The first 90-days of 2016 were a tumultuous time for high-profile tech stocks. LinkedIn lost 44% of its market value in one day in February, while in the first 10 days of February, Twitter lost 20% of its market value. Sadly, this marks its eighth consecutive quarter of steady decline bringing Twitter’s value 50% below its IPO.
To add insult to injury, neither company was even doing that badly: Twitter was frequently beating revenue estimates and LinkedIn had several quarters of impressive EBITDA profitability – $249 million in Q4 alone – something Twitter still struggles with. So if they’re doing OK, why has the market hammered both of these tech darlings? And what does it mean for the future of tech IPOs?
I tackle each question separately here:
Why has the market hammered both of these tech darlings?
Simple. Their future growth rates are too low.
Young tech companies are highly valued in public markets for their ability to drive regularly outsized returns — quarter over quarter — for asset managers and stockholders. Unlike mid and large cap stocks which can get by with single-digit QoQ growth rates, recently listed tech stocks are expected to see double-digit QoQ growth rates for several years.
Though LinkedIn produced a solid Q1 in revenues and profits, their growth indicators were conservative, yet again, which the public markets seem to have little to no patience for.
Both of these companies continued to reap the returns of pre-IPO product innovation and company momentum but have struggled to radically grow post-IPO.
Twitter’s stagnating user-base and poor engagement numbers are lagging indicators of struggles to evolve the product. Of Twitter’s roughly 25 latest acquisitions, nearly half are directly related to monetizing users and not about growing the product and its functionality.
For LinkedIn, though they have a diversified revenue stream across talent management, marketing and premium subscriptions, their display advertising offering is poorly differentiated from ad industry titans. “LinkedIn’s value proposition to advertisers isn’t as compelling as Google and Facebook,” says RBC analyst Mark Mahaney. As LinkedIn pivots its ad unit to sponsored updates, its legacy display ads business is “declining materially year over year.”
What do the write-downs of LinkedIn and Twitter mean for the future of public tech companies?
First, despite the press’ fascination with “doom and gloom” headlines, both Twitter and LinkedIn have opportunities to remain industry titans. With Jack Dorsey at the helm of Twitter again, and even with the shedding of several executives, there seems to be a move back to product and innovation (a return that Twitter’s boosters hope will be reminiscent to Steve Jobs’s resurgence at Apple in 1997). LinkedIn has growth potential in several new markets both geographically and across new platforms. They also have yet to even start to unlock the power of human capital. If the knowledge economy is the great driver of the overall economy, imagine the treasure trove that LinkedIn owns. They may indeed be the most undervalued of the existing tech companies.
Second, each IPO market cycle seems to value different things at different times. Pre-2000, the focus for tech was on companies with a lot of registered internet users or, in the tech vernacular of “eyeballs”- hoping for future monetization. In the tech resurgence leading up to 2008, the focus was on the ability to monetize the technology. Perhaps the 2016 write-downs indicate the market’s requirement for double-digit QoQ revenue growth. Whatever the key metrics are for a particular IPO market, it only reinforces how important product innovation and engagement are for public tech companies.
In fact, turbulent times in a company’s history are perfect breeding grounds for ingenuity. Recall that after Facebook’s IPO, their valuation significantly dipped. Many analysts were writing off Facebook and claiming it was overvalued. Only after Facebook got mobile right did their revenue growth skyrocket.
Tech companies with high valuations have demonstrated they know how to innovate, or as is common speak in the valley, “disrupt.” That reputation for innovation though carries with it a heavy burden: the need to consistently produce new products that drive massive growth, not just incremental change.
So this will not be the beginning of the end of LinkedIn or Twitter. Nor will it be the bursting of a tech bubble. This is simply a correction in Twitter and LinkedIn’s valuation. If they heed the signals from the public markets, their write-downs could be the spark they need to get back to basics: consistently releasing innovative products people enjoy using.
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