This is a must read for LinkedIn Investors.
“When the ducks are quacking, feed them.”
This was one reader’s sardonic comment left on a Reuters Breakingviews commentary about high-flying LinkedIn’s recent sale of stock worth $1.2 billion at $223 a share. It raises a question about such hyped share sales. They are no doubt good for LinkedIn and its advisers, but do they benefit LinkedIn shareholders? Or do they just feed a trading frenzy?
That shares of LinkedIn are on fire is not in doubt. LinkedIn went public at a price of $45 a share in 2011. Since then, the stock price of the business-oriented social networking company has steadily risen, even as Facebook went through a troublesome initial public offering from which it is just recovering. LinkedIn shares closed on Tuesday at $252.17. At that price, LinkedIn, which had just $688 million in revenue for the first six months of its 2013 fiscal year, has a market value of nearly $33 billion, according to Google Finance. As for earnings, something Silicon Valley typically scoffs at, LinkedIn actually makes money. Last quarter, it had net income of $26 million — not much, but something.
LinkedIn is a real company with tremendous growth potential, but let’s face it: with these earnings and revenue figures, LinkedIn’s stock price is in nosebleed territory. LinkedIn trades at a price-to-earnings ratio of 722. For comparison, Facebook stock trades at a ratio of 165 times price to earnings and Google 27 times price to earnings.
Selling more of your stock when it is in high demand, even superhot, is not unique. It is also not unusual to see technology companies with no earnings and not much revenue sell stock. We saw it in the Internet bubble.
In May, Tesla, the highest of all the high-flying stocks on the market right now, sold $360 million worth of stock at the price of $92.24. Since then, Tesla stock has only gone higher. It now trades at $166.37 a share, giving it a market capitalization of $20 billion for a car company. Yes, a car company.
Research on secondary stock offerings, offerings of stock once the company has already traded, has shown that in general, they tend to underperform the market. That is not surprising. Management knows its company the best. Assuming it wants to maximize the value of its stock, management will sell stock when it thinks the stock is overpriced, and buy when it thinks it is underpriced. That is why stock buybacks are all the rage on Wall Street. They are a signal to the market that the company’s shares are underpriced.
Indeed, one of the things that happened in the Tesla stock sale was that its founder,Elon Musk, bought an additional $100 million of stock. This was no doubt deliberately done to ameliorate this well-known problem and send a countersignal to the market. After all, if management — and Mr. Musk at that — is buying part of the stock, the sale is more likely underpriced, not overpriced. Then again, Mr. Musk owns about 26 percent of Tesla, a stake now worth over $5 billion, so what’s $100 million more?
Because of the quality problem with secondary offerings, they are often sold at a discount to the share price at the time. In LinkedIn’s case for example, the shares were sold for $223 a share, a discount of almost 7 percent from the closing price of LinkedIn stock on Sept. 4, the day the offering was priced.
According to one study, the average discount for a secondary offering is 2.75 percent. The higher number here is most likely a result of LinkedIn’s share price. Given its volatility and heights, buyers wanted to make sure they had enough room to make a profit. And given that volume in LinkedIn shares was more than double the norm on the day after the offering, at six million shares, it is likely that most buyers of the stock were simply quick to flip it.
Secondary offerings are big business. According to Dealogic, $184.3 billion worth of stock was sold last year in secondary offerings. But in most cases these were intended for specific purposes or otherwise just normal capital markets fund-raisings.
But in the case of LinkedIn, and Tesla, too, these secondary offerings are different. They are sales in a trading mania. And make no mistake, there is a frenzy around these stocks, particularly Tesla. When a college student puts his entire savings of$30,000 in Tesla and sees it go to $250,000 but still doesn’t sell — well, you know you have probably seen this movie before.
There is a real likelihood that this could all end in tears, and I say that as someone who back in the tech bubble bought Ask Jeeves at $180 a share.
At this point, the question becomes whether LinkedIn has a responsibility here not to sell shares, given the place of its stock price.
It’s a hard call really. The ducks are quacking, and there is money that can help the company later on if things go completely awry. But companies should also be looking after the best interests of their shareholders.
LinkedIn did not respond to a request for comment.
It is easy to say that the company can sell stock, so it should. But it was that kind of behavior that got us into the tech bubble and the tremendous crash that came afterward. As Reuters Breakingviews wrote in praising LinkedIn for selling at such a high price, perhaps LinkedIn “will eventually reverse the trick and repurchase stock at a bargain-basement price.”
That is the real risk here. The stocks may be going up now, but if the past is anything on Wall Street, these big stock run-ups are too often accompanied by falls.
That is what it comes down to. Do companies have a responsibility to halt a crazy run-up in their shares and to look out for their shareholders? There are reasons to think that they do, but it’s clear for Tesla and LinkedIn that they seem fine with feeding the animals.