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LinkedIn – Partying Like it's 1999, Hangover like 2012

Anyone who uses social networking websites (who doesn’t?) has probably internalized the media buzz of how companies like Facebook, Twitter and LinkedIn are allegedly changing the way we interact and do business. If you are in this camp, then you probably heard the news about LinkedIn going public in an initial public offering (IPO) of shares late last week.

 

As the first mainstream social networking site to float on a stock market, excluding China’s already public RenRen social [surveillance] networking site, LinkedIn’s (NYSE: LNKD) IPO was the only show in town last week. The share rocketed from an opening price of US$45 on the New York Stock Exchange to a high of over $122 on opening day before settling in for the night at around $94.25. It closed out last week at $93.09, more than doubling its offer price, and valuing the company at something around $8.5 billion, give or take a few hundred million.

 

Many people who got in on the LinkedIn IPO think they just won the lottery. Many who missed the boat are suffering from acute envy and the powerful and insidious feeling that they have lost out while everyone and his grandma was apparently banking a packet.

 

Many of these same people are probably preparing themselves to get in on the action when other social networking sites go public this year or next. Most eagerly anticipated is of course Facebook, the real heavy weight of social networking, already ‘valued’ by Goldman Sachs at something like $50 billion, and slated to go public 2012.

 

So what the hell is going on here? And why do I feel like I’ve heard this all before?

 

Let’s look at some numbers.

 

LinkedIn’s 2010 revenue was $243 million with a puny profit of $15.4 million, which means that LinkedIn is currently valued at 35 times its revenue and an eye watering 552 times its profit. To put this in perspective, Google, the most powerful internet company, is valued at only six times revenue. Yet a company that actually produces something people need, like say Scottish and Southern Energy (LSE: SSE), which generates and supplies power to people’s houses, had revenue in 2010 of £21.5 billion, a profit of £2.111 billion and a market value of only £12.5 billion. Put another way, ‘the market’ values Scottish and Southern at a mere 1/60th of the ratio of value to revenue it has bestowed upon LinkedIn. Yet Scottish and Southern actually produces something and pays investors a hefty dividend while LinkedIn keeps its lights on through the promise and peril of the internet advertising Ponzi scheme.

 

But surely, I hear the pundits pounding their keyboards, LinkedIn is part of a new economic era of virtual living and blue sky thinking. It’s a growth story with no upper limit. Scalable beyond scale. And ‘leveraging’ networks to produce, err, what exactly? A trickle of money from people willing to pay a few dollars to be introduced to someone they were too drunk to talk to at a tradeshow, to gratify their egos by finding out who is viewing their profile or to stalk an ex-colleague? Indispensible, no doubt about it. Worth $8.5 billion? Without question.

 

Clearly people like me just don’t ‘get’ the new world economy and are living in the past.

 

And think of Facebook! With 600 million users worldwide surely it will float for $50 and by the end of the day be worth $100 or $150 or $200 billion and be heralded as the most important stock of the 21st century. Clearly if you aren’t ‘in’ then you are definitely going to be ‘out’.

 

But wait. We’ve all been here before. In 1999 we partied around the dotcom punch bowl with its 3 am promises of ‘new paradigms’ and instant millionaires, and then the party crashed into a decade long $5 trillion dollar hangover. One that only ended when Mark Zuckerberg found the keys to the social networking liquor cabinet and kick-started the party again under the banner of ‘Web 2.0’.

 

As I’ve said before, the most fatal words in investing are ‘it’s different this time.’ Anyone uttering them with sincerity is wandering through a fantasy world high on the opiate of easy money. Anyone parroting them is either a speculator about to lose his shirt and trousers, a broker, a mutual fund manager or someone who works for the great vampire squid.

 

So let the good times roll. Until they don’t any more. Let’s party like it’s 1999 all over again and when the hangover comes, I’m sure it will be different this time.

 

Either that or realize it isn’t different this time and buy Scottish and Southern and other companies that actually produce something that people have to have. Companies that make a profit and that pay you to own them through a hefty dividend. And leave LinkedIn and Facebook for posting photos of your Friday night at the pub and for the Greater Fools.

 

In the meantime, while we wait for more social networks to go public, I’ll continue to use the financially anemic LinkedIn and Facebook and money black hole Twitter to promote this blog without shame and without paying a penny. As for the energy needed to run my laptop? Well, that unavoidable Scottish and Southern bill will be due for payment shortly.

 

In the spirit of full disclosure, I own shares in Scottish and Southern.

