Name That Trade – $LNKD: LockedOut

by Enis March 4, 2014 2:25 pm • Commentary

The social media bubble has been all the rage over the past year.  Yes, I called it a bubble.  Trying to time when a bubble will pop is a very difficult game, which is why we have generally stayed away from trying to short social media stocks for most of the past year (excluding a few burnt fingers from a couple occasions late last year).

Personally, I’m amazed at the euphoria surrounding the sector, which is eerily reminiscent of the tech bubble in the late 90’s.  TWTR’s IPO and subsequent price action (for a company worth tens of billions of dollars) was quite similar to the IPO’s of that period.  And Facebook’s acquisition of WhatsApp for $19 billion could have been a headline from late 1999.

In my post following that acquisition, I laid out my view on why many of these stocks are a bubble:

For any investment, at the end of the day, cash flow is king.  Maybe not today, maybe not tomorrow, but eventually, I want to see your cash.  Granted, FB paid for most of the deal with stock, so the acquisition could also be that Zuckerberg and Co. see their own stock as overvalued.  However, whatever the long-term plan for WhatsApp, I have a very hard time envisioning the long-term cash flow stream that justifies $19 billion of value out the door today.  Do you think WhatsApp has better long-term cash flow prospects than the following companies, all worth less than WhatsApp?

Most incredibly, no one seems to be concerned about one of the principal tenets of investing – Barriers to Entry!  Warren Buffett always emphasizes investing in companies with big moats because competition is a major risk for any profit-machine.  Well, WhatsApp has 55 employees, and was only started in 2009.  Doesn’t sound like much of a barrier to new entrants to me.

This overall market backdrop is clearly built on a veil of ignorance in the investment community at the moment, and most social media stocks are trading near all-time highs with charts all exhibiting a great degree of momentum.  But one sticks out like a sore thumb – LinkedIn.

LNKD has actually been trading below its 200 day moving average for much of the past month, quite a divergence in relative price action compared to the broader sector:

[caption id="attachment_37075" align="alignnone" width="600"]LNKD daily, 200 day ma in yellow, Courtesy of Bloomberg LNKD daily, 200 day ma in yellow, Courtesy of Bloomberg[/caption]

The $200 level was support throughout late 2013, but it broke convincingly in February.  The stock has since recovered that level but hardly looks healthy, especially in such a strong sector.  On the downside, the $160 level is the 1 year low.

I discussed LNKD’s prospects in my CotD post in mid-February:

Here’s the thing about LNKD – I don’t really know why investors were willing to bid it up to $200 in the first place, so I wouldn’t be too surprised if the stock sold back down to $125 over time.  The stock is projected to have 40% sales growth and flat earnings growth in 2014, which does not seem stellar for a stock with a 120x P/E multiple.

Fundamentally, this stock has not made sense to me in quite some time, which is why the technicals are my guide here.  LNKD’s relative weakness, price action below all of its major moving averages, and the stock right at the pivotal $200 level have my attention for a move lower to test $175 support in the coming weeks.

Hypothetical Trade:  Buy the LNKD ($205) Apr19th 200/180/160 Put Butterfly for $4.10

This structure does well if LNKD retests the low from earlier this year near $180, and it does not start to lose money on the downside until the $164 level, which is just above the 1 year low.

We are going to hold off from executing this trade given the fickleness of the broader market and the social media sector in particular, but wanted to lay out a decent risk/reward structure for those who are interested.