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Seeking Alpha founder David Jackson (not the guy in the photo -- that's Jim Cramer) writes: I've been short TheStreet.com Inc.'s stock (TSCM) for ages, and it's been a painful and expensive experience. But this quarter's results, and the subsequent sell-off in the stock, finally suggest that all is not well with this story.

The Mad Money Effect

TheStreet.com has benefited strongly from the popularity of Jim Cramer's Mad Money TV program. This has been free money for TheStreet.com, as CEO Tom Clarke explained on his July 2005 conference call:

… Jim has had tremendous success with the show… and we are starting to see a benefit… There is no tie economically. But what happens is… we are starting to see people that want to find out what Jim is writing about… what he is talking about… So we are seeing a tremendous amount of interest coming from that...

TheStreet.com responded to this opportunity in the smartest possible way. It invested in search engine optimization so that the top search result for "Jim Cramer" is TheStreet.com. It redesigned its Web site to maximally capitalize on its association with Mad Money via Jim Cramer, and to promote the articles he publishes on TheStreet.com -- the first tab on its web site, for example, is titled simply "Jim Cramer". It published a recap of Mad Money even though TheStreet.com has no intellectual property rights to the TV show, just rights to the radio show. And it used photos of Jim Cramer to promote its subscription-based products, even when they weren't authored by Jim Cramer.

The Growth Problem

The result was that traffic to TheStreet.com's web site exploded, advertising revenue from the free area of the site climbed, and the number of people paying for subscriptions to TheStreet.com's Real Money paid service took off.

But is this growth sustainable? If you think that Mad Money will lead to continual and sustained increases in traffic to TheStreet.com, then yes. But if the impact of Mad Money is a one time step-up in traffic that plays out over 4-12 quarters, then no. As the initial impact of Mad Money on TheStreet.com's traffic gets reflected in its traffic numbers, year over year growth becomes harder to find. That doesn't mean that TSCM's traffic has to actually shrink, rather that its phenomenal growth in unique users and paying subscribers over the last year peters out.

This Quarter's Results

The sequential declines in TheStreet.com's traffic metrics this quarter seemed to answer this question about TSCM's growth. The number of unique users to TheStreet.com's web site was up 68% year over year in Q1, but only 57% in Q2. (You can't blame that on seasonality, as these are year-over-year numbers.) And subscription bookings rose 70% in Q1, but only 39% in Q2.

That's a significant slow down in growth.

Page views, meanwhile, did better than unique users. They were up 98% year over year, down from 111% growth the previous quarter. TheStreet.com did a good job of boosting its page views per user by improving its site navigation and perhaps by splitting up its articles into multiple pages to maximise advertising opportunities.

What's Left if Traffic Growth Slows?

So investors now need to ask themselves what TheStreet.com will look like once the Mad Money effect is fully reflected in the company's traffic numbers, growth of unique users peters out and the company is unable to squeeze more page views per user.

Before the Mad Money effect kicked-in (it launched late in the first quarter of 2005), TheStreet.com's subscription business was a slow-growth business. In Q4 2004, for example, it grew by only 10% year over year, and in Q1 2005 subscription revenue was flat.

TheStreet.com's management realized that the subscription business wasn't great, and that's why it turned to institutional equity research to ignite growth. But that failed, and was shut down.

Trying to capitalize on the popularity of online advertising, TheStreet.com even put itself up for sale. But as with CNET, there were no takers.

In other words, if it hadn't been for the Mad Money effect, TheStreet.com's stock probably wouldn't be looking too good right now. Sure, it would have got a boost from the cost savings of shutting down the money-losing institutional research business. But once that was done, investors would focus on growth. And there wasn't really any.

And now TheStreet.com faces a more significant problem. The volume of high-quality, free stock market content on the Internet is rising, and sites like SeekingAlpha.com are making it easier to find. For example, look at the quantity and quality of Seeking Alpha articles about TSCM. And remember that TSCM is a small cap stock. Or look at how Seeking Alpha also provides coverage of Jim Cramer's stock picks - which you can get emailed to you every day for free, and only require one page view to read, not four.

That means TheStreet.com's free content is facing more competition. But more signficantly, many investors are going to discover that they don't need to pay TheStreet.com for expensive subscriptions when they can get equally good analysis for free -- plus a recap of Cramer's media appearances -- on sites like this.

Valuation

Sell-side analysts, however, are bullish on TheStreet.com's prospects. The consensus revenue estimate for this year is about $48 million, rising to over $61 million in 2007.

The consensus EPS estimate for this year is $0.42, rising to $0.60 in 2007. Strong expected growth, indeed.

Based on that 2007 EPS number, TheStreet.com's stock (TSCM) is trading at over 16 times forward earnings.

I've no idea whether the 2007 EPS estimate takes into account the risk of a downturn in the stock market. Brokerage stocks, also highly leveraged to the stock market, trade at discounts due to the cyclicality of their businesses. Morgan Stanley (NYSE:MS), for example, trades at under 11 times 2007 estimated earnings.

Sure, you might say, but Morgan Stanley hasn't demonstrated the phenomenal growth of TheStreet.com over the last year. True, but then Morgan Stanley hasn't tied its prospects to the fate and reputation of a single individual in the way that TheStreet.com is dependent on Jim Cramer.

Insider Selling

Perhaps that's why Jim Cramer and TheStreet.com CEO Tom Clarke set up automated stock sale plans in February of this year. According to the press release,

Mr. Clarke's plan will provide for the exercise and sale of up to 800,000 stock options held by Mr. Clarke through December 31, 2006, by which time many of the options will expire if not exercised. Proceeds from the sales will be used to pay withholding taxes and the option exercise price and to assist in the diversification of personal assets. Mr. Clarke has options to purchase an additional 650,000 shares that are not subject to this plan.

It should be noted, however, that when I originally wrote about the stock sale plan, Jim Cramer himself commented on the article:

I love shortsellers, always have. But they should always have info right. The numbers of shares you think we are selling personally is just plain wrong, and if you are short because of it, you need a better thesis. Best of luck!!!

I still don't undertand that comment. Perhaps he means that Mr Clarke has the option to sell up to 800,000 shares, not that he will. But the way the Q2 numbers looked, he'd be daft not to.

Full disclosure: short TSCM at the time of writing; and also aware that SeekingAlpha.com, which I founded, competes with TheStreet.com.

Source: The Short Case for TheStreet.com