Friday, August 5, 2016

Microsoft: $10 Billion Boost From LinkedIn Earnings

About: Microsoft Corporation (MSFT), Includes: FB, LNKD


LinkedIn's Q2 2016 earnings show that Microsoft got a bargain.
For the past three quarters, LinkedIn's actual earnings exceeded where expectations stood on February 3 2016, hence rendering the February 5, 2016 decline of over 43% in LinkedIn shares unjustified.
Microsoft shares stand to get a boost from LinkedIn.
In a recent article we published on 8/3/2016 prior to LinkedIn's (NYSE:LNKD) latest earnings announcement, "Microsoft's rebirth could boost shares by more than 20%", we had stated that we believed that Microsoft's (NASDAQ:MSFT) purchase of LinkedIn was a bargain. Now that LinkedIn has announced its earnings, our assessment is confirmed.
LinkedIn announced its earnings after the market closed on 8/4/2016, shattering all expectations. Net earnings for the quarter ending in June 2016 came in at $1.13/share vs. consensus estimates of $0.78/share, a beat by a whopping $0.35/share. Compared to same period one year ago (where LinkedIn had net earnings of $0.55/share), LinkedIn's latest net earnings results represent an increase of 105%. Meanwhile, revenues came in at $933 million, an increase in excess of 31% over same quarter last year, and exceeding consensus estimates of $898 million.
All of LinkedIn's business lines recorded impressive results. Talent Solutions revenues increased 35% year-over-year to $597 million, beating consensus estimates of $576.3 million. Marketing solutions revenues increased 29% year-over-year to $181 million, beating consensus estimates of $168.2 million. Finally, Premium Subscriptions revenue increased 21% year-over-year to $155 million, beating consensus estimates of $150.5 million.
LinkedIn stock price 5-year chart - Source: Yahoo Finance
As LinkedIn is being acquired by Microsoft for $26.2 billion ($196/share), LinkedIn shares had a muted reaction in the after-market hours following earnings release. However, if LinkedIn had not been acquired by Microsoft, what effect would such earnings have had on LinkedIn's stock price?
On February 5, 2016, LinkedIn shares dropped by over 43.6% in a single day, from 192.28 to 108.38, a drop of almost $94, erasing over $11 billion in market capitalization. Such drop materialized despite LinkedIn announcing net earnings of $0.94/share for Q4 2015 beating consensus estimates of $0.78/share, and revenues of $862 million beating consensus estimates of $558. However, LinkedIn provided a future outlook below expectations, as it announced it expected net earnings of $0.55/share on revenues of $820 million for Q1 2016 vs. consensus estimates of $0.75/share on revenues of $868.3 million. At such time, LinkedIn CFO, Steve Sordello, said:
LinkedIn's focus on sponsored content will impact short-term revenue growth in favor of the long term
Prior to Microsoft's announcement of its acquisition of LinkedIn, the social network company's shares were trading at 131.08 on June 10, 2016. The latest earnings announcement from LinkedIn beat consensus estimates by a much wider margin than the outlook disappointment provided for Q1 2016 at the release of Q4 2015 results; such outlook disappointment guided net earnings $0.20/share below expectations, while the latest earnings exceeded expectations by $0.35/share. Furthermore, earnings for Q1 2016 actually turned out to be $0.74/share, closer to analysts' initial estimate of $0.75/share, as opposed to LinkedIn's guidance of $0.55/share.
In other words, the massive sell-off of February 5, 2016 was totally unjustified, as LinkedIn's statement that caused the sell-off actually turned out to be not true. If we actually combine LinkedIn's actual net earnings results for Q1 2016, along with its latest results for Q2 2016, the combination of such results turned out to exceed by $0.34/share ($0.35 + -$0.01) where analysts expectations for such two quarters stood on February 3, 2016 before LinkedIn had provided the erroneous outlook. To add insult to injury, LinkedIn's earnings for Q4 2015, which had also exceeded expectations by $0.16/share, were totally overlooked due to LinkedIn's erroneous outlook.
Hence, the three quarter combined (Q4 2015, Q1 2016 and Q2 2016) exceeded expectations by $0.50/share. Given that LinkedIn's shares stood at 192.28 on February 4 prior to LinkedIn's announcement of Q4 2015 results, we estimate that (ceteris paribus) had LinkedIn not provided such outlook, and had Microsoft not announced its proposed buyout of LinkedIn, LinkedIn shares would be today at least at 212. We derived such value by taking the $0.50/share earnings exceedance during the combined last three quarters, annualizing them to $.667/share, and multiplying by a modest P/E ratio of 30 (while LinkedIn had been trading at a much higher P/E ratio than 30 on February 3, 2016).
Naturally, there are a lot of nuances, and an exact science does not exist to determine exactly what would have happened and where LinkedIn shares would be today following the latest earnings release for Q2 2016, if the controversial outlook was not provided by LinkedIn in February 2016, and if Microsoft had not made an offer for LinkedIn. However, we believe it is a fair and modest methodology.
Interestingly, most recently, Victor Anthony from Axiom Capital Management stated on Bloomberg that he believes that LinkedIn shares would be up by as much as 30% if LinkedIn was not being acquired by Microsoft. Using LinkedIn's pre-acquisition stock price of 131.08, that could place LinkedIn shares at 170 [assuming LinkedIn shares had recorded no change between June 10, 2016 (pre-Microsoft acquisition announcement) and August 4, 2016 (pre-earnings announcement)]. If we assume LinkedIn shares would have appreciated by NASDAQ's 5.5% appreciation between such two dates, LinkedIn shares could be at 178.5 according to Mr. Anthony. Our own derived number of 212 from the previous paragraph is higher, as we are also incorporating the scenario of excluding the controversial outlook provided by LinkedIn in February 2016.
Using our own derived price for LinkedIn of 212, and adding an acquisition premium of 30%, which we believe is a fair general acquisition premium as per NYU paper, we arrive at a fair acquisition price of $275 per share. We also believe we are being conservative, as Microsoft actually paid a premium of 49.5% for LinkedIn vs. its market price. However, Microsoft may have had an inside look at pending results for Q2 2016 (which we had incorporated into our price of 212), and hence had LinkedIn been trading at 212, they may have been less aggressive on the premium. In other words, we believe that Microsoft's acquisition price of $196/share is quite a bargain vs. our estimated fair acquisition price of $275/share, representing a savings of over $10 billion.
Given that Facebook (NASDAQ:FB) currently has a market capitalization of $357 billion, Our derived acquisition price of over $36.2 billion for LinkedIn (about 1/10th of Facebook's market capitalization) seems quite modest. This is especially true considering that LinkedIn's 450 million members are more than a quarter of Facebook's members of about 1.7 billion, while LinkedIn's latest results point to accelerated growth, while Facebook's CEO stated that he expects slower growth in the next two quarters. Furthermore, Facebook's Q2 2016 net earnings of $0.97 beat estimates of $0.82/share by $0.15, while LinkedIn beat estimates by $0.35.


We believe Microsoft got a bargain of at least $10 billion on its LinkedIn's acquisition. Furthermore, Microsoft stands to benefit from LinkedIn's improved performance, as we had already stated in our prior article referenced in the introduction. As a result, we continue to favor owning Microsoft shares, as we believe that LinkedIn will provide a boost to Microsoft shares, despite LinkedIn's small market capitalization relative to Microsoft.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MSFT over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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