LinkedIn IPO: sign of a second internet bubble? three reasons I don’t think so

the LinkedIn IPO

Class A shares offered

Social networking company LinkedIn (LNKD) went public last Thursday, offering 7.8 million Class A shares.  According to the preliminary prospectus, 4.8 million of them were new shares sold by the company;  the rest were secondary shares sold by existing stockholders.

LinkedIn also has Class B shares, which differ from Class A mostly in that each has 10 votes while Class As have one apiece. This is a standard device used by family-owned or other closely held firms to raise public money and have a listed stock, while retaining complete control over operations.  News Corp., Hershey and Google are other US examples.  In the case of LNKD, the insiders who own Class Bs still muster 99.1% of the corporate votes, making the class As, in my mind, more like preferred shares than common.  For Thursday and Friday, though, no one cared.

pricing and initial trading

Underwriters initially talked of an offering price in the low thirty-dollar range–maybe $32.  But as they saw the strength of investor demand for the issue, the number gradually rose to $45.

The opening trade for LNKD was $83.  The day’s low was $80, the high $122.70.  The stock closed at $94.25, on volume of 30+ million shares–meaning each share changed hands 4x on average during the day.

I was in PA

I was driving to Pennsylvania while this was going on, listening to the Bloomberg Surveillance program on satellite radio.  The reporters on the broadcast commented a number of times that this felt to them like Internet-Bubble activity of late 1999-early 2000.  When I got home, I read similar comments in the Wall Street Journal and the Financial Times.

How quickly they forget!

Yes, there are some similarities.  Both then and now are periods of very easy money policy, and extra money sloshing around the system invariably gets into speculative mischief.

But the late-1999 Fed had the money taps wide open in spite of economic strength, not like today when the central bank is fighting to reduce sky-high unemployment (how effective today’s Fed policy can be is another question).

Y2K

If you recall, the Fed’s big worry back in 1999 was Y2K–the possibility that every computer in the world would shut down at midnight on 12/31/99, stopping commerce everywhere dead in its tracks (kind of like the Lehman failure did in 2008, only worse).  That would supposedly have left us with blue screens, warm refrigerators, stuck elevators, dead machine tools and ATMs that refused to give out cash.  All our financial information might be wiped out.

In 1999, Amish farmers couldn’t replace worn out horse-drawn plows, because survivalists preparing for this potential Armadeggon bought them all up.  Silver coins were trading at 10x face value, on the idea that paper money would be worthless as developed economies fought to avoid sinking back into pre-industrial chaos.

The Fed injected a lot of extra money into the system to help ease any Y2K damage–none of which occurred.

three big stock market differences:

1.  cult of the internet back then

In late 1999-early 2000, the US stock market was flooded with internet-related IPOs.  Many of these firms had no actual businesses and little more than business plans (sometimes, not even that).  In normal circumstances, they would be looking for venture capital financing.  At investor meetings, which had a cult-like quality to them, company executives focused on concept, not near-term business prospects.

Even a survivor of the subsequent dot.com meltdown like Amazon didn’t make money back then.  The company wouldn’t turn profitable until 2003, and had negative net worth until two years later.  In my opinion, Amazon only made it because it had large follow-on offerings of stock and bonds.  But very many more, like eToys or Boo.com, went out of business as soon as they burned through their IPO proceeds.

It wasn’t just crazy IPOs, either.  At the peak of the frenzy, media conglomerate Time Warner traded half its assets for a near-worthless AOL.

In contrast to the hundreds and hundreds of highly speculative transactions in 1999-2000, in 2011 there have only been two questionable ones that I see:  the first-day price of the LinkedIn IPO, and Microsoft’s purchase of Skype.

2.  wild overvaluation in 2000

…in the TMT sector…  internet-related stocks as a group were known as Technology-Media-Telecom (TMT) stocks.  They made up a significant chunk of the overall US stock market, even before the buying frenzy began.

As I mentioned above, many e-commerce stocks had no earnings at al–and therefore no meaningful PEs.  More mature companies did have earnings, though.  And they were priced through the roof.  At the peak, Qualcomm was trading at 177x its 2000 profits; smaller chipmakers traded at even higher multiples.  Staid, slow-growing, highly cyclical communications equipment providers, like Ericsson and Alcatel traded at 137x and 110x respectively.  Similar “hot” names like Nortel no longer exist.

Brokerage house analysts like Henry Blodget (since barred from the securities industry and now a blogger) and Mary Meeker (now in vc) whose horribly inaccurate forecasts helped justify the mania, acted like–and were treated like–rock stars.

…and in the stock market as a whole

In March 2000, the S&P 500 peaked at about 28x earnings for 2000.  This compares with a ten-year Treasury yield at that time of about 6%, which would justify a stock market PE of 17.  Relative to bonds, then, stocks were 65% overvalued.

In contrast, the S&P is trading today at under 14x the consensus estimate of 2011 profits.  The ten-year Treasury is trading at a 3% yield, implying a stock market multiple of 33x.  So stocks are 60% below the level implied by bond yields.  Put another way, if stocks are fairly valued, bonds are trading at well more than twice the price history would say they should be.

3.  real rocketship IPOs back then

Yes, LNKD did double from the IPO price on its first day.  So what.  Renren (social networking in China), a first-day star a couple of weeks ago, is now trading $1 below its initial offering price of $14.

If you want to see real IPO action, take a look at UTStarcom (which still exists today).  It debuted in March 2000 at an IPO price of $18.  It closed that day at $68, up 277%, after having reached an intra-day high of $73.  It then proceeded to run up to its all-time high of $93.50–5x the IPO price–before the end of that month.  (It closed last Friday at $2.09–but, hey, it survived, which is more than you can say about most of the dot-com names.)

my thoughts

Yes, there may be overvaluation in today’s financial markets, but I don’t think it’s in publicly traded stocks.  Maybe  privately-traded equities are too expensive.  But that’s a relatively small market whose failure wouldn’t have severe negative consequences for the US economy.  For my money, if you want to see expensive, look at bonds and commodities.


2 responses

  1. I’m curious to know your reaction to Joe Nocera’s column in the NYT Friday (http://tinyurl.com/3vtc4zl). He charged that Morgan Stanley, et.al. may have scammed the owners of LinkedIn by deliberately setting the IPO’s price too low.

    • Thanks for your question. My short answer is that I don’t think the article is very good. It looks to me as if the author was under deadline pressure and dashed the piece off without giving the topic much thought–or any research. I agree that “hot” iPOs always go to favored clients. But the process is a little more complex than that. Also, I don’t see any percentage in underwriters treating LinkedIn so badly that they put themselves out of the running for the Groupon or Facebook IPOs. There’s a bunch more to say. I’ll blog about it tomorrow.

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