In his New York Times article Waiting for Gravity to Hit Linkedin, James Stewart describes valuation methods that niche social networking sites should recognize.
Social Network Valuation Methods
Price-Earnings Ratios — To value Linkedin, Stewart rejects this method because the site is investing to expand and too new to have predictable revenues.
Price-to-Sales Ratios and Growth Rates — Stewart projects 2011 revenues for Linkedin at $450 million and uses its stock price of $99.60 to get a valuation of $8.8 billion. That yields a price-to-sales ratio of just over 30. He then compares that to mature competitors Monster Worldwide and Dice Holdings, with ratios of 1.89 and 6.58. Using revenue growth rates from the three companies, Stewart concludes that Linkedin is overvalued.
Discounted Cash Flow Analysis — Stewart reports that Ken Sana of Evercore partners used discounted cash flow analysis to determine a base price for the IPO of $65.
What about Massive Potential for Social Networking Websites?
Some argue that social networking websites are worth huge premiums because of their game-changing nature and huge potential. But, says Stewart, “It’s one thing to talk of ‘massive scale’ and another thing to achieve it.” His bottom line? Linkedin is probably overvalued at $99.60 per share. Entrepreneurs building social networking websites who are unfamiliar with accounting should understand the second and third methods when doing internal valuations. They should also appreciate the difference between niche site potential and building sustainable revenues.
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