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Articles from the tag of Economy
LinkedIn got screwed?
Posted by: Joseph E Poff, CPA CITP from Auburn Software, Inc. on Wednesday May 25, 2011 at 1:08 PM   (-07 GMT) | Comments (5)
Tags | Businesses, | Economy, | Stocks | Categories: | Financial Markets - Stocks, | Economy - United States
So, wow - don't know if you followed the LinkedIn IPO- what a story - and perhaps a message for us too.

It was set to go public at $38 or $40 - something like that and when it was issued it immediately hit about $85 before hitting $115. I think a day or so later it was around $85 again.

So, what does that tell us? Well, a couple of things.

One is that LinedIn got screwed. The company itself got the $40 a share - they didn't participate in the run up to $115 or even to $85. The company got whatever it contracted for - the Initial Public Offering price of $40.

So, whoever set the IPO price of $40 should be flogged if not worse. It didn't take a braniac to figure out this stock would take off.

In fairness though, let's look at what happened. When a private small business is sold it's typically sold at the price of 3 to 7 times earnings - plus the assets. So, if the business is making $150,000 a year (after an owner's salary) and has $10,000 in equipment and $50,000 in assets then a good starting point on a price might be between $510,000 and $1,110,000 or (3 or 7 times $150,000) plus ($10,000 + $50,000). So, again, 3 to 7 times earnings plus assets.

A public company will usually go for a higher multiplier - so you'll probably find them selling for 5 - 25 times earnings.

If you think of it like this it might help to understand it. If a company is selling for 5 times earnings, then in theory you'd make all your purchase price back in 5 years and would still have your investment. A great deal.

Now, if it is at 20 times earnings - well, in theory that's 20 years......

But, what are earnings? Well, they can be based on the prior few years or using the current year as the basis for your projections. Or, you can base it entirely on projected earnings. Which is correct?

Let's say the earnings in the last 3 years were - Loss - $65,000, Loss - $22,000, Loss - $5,000. Let's also say the current earnings are $70,000. How would you determine how to value it?

It's not hard to see that since the earnings are one of the multipliers then it's probably more important in the formula than the assets in a sale. So, how this is determined is critical.

Usually, a buyer is going to want to use the lowest, most pessimistic earnings projections while a seller will paint the most optimistic projections of the future. Probably, a good number is somewhere in between.

So, as I indicated, usually in private companies 3 - 7 times earnings and in public companies 5 - 25 times earnings with the lower number 'usually' meaning a better bargain - assuming the earnings you're basing it on are reasonable.

In the LinkedIn situation, my understanding is that it reached 500+ times earnings. Oh, wow. In my simple mind, that told me it will really need a turn around to greatly increase the earnings to make that price be anywhere near reasonable. A lot of pressure on this stock - that's for sure.

This reminds me of the tech crash. When companies where coming off the IPO's (and even regular trading) and the prices were 200 times earnings - or in a lot of cases had 'never' turned a profit - I just could not understand it. It really went against all my years of training - and defied logic. But, like a dope - I finally caved in and bought into the tech bubble because even taxi drivers were making more in the market than me - not long before it did crash. (No offense to taxi drivers - it's a subtle reference to the taxi driver stock 'guru' who is now in jail)

So, 500 times earnings is like - wow. Is this the start of a new movement for stocks?

When you look at what happened, it's hard to blame the underwriter for letting the stock come out of the gate at $40 - to set it higher would have been irresponsible, but if I was LinkeIn - the company - I'd be annoyed that extra money - or some of it - didn't find it's way into the company.

Who got it then? Well, the big industrial investors got the IPO's - so they pretty much had a lock - they knew they'd be buying at $40 and selling at probably $80 - at $115 - after one day - a banker's kind of wet dream.

Of course, the founder's do well too. But, they are limited on how much stock they can sell for a few years, so they are happy to see it go to $85 or whatever. Great for them. Hard to be critical here - but notice I didn't say that about the industrial investors. But, without them a lot of lesser know IPO's might not happen.

The whole idea of a public offering is to get money for the company to expand - to do things they couldn't do without a huge infusion of cash - the kind you don't have to repay - and that only comes from a stock offering. Too bad they missed out on hundred's of millions - but all is not lost - the big Wall Street guys made out ok! Unfortunate there isn't a better system for us all to be able to participate in an IPO - I mean - what does that second letter stand for? Public I think...

All in all - an interesting side note to today's economy and perhaps a sign of optimism - a sense that better times may be coming.

Joseph E Poff, CPA

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Comments

Posted by Elly from United States posted at Thursday, November 24, 2011 15:46
Comment from Elly is -
Many many quality points there.
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Posted by Regina from United States posted at Sunday, July 10, 2011 15:45
Comment from Regina is -
Please keep throwng these posts up they help tons.
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Posted by Kaylynn from United States posted at Sunday, July 10, 2011 04:41
Comment from Kaylynn is -
Great stuff, you helped me out so much!
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Posted by Benon from United States posted at Saturday, July 09, 2011 20:00
Comment from Benon is -
Wow! Great thinking
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Posted by Jas from United States posted at Tuesday, May 31, 2011 13:21
Comment from Jas is -
Great!
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