Glenn Solomon is a Partner with GGV Capital. Some of his recent investments include Pandora, Successfactors, Isilon, Domo, Square, Zendesk, Quinstreet and Nimble Storage. His personal blog, focused on growth stage entrepreneurs who are thinking big; can be found at here. Follow him on Twitter @glennsolomon.
In 2010, had you suggested to the smartest Silicon Valley entrepreneurs and investors that LinkedIn would have a larger market value in 2013 than Groupon, Zynga or Twitter, you would have been laughed at. Had you hypothesized that LinkedIn would be worth more than Groupon, Zynga and Twitter combined and worth nearly one-third the value of Facebook, no one would have believed you. LinkedIn just wasn’t as exciting as the internet darlings of the day, and, as a result, there were many LinkedIn doubters at that time, myself included.
While LinkedIn circa 2010 might not have been as exciting as its go-go Internet brethren, the company was clearly doing something very right, building out a product roadmap, company strategy and team that has paid handsome dividends since the company’s IPO. The case study of LinkedIn raises interesting questions for founders and investors alike: Why has LinkedIn worked so well as a public stock? What can we all learn from its IPO and after-market performance? In this post, I’ll briefly make four arguments as to why LinkedIn has performed so well:
- The value of beat-and-raise methodology on Wall Street
- Creating a deep competitive advantage and position
- Building multiple growth vectors
- Designing a product that gets better as it gets bigger
LinkedIn has played Wall Street perfectly. The company priced its IPO well below the market-clearing price, kept expectations muted and, since its public debut, has obliterated both its guidance numbers and consensus Wall Street estimates. In fact, as you can see below, the consensus Wall Street expectation for LinkedIn’s 2013 revenue has risen from $755 million at the time of its IPO in mid May, 2011, to $1.5 billion presently. Ditto for 2013 EBITDA consensus, which has climbed from $147 million at IPO to $367 million today. As revenue and profit expectations have shot up, so has the stock price.
This strategy requires patience. It takes time to build enough maturity in a business for the team to predictably deliver results and maintain visibility. On Wall Street, to quote Radiohead, “no alarms and no surprises.”
This strategy also requires the company to take a hit, a tough thing to do. The value transfer from early investors to the new IPO investors comes in the form of higher dilution or less money raised in an IPO. Most Valley folks are trained not to do this, but one has to think about paying it forward, even for Wall Street, as crazy as that sounds. If companies can make money for their investors, these shareholders tend to remain loyal and attract others who recognize the value. At the same time, management gains more and more credibility among investors, a very valuable asset for public companies.
Creating A Deep Competitive Advantage
Though it’s now obvious to us all, LinkedIn created a very deep competitive position for itself. The heart of LinkedIn is its remarkably large data set of professional information on individuals and companies. The company spent many years figuring out how to build up this corpus of information and create the right user experience to keep the data set growing in value. Arguably, no pot of money from Microsoft, Google or Salesforce.com could rebuild this data set at this point. This is the moat. The fact that it took a long time to build only makes it more valuable, and it’s not going anywhere.
Wall Street has gained confidence that a competitor cannot come up and kill LinkedIn, and on Wall Street, once the fear of credible competition evaporates, valuation multiples shoot up. To wit, while 2013 revenue expectations have nearly doubled since the IPO, as the chart above shows, the multiple investors are willing to pay for this revenue has more than tripled (from 5.2x to 17.5x). Fear of competition is subsiding and confidence in the company’s ability to exceed its guidance is growing.
Building Multiple Growth Vectors
LinkedIn built not one, but many, growth vectors. Wall Street investors love a large, addressable market, and while they don’t love when companies spread themselves too thin by going after many disconnected markets, they do love adjacent markets that leverage core assets. With this, investors can model out more growth over more time and will continue to pay up for a stock, expecting high growth rates. LinkedIn has done incredibly well at building multiple revenue streams (Talent Solutions, Marketing Solutions and Premium Subscriptions are all rapid growers that contribute a healthy share of overall revenue), increasing their product set, and moving to mobile with an aggressive iOS plus HTML5 strategy, all leveraging their core data set.
Designing A Product That Gets Better As It Gets Bigger
LinkedIn has aged like a fine wine, getting better and better with age and size. In the Valley, people focus on growth at all costs. This makes sense. Wall Street is also enamored with growth, but investors also typically love margin expansion and expanding profit growth as much (and sometimes even more).
LinkedIn has invested in its business so that the company now benefits from great profit dynamics — a fast-growing top line alongside expanding margins (EBITDA margins, for example, were up in the June quarter to 24.4 percent from 22.1 percent a year earlier). My guess is that company management opted to sacrifice more rapid growth early on in order to make sure they engineered the right model. This may explain why some didn’t view LinkedIn positively on Sand Hill in the early days, but it’s all moot now as their patience is paying off on the Street.
In the wake of the Facebook IPO debacle and recent resurgence, I’m often asked about how companies should plan for Wall Street. My answer: the more you can emulate LinkedIn’s approach, the better.