 

 



 

Anyone who uses social networking websites (who doesn’t?) has probably internalized the media buzz of how companies like Facebook, Twitter and LinkedIn are allegedly changing the way we interact and do business. If you are in this camp, then you probably heard the news about LinkedIn going public in an initial public offering (IPO) of shares late last week.

 

As the first mainstream social networking site to float on a stock market, excluding China’s already public RenRen social [surveillance] networking site, LinkedIn’s (NYSE: LNKD) IPO was the only show in town last week. The share rocketed from an opening price of US$45 on the New York Stock Exchange to a high of over $122 on opening day before settling in for the night at around $94.25. It closed out last week at $93.09, more than doubling its offer price, and valuing the company at something around $8.5 billion, give or take a few hundred million.

 

Many people who got in on the LinkedIn IPO think they just won the lottery. Many who missed the boat are suffering from acute envy and the powerful and insidious feeling that they have lost out while everyone and his grandma was apparently banking a packet.

 

Many of these same people are probably preparing themselves to get in on the action when other social networking sites go public this year or next. Most eagerly anticipated is of course Facebook, the real heavy weight of social networking, already ‘valued’ by Goldman Sachs at something like $50 billion, and slated to go public 2012.

So what the hell is going on here? And why do I feel like I’ve heard this all before?

Let’s look at some numbers.

LinkedIn’s 2010 revenue was $243 million with a puny profit of $15 million, which means that LinkedIn is currently valued at 35 times its revenue and an eye watering 567 times its profit. To put this in perspective, Google, the most powerful internet company, is valued at only six times revenue. Yet a company that actually produces something people need, like say Scottish and Southern Energy, which generates and supplies power to people’s houses, had revenue in 2010 of £21.5 billion, a profit of £2.111 billion and a market value of only £12.5 billion. Put another way, in terms of the ratio of value to revenue, ‘the market’ values Scottish and Southern at a mere 1/60th of the ratio of value to revenue it has bestowed upon LinkedIn! Yet Scottish and Southern actually produces something and pays investors a hefty dividend while LinkedIn keeps its lights on through the promise and peril of the internet advertising Ponzi scheme.

But surely, I hear the pundits pounding their keyboards, LinkedIn is part of a new economic era of virtual living and blue sky thinking. It’s a growth story with no upper limit. Scalable beyond scale. And ‘leveraging’ networks to produce, err, what exactly? A trickle of money from people willing to pay a few dollars to be introduced to someone they were too drunk to talk to at a tradeshow, to gratify their egos by finding out who is viewing their profile or to stalk an ex-colleague? Indispensible, no doubt about it. Worth $8.5 billion? Without question.

Clearly people like me just don’t ‘get’ the new world economy and are living in the past.

And think of Facebook! With 600 million users worldwide surely it will float for $50 and by the end of the day be worth $100 or $150 or $200 billion and be heralded as the most important stock of the 21st century. Clearly if you aren’t ‘in’ then you are definitely going to be ‘out’.

But wait. We’ve all been here before. In 1999 we partied around the dotcom punch bowl with its 3 am promises of ‘new paradigms’ and instant millionaires, and then the party crashed into a decade long $5 trillion dollar hangover. One that only ended when Mark Zuckerberg found the keys to the social networking liquor cabinet and kick started the party again, this time calling it ‘Web 2.0’.

As I’ve said before, the most fatal words in investing are ‘it’s different this time.’ Anyone uttering them with sincerity is wandering through a fantasy world high on the opiate dream of easy money. Anyone parroting them is either a speculator about to lose his shirt and trousers, a broker, a mutual fund manager or someone who works for the great vampire squid.

So let the good times roll. Until they don’t any more. Let’s party like it’s 1999 all over again and when the hangover comes, I’m sure it will be different this time.

Either that or realize it isn’t different this time and buy Scottish and Southern and other companies that actually by produce something that people have to have. Companies that make a profit and that pay you to own them through a hefty dividend. And leave LinkedIn and Facebook for the Greater Fools and for posting photos of your Friday night at the pub.

In the meantime, while we wait for more social networks to go public, I’ll continue, without shame, to use the financially anemic LinkedIn and Facebook and money loser Twitter to promote this blog without paying a penny. As for the energy needed to run my laptop? Well, that Scottish and Southern bill will be due for payment shortly.

As I’ve said before, the most fatal words in investing are ‘it’s different this time.’ Anyone uttering them is wandering a fantasy world high on the opiate dream of easy money and anyone parroting them is either a broker, mutual fund manager or works for the great vampire squid.

