Citigroup initiates on CNET with Buy

Here's a different, more optimistic perspective on CNET - particularly important to highlight since my short position in the stock (which I disclose at the bottom of every relevant post) reflects a bearish view of the company. Citigroup analyst Mark Mahaney initiated coverage Thursday morning with a Buy rating and a $13 price target. Short excerpts, focusing on the bull case:

CNET: Initiating Coverage

• We are initiating coverage of CNET with a 1H INTERNET (Buy, High Risk) rating and a $13 price target. Key components to the Long thesis: 1) Strong secular growth of online advertising; 2) Broadening advertiser base; 3) Business model leverage; 4) Online category leadership; and 5) Potential acquisition candidate.
• We focus on two key factors: 1) How significantly CNET is expanding its advertiser base away from its traditional enterprise technology base; and 2) How CNET's margin expansion potential -- from 12% in '04 to 27% in '07 -- can drive sustainably strong bottom-line growth (25%).
• We arrive at our $13 price target based on a combination of EV/EBITDA and P/E analysis. Our EBITDA estimates are generally in-line with consensus.
• Key risks include: 1) Significant competition from other Internet companies, especially Yahoo!; 2) Limited and currently unprofitable international presence; 3) Roll-up risks; and 4) A no-growth, low-margin publishing segment.

CNET INVESTMENT POSITIVES

1. A play off the strong secular growth of online advertising -- After double digit declines in 2001 and 2002, U.S. Internet advertising revenue grew 21% in 2003 and 33% in 2004. Just as impressive as the overall growth rate is the accelerating growth U.S. Internet advertising posted in 2004.  And it’s not just easy comps that drove these growth rates – results from several leading online advertisers consistently indicate renewed interest in online advertising among Fortune 500 companies and small enterprises...

2. Broadening advertiser base – One of the most important developments at CNET over the past few years has been the broadening of its content offerings from a large focus on business technology to a combined focus on personal technology, business technology, and games & entertainment.  Although CNET doesn’t provide a revenue breakout along these lines, we believe that personal technology (which includes sites like CNET.com, Download.com, and Webshots) is the largest online revenue category for CNET (approximately 55% of 2005 revenue).  Business technology (which includes sites like ZDNet, News.com, TechRepublic, and Release 1.0) would be second at around 33%.  And the games & entertainment category (which includes sites like GameSpot and MP3.com) would be third at around 12%, although it is the fastest growing segment.  Recently, CNET launched two new verticals (Car Tech and TV.com) that again broadened CNET’s content offerings...

3. Business model leverage -- In Q1:05, CNET reported an EBITDA margin of 8.7%, up 490 bps Y/Y.  There is significant seasonality in CNET’s business that does impact its EBITDA margin.  For example, CNET’s Q4:04 EBITDA margin was 23% vs. 4% in Q1:04 and the 8.7% in Q1:05.  But the clear trend over the past two years has been one of margin expansion.  And we believe that CNET’s EBITDA margin can continue to expand going forward for several reasons.

4. Category leadership – CNET has consistently been one of the leading U.S. Internet properties in terms of monthly unique visitors.  In April, it ranked as the 8 th most visited site, behind sites like Yahoo! and eBay, but ahead of others like The New York Times and Walt Disney.  Acquisitions of traffic-heavy sites like Webshots have clearly helped CNET’s visitor ranking, but the company’s overall position as one of the top 15 U.S. Websites has been consistent over the past two years...

5. Potential acquisition candidate – The Internet sector has experienced significant consolidation recently – the pending acquisition of Shopping.com by eBay and the pending acquisition of Ask Jeeves by InterActive Corp. are the most recent examples.  More relevant to CNET as an online vertical are the recent acquisitions of MarketWatch by Dow Jones and About.com by The New York Times.  Our view is that there is a scarcity value in online content plays.  And traditional media (print, television, cable, radio) are facing some secular growth challenges that make an online content acquisition a logical possibility...

CNET chart below.

Full disclosure: at the time of writing I'm short CNET.