LinkedIn tests the bubble

There is a great line in The Guardian‘s report of LinkedIn’s $3.3 billion IPO which explains how the business is valued at 13 times last year’s revenue of $243 million, which is apparently much lower than peers such as Facebook.

Um… I’m no expert in company valuations, but I am pretty sure that the common approach is to value a company based on its earnings.

If you do take this apparently old-fashioned approach, you’ll learn that LinkedIn is valued at a staggering 214 times its 2010 profit of $15.4 million.

Let’s be generous and say that LinkedIn could double its profit to $30 million in the 2011, which would value the business at 110 times earnings.

That’s still very, very steep, compared to Google’s price-to-earnings ratio of 19 times and Apple’s price-to-earnings ratio of 16 times.

Even if you use a ratio of price to earnings before interest tax, depreciation and amortisation, LinkedIn is still valued at 55 times. Very steep compared to Google at about nine times.

Apple and Google are obviously much different businesses to the emerging social media stars, but the sharp difference between these emerging social media leaders and Wall Street’s established tech stars does highlight how companies like LinkedIn and eventually Facebook will need to do a big sell job to get investors to buy into the blue sky.

As a number of analysts have noted today, this is what Wall Street calls a “story stock” – investors are being asked to buy the story, rather than the valuation.

But as many analysts with memories of the dotcom crash will tell you, buying blue sky without at least an idea of how the company can ever live up to its mammoth valuation can lead to trouble.

Indeed, remember earlier this year when we discussed the signs that a new tech bubble could be building? Finding new and unorthodox ways to value a company was given by Alan Patrick, co-founder of technology consultancy Broadsight, as the first sign a bubble can be building.

LinkedIn will float on May 19, so we will soon have a very good idea of the investor appetite for social media floats. No doubt Facebook, Groupon and Zynga will all be watching this float very carefully, and hoping it goes very well.

No doubt these companies might be more than a bit worried to hear Wall Street giant Goldman Sachs is selling its entire stake in LinkedIn into the float.

For all of that, LinkedIn does actually have a pretty good story to tell in terms of being able to monetise its traffic. As chief executive Jeff Weiner is busy arguing, the company is well placed to grab a big slice of the $85 billion-a-year global recruitment sector by offering businesses and recruitment firms a better way to find executives.

“LinkedIn aspires to replace the resume, the business card and the Rolodex,” said Weiner overnight.

“As Google is to search, and Bloomberg is to financial information, which company is the definitive leader in connecting talent to opportunity? LinkedIn connects talent to opportunity on a massive scale.”

It’s an impressive sell, but is it impressive enough to justify a business valued at over 200 times earnings? Time will tell.