How to Profit When Your Favorite Company Goes Public

By David Sterman
April 11, 2011

Way back in 2005, I got "linked in."

That's when I joined four million other Internet users and created my profile on the Facebook of business networking sites, LinkedIn.com. Six years later, there are more than 100 million LinkedIn users, and the company has decided that the time is right to shift gears and enter the public markets.

LinkedIn plans to sell stock through an initial public offering (IPO) from most individual investors has been, "How do I get in on it?"

And as I mentioned in a previous article explaining these social media IPOs, it's hard to blame investors for wanting in on the action. After all, a $10,000 investment in Google's IPO in 2004 is now worth more than $55,000.

So let's take a look at why LinkedIn would want to go public -- and if it's a good idea to get in line for shares in the young company.

Why? And Why Now?
The first question an investor could ask is, "Why would the company want to go public, anyway?"

The simple answer is that the company's original investors, like founders Reid Hoffman and Michelle Yee (who own a collective 21%), as well as venture capital (VC) firms Sequioa Capital and Greylock Partners (19% and 16% ownership, respectively), would like to finally reap the financial rewards from their investment. If everything goes as planned, LinkedIn would raise as much as $200 million via the IPO, and at that price per share, the value of the whole company would be nearly $3 billion. And 16%, 19%, and 21% of $3 billion is a lot of dough.

It's also not difficult for LinkedIn to notice that other social media firms -- Facebook, Groupon, etc. -- are also thinking about IPOs. And why shouldn't they? These kinds of businesses are red hot right now, and investors are chomping at the bit to own a piece of them. But in the IPO game, timing is everything. If LinkedIn waits a few more years, investors may already be on to the "next big thing," which could translate into an IPO with a much lower price per share. 

But it's not just about cashing out. By becoming a public company (known as "going public" in the financial world), LinkedIn will raise a lot of money. The millions raised from the IPO will enable LinkedIn to expand its business, either through acquisitions or the development of better software. Acquisitions are easier for public companies because they're able to use their newly issued shares as a currency of sorts; i.e., we'll buy your company in exchange for X number of shares of LinkedIn. Potential acquisition targets want a clear value of the shares they'll get in a deal, so once LinkedIn is publicly traded, there is little guesswork as to its perceived value.

[InvestingAnswers Feature: The Leveraged Buyout Value Equation]

Google (Nasdaq: GOOG) is far stronger post-IPO than it ever was as a private company.  If Google had remained private, it would likely have had to choose only a few key projects to pursue, rather than the dozens of projects it is now involved with, including the development of its wildly successful Android mobile phone software.

Buyer Beware
Will LinkedIn be a good investment? It's too soon to say. The company's investment bankers are still lining up potential demand for an IPO and still need to come up with the right price for shares. If demand is strong, and the deal carries a high price, it may not be a bargain. It's important to look at the valuation of any investment, so let's take a look at some numbers.

LinkedIn sales are zooming ahead, rocketing from an estimated $80 million in 2009 to more than $200 million in 2010 (these are just expert opinions -- because it's still a private company, it doesn't have to disclose its financial results).  Most of that revenue came from job listings and advertising.

If the IPO is valued at $3 billion, as some suspect it will be, then this will stand out as a pricey deal. Besides, it's very difficult for investors like us to get a piece of an IPO -- shares are usually reserved for the investment banking firm's best clients.

Many investors get excited about IPOs. The anticipation of grabbing the next big thing drives some to excess. If you decide that LinkedIn has potential, but you're not on Goldman Sachs' list of "favorite clients," there is a way to profit from IPOs like this: hope they stumble after going public. Often times, a company will primp itself to look really good as it enters into an IPO. And just a few quarters later, companies often start to show growing pains, perhaps by delivering disappointing quarterly results. That can really punish a stock. If that happens, you may have a chance to buy an otherwise good company while its shares are temporarily in the doghouse.

Photo courtesy of nan palmero.