Why the LinkedIn IPO Could Be Dangerous to your Portfolio

Last Updated May 23, 2011 8:56 AM EDT

Even if you are clued into the downside of chasing after initial public offerings, and you were content to watch from the sidelines last week as LinkedIn's IPO more than doubled in its first day of trading, your portfolio could soon face more risk courtesy of LinkedIn.

The relative merits of LinkedIn as an investment, whether it be at its IPO price of $45, or its close (as of Friday) at $93, is somewhat beside the point. What really matters going forward is what the LinkedIn IPO may unleash. The real big event last week was the number crunching and salivating among Silicon Valley's top tier of high-profile private firms and the investment bankers who'd love to escort them into the public market, as they watched the LinkedIn IPO unfold. It's not exactly crazy to think the timetable for the likes of Facebook, Groupon, Zynga, and Twitter may have just sped up, as well as for tech firms outside of the white-hot social media category.

If that's how it plays out, it will be interesting to see if a string of more eye-popping IPO debuts sets off a broader -- yes, here it comes -- stock market bubble led by the tech sector. A reprise of the 1990s tech bubble is certainly the story line that emerged after LinkedIn's one-day double. And it was on Larry Summers' radar the day after the LinkedIn IPO. The former Obama administration economic honcho and past U.S. Treasury secretary told a conference in Shanghai last week: "Who could have imagined that the concern with respect to any American financial asset, just two years after the crisis, would be a bubble...Yet that concern is increasingly raised with respect to American technology."


How to Soar from $35 to $122 Without Really Trying
A week before it went public, LinkedIn was valued at $35 a share. A few days before the big day, the IPO offering price was raised to $45. Yet during its first day, LinkedIn traded as high as $122.70 and closed at $94.25. That seems to be a long way past what some telling data points suggest is its more fundamental value. Consider these points:

  • Insiders last traded it at $35 a share. Prior to going public, shares of LinkedIn traded on a secondary private market of insiders. As reported at AllThingsD, the last private-market pricing for LinkedIn as of the end of March was $35 a share. Absolutely nothing changed in LinkedIn's business model between then and now. So the fact it now trades north of $90 a share suggests the insiders were wrong, or market sentiment has taken over. I am betting on the latter.
  • Goldman Sachs flipped LinkedIn at $45. You don't build up billions in profits and a global rep as a giant vampire squid by making it a habit to leave money on the table. Yet Goldman didn't hold onto any of its IPO shares, choosing to sell all 871,840 shares on opening day. While that is being held up as a blown call in light of how things played out for the first two days, it suggests Goldman has a strong opinion about LinkedIn's fundamental value. Goldman still exited with a tidy profit, and can watch from the sidelines to see if LinkedIn pulls a Renren. That's the Chinese social media company that went public earlier this month, had a decent price bump in the very early going, but is now trading well below its IPO price.
  • Morningstar gives LinkedIn a $27 per share fair value. Yep, $27, or about 70 percent below its Friday close. Morningstar isn't down on LinkedIn. It cites the firm's dominant market position and strong growth potential, saying "we are very positive on the prospects for the company. Still, even good companies should be bought for less than they are worth."

Comparisons to 1999 Are Overblown. For Now.

Despite what looks like way too much investor enthusiasm, the "Party Like It's 1999" headlines that drew comparisons between LinkedIn's debut and a return to those crazed IPO days are off base. MoneyWatch's John Keefe points out that overall market valuation right now bears little resemblance to the late 1990s when a massive gap emerged between profits and prices. In fact, the tech sector as whole trades at a price/earnings multiple no greater than that of the S&P 500 these days. Dave Kansas at the Wall Street Journal points out there's even a case to be made for tech titans like Google, Intel, and Cisco being value plays these days.

While the valuation of the tech sector, as well as that of the overall market, have more in common with the early 1990s than the late 1990s, that's not to suggest we're screaming cheap right now either. As MoneyWatch's Dan Burrows wrote recently, one level-headed (OK, very cautious) money manager believes that at year three of a bull run, the market is looking especially pricey. If that's your bent, the prospect of LinkedIn setting off a flood of IPO/tech enthusiasm at this juncture is plenty of reason to be even more nervous.

So what to do? Well, now is not the time for benign neglect of your portfolio, no matter how strongly you adhere to a buy and hold strategy. If the LinkedIn IPO does, in fact, trigger some sort of non-fundamental-based market rally as more firms go public, periodic rebalancing to hew to your long-term allocation target moves from solid evergreen advice to absolutely imperative advice. If LinkedIn's IPO turns out to be a one-off event, well, there's not much to worry about. But if it in fact is the beginning of a rash of pumped-up IPOs that inflates the entire market, the history lesson to focus on isn't so much 1999, but how to make sure you're not overexposed if we get another 2000.


Photo courtesy Flickr user AxelBuhrmann
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