an acquisition-led global expansion is the sort of thing Bain Capital knows how to do. It is slightly foreign territory for LinkedIn's earlier investors. So, this deal seems to make excellent strategic sense.
So, this is a two horse globalization race. The American horse - LinkedIn - has private capital. The European horse - Xing - has public market investors. This does illuminate some of the bigger market questions:
- Why has the public market for tech stocks disappeared? Because a bunch of slick promoters hyped up tech stocks in the 1998 to 2000 era and some of them turned out to be outright scams. The bar is now really high - as it should be. But, on historical standards, LinkedIn looks strong enough for IPO.
- Where has it disappeared to? To Europe and Asia, which did not have the same wild boom and bust and which therefore is not suffering the same regulatory and investor pushback that we see in America.
- Will it ever return? It has to. Private Equity needs a public market at some stage for their exits to get maximum return. Public markets are still the best way for ordinary investors to operate in a level playing field and for companies to raise large amounts of capital.