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Junior Bond – Investment Death by a Thousand Cuts

A few weeks ago we received a sales pack in the post for something called a ‘Junior Bond’ from a company called Family Investments in association with a firm called Bounty: www.bounty.com/juniorbond. The pack arrived because our names and address had been harvested in the hospital ward when Mia was born by someone who was handing out free bags of baby related items. Presumably our details were then given or sold to Bounty / Family Investments who followed up with their sales pack. If you get this sales pack in the post, which I suspect you will if you are a new parent in the UK, it is worth reading as an example of exactly the kind of investment you want to avoid and that I warn against in The Child Millionaire.

 

The sales letter kicks off with a hearth felt congratulations on the birth of your child complete with (!) before launching into a patronizing bit of dross about how life is going to get really hectic and how you can easily forget to do things like make provisions for your child’s future. Thankfully, the letter assures you, Bounty / Family Investments are here to help.

 

The ‘Junior Bond’ is described in the literature as ‘a Tax-Exempt Savings Plan or TESP’ into which the UK government allows a maximum contribution of £25 per month or £270 a year [it isn’t explained why £25 x 12 months = £300 is permitted when in the same sentence the annual cap is cited as £270] to be invested by parents for their child. The sales brochure makes the case for parents to invest in the Junior Bond for at least 10 years via regular monthly contributions – so far so good from a Child Millionaire point-of-view. However, digging into the information a bit further it becomes evident that this is a pretty poor investment option for a whole raft of reasons.

 

First of all, the terminology is intentionally or unintentionally confusing. The ‘Junior Bond’ isn’t actually a bond but rather it’s a fund that invests in a mix of shares, property and fixed interest assets.

 

Once parents sign up for a child and earmark their monthly contribution of up to £25 per month to purchase units in the fund, this amount cannot be increased or decreased and the payments must continue for a minimum of 10 years.

 

The real kicker comes however when one looks into the fee structure. Let the death by a thousand cuts begin.

 

Firstly, there is an initial charge of £60 taken from the first year’s payments. This means that on a maximum contribution of £270, some 22.22% is skimmed off as a fee leaving a paltry £210 in the ‘Junior Bond’ at the end of year one. Furthermore, an annual management fee of 1.5% of the fund value is sucked off by Family Investments regardless of underlying fund performance. And it gets worse. The ‘Sovereign Fund,’ which is one of the two available fund options, may, presumably at the fund manager’s discretion, levy an additional fee of up to 0.2% of the value of the fund to cover ‘certain expenses,’ which aren’t explained. Finally, there is an unspecified ‘life cover’ charge deducted every year on the Bond’s anniversary if the value of the Junior Bond is less than the amount of the life cover. The ‘life cover’ is basically mandatory insurance in case your child dies within the term of the investment. The literature indicates that the life cover value is £1,350, which means that at a maximum contribution of £270 a year it would take five years for the value of the Junior Bond to reach £1,350 assuming the value of the fund stays static. Obviously the timeframe could be slightly shorter or longer depending on the performance of the fund but in any event for around a half a decade Family Investments bleeds off a further unspecified ‘life cover’ fee until the value reaches £1,350.

 

If parents miss any monthly payments within the 10 year term they have 13 months to make up the payment in a lump sum or else the Junior Bond is designated as ‘paid up’ [a strange and confusing term], which may incur a charge of £50. In the first year of the Junior Bond, if parents choose to cash out then they forfeit all of their money to Family Investments. If money is withdrawn in the subsequent 9 years then an ‘early surrender charge’ of £50 is levied unless the ‘paid up’ charge has already been levied. Furthermore, the literature notes that ‘additional costs may be incurred by the fund for the safe keeping of certain assets’. These costs and assets aren’t specified but with the outrageous bonuses handed out in the financial services industry, one could speculate as to what and whose assets are being kept safe at your cost.

 

During the 10 year term parents can’t switch their money to a different fund so the money remains locked into the initial fund choice. After 10 years, parents have the privilege of extending the term for another 10 years worth of contributions, withdrawing the money or keeping the money invested but no longer make contributions.

 

So where do we start with how rubbish this investment is?

