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Facebook and LinkedIn Early in Monetization; Neither a Bargain

Thursday - 5/9/2013, 2:49pm  ET

During the past week, publicly traded social media giants Facebook and LinkedIn both reported strong first quarter results. Facebook’s revenue grew 38% year-over-year to $1.46 billion, exceeding consensus estimates, while earnings per share were flat at $0.12. LinkedIn’s revenue surged 72% year-over-year to $325 million driving earnings per share of $0.45—both figures were handily better than consensus expectations.

Cash flow at both companies revealed significantly different stories. LinkedIn generated roughly $59 million in free cash flow as the company’s research and development spending was kept in check. Facebook posted negative free cash flow of $12 million as the firm invested heavily in mobile, servers, and data centers. Both firms’ valuations are highly dependent on their respective long-term free cash flow generating abilities, but I believe free cash flow will continue to be relatively inconsequential to their price fluctuations for at least the next few years (as the market focuses more on growth potential). Facebook in particular stores so much data and will likely increase the amount of data it stores over the next few years, making internal capital investment even more critical to growth. Data will eventually drive long-term advertising revenue and could give Facebook a competitive advantage in the space.

As for LinkedIn, the firm has to invest for much of the same reasons why Facebook is investing—though we think product development will be much more critical to the company’s future. Though LinkedIn’s advertising revenue grew 56% year-over-year to $74.7 million, we at Valuentum simply do not think engagement and time spent on the social networking site will be strong enough to make LinkedIn an advertising Goliath. We think Talent Solutions, which increased 80% year-over-year to $184 million, will be LinkedIn’s gold mine. The firm has already changed the human resources landscape, and continued innovation in the space has given the firm terrific long-term growth potential.

Mobile continues to change the fundamentals of the social media business--something Facebook clearly understands (Image Source: Facebook). Monthly active mobile users have more than doubled during the past year, and Facebook understands that the mobile advertising landscape differs greatly from the desktop market. Founder and CEO Mark Zuckerberg indicated that there isn’t a great app advertising platform, and Facebook could strive to provide that solution in the advertising marketplace. LinkedIn revamped its mobile app, but we doubt it will ever reach Facebook levels in terms of popularity.

Although both companies look to have strong futures, even if Facebook has lost some of its luster with younger users, I'm not interested in either stock at this time. Shares of LinkedIn trade at a huge premium to Valuentum's intrinsic value estimate, and I think any hiccup in the story (including the lighter than anticipated guidance given for 2013) could cause shares to plummet. Facebook, on the other hand, looks fairly valued, though I like its long-term prospects. Neither stock fits the criteria to establish a position in the portfolio of our Best Ideas Newsletter.

In the online space, my favorite name remains Google . Google has capitalized on strong advertising momentum, increased global Android market share, and potentially has a strong pipeline of products. Google Glasses and self-driving cars could both be game-changers. Importantly, however, the company currently has fantastic fundamentals, so the product pipeline is simply icing on the cake. Either product could translate into multi-billion dollar categories, but we like the possible business solutions of Google Glasses most. Large amounts of real-time data could be of great use in nearly every industry, including medical, mining, and logistics.

Even without accounting for new products, we think Google can grow its revenue at a compounded rate of nearly 15% over the next 5 years, driving compounded annual free cash flow growth of 12%. We hold shares in the portfolio of our Best Ideas Newsletter.

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This article was originally published as Facebook and LinkedIn Early in Monetization; Neither a Bargainon Fool.com

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