 

Let’s summarize the main points:

 

  • £60 as an initial charge out of a maximum contribution for £270 in year one
  • Loss of all of your money if you opt to withdraw in year one
  • An annual charge of 1.5% of the fund value
  • Additional charges of up to 0.2% of the value of the Sovereign Fund
  • Approximately 5 years of unspecified ‘life cover’ charges until the value of your Junior Bond reaches £1,350
  • A discretionary charge of £50 if you miss payments and don’t make up the amount within 13 months
  • A charge of £50 for early withdrawal
  • The inability to change funds or alter the contribution amount for 10 years

 

So how would all of these fees impact your investment return? Well, presumably because the Financial Services Authority (FSA) requires them to, Family Investments’ brochure tells the tale. With monthly contributions of £15, after ten years you would have contributed £1,800 and paid a total of £209 in fees assuming you don’t miss payments. This amounts to fees totalling a staggering 11.6% of the entire contribution, while the impact of the fees in terms of both their value and lost return on this vanished money (assuming the fund returns 7% per annum) would total £330. So at 7% per annum, after ten years your Junior Bond would be worth £2,240 meaning you’d have made a total return of £440 while shelling out £209 in fees plus £121 in lost income on the fees. In other words, the 7% per annum return would be reduced to a real return of 4.7%! And this assumes that the fund makes an average return of 7%, which is highly speculative. If it earns less you could actually lose money but will still pay all of the fees regardless of the fund’s performance. So for a pretty anaemic return you incur substantial risk, have no flexibility and are locked in for 10 years unless you pay to get out. The apparent benefit is that the return is tax free in the Junior Bond. However this is a red herring because every child is eligible for the basic tax exemption of £7,475 per year (tax year 2011-12) so your child would never have to pay tax on such a paltry return even if it wasn’t in a tax shelter.

 

Now, let’s compare the Junior Bond with what might happen if instead we bought high-quality, high-yield dividend paying shares in a company with a track record of increasing dividends. Let’s use Standard Life, which I bought for Mia’s Child Millionaire Portfolio last month, as an example. Standard Life shares currently yield around 6% meaning that even without any share appreciation or a rising dividend, our annual return is 6%, and if we reinvest the dividend then over time our return would be substantially higher.  Furthermore we’d retain complete control over the investment and could buy more or sell at any time for a total commission of about £12.50 with no other ownership fees payable.

 

Using the Child Millionaire Calculator, let’s compare the 10 year returns assuming that we contribute the same £15 a month towards buying Standard Life shares. With a trading account at TD Waterhouse we could either choose to purchase the shares monthly for a cost of £1.50 per month (£18.00 per year) or save the money in a bank account and then invest it once per year with a commission payable on the share purchase of about £12.50. If we go with the annual purchase then each year we’d save £180 to invest and pay £12.50 in commission leaving £167.50 for the share purchase. Over ten years we’d shell out £125.00 in commissions and purchase £1675 worth of shares. Assuming a 3% annual appreciation of the shares, a 6% yield and a 6% annual increase in the dividend, by the end of the tenth year we’d have our initial £1675 worth of shares plus we’d have earned £935.07 in dividends, which we’d have automatically reinvested at no charge into more shares, and we’d have made a further £393.74 in capital gains. The total portfolio would be worth £3,003.81 – so £760 more than the Junior Bond – and would be throwing off dividend income of about £200 a year. No tax would be payable on this income if it is held in trust in the child’s name or sheltered within your tax-free Individual Savings Account (ISA).

 

As we’d be in complete control of the investment at all times, we could choose to increase or decrease the monthly contribution, stop payments altogether, invest a lump sum from a birthday or Christmas present, sell the shares or purchase shares in a different company.  Overall this option would offer a high return and complete control.

 

Compare this to the Junior Bond example. After ten years the Junior Bond would total £2,240 and would have incurred known fees of £209 plus other potential unspecified fees for the life cover. We’d have no control or flexibility in terms of altering the monthly contribution, no control over the contents of the investment and no ability to cash out without incurring a £50 fee. Overall this option would offer a low return and complete lack of control.

 

Family Investments boasts that they manage accounts for 1.2 million children in the UK. This alone peaks volumes about the general lack of knowledge about investing amongst parents and it speaks volumes about how much money financial services companies are making from this ignorance. 1.2 million accounts X £60 first year charge = £72 million pocketed just for opening the accounts plus a further 1.5% of the total value of all money invested with them per year, probably amounting to tens of millions in fees regardless of performance, plus the array of other fees. This Junior Bond is a definite money spinner for somebody (not you).

 

I only single out this ‘Junior Bond’ because the literature came through our mail slot. Yet there are probably dozens or hundreds of similarly rigid, high-fee products being flogged to well-meaning but unsuspecting parents around the world.

 

So the way I see it, you can get roped into high cost and lack of control or opt for The Child Millionaire route of low cost, higher return and complete control.

 

Buyer beware indeed.

 

Just published! The Kindle edition of The Child Millionaire is now up for sale on Amazon.com and Amazon.co.uk.