Although 2006 was a challenging year for Internet stocks, with the Internet index (HHH) down 20% (vs. the S&P up 14%), we believe the industry is poised for a strong rally in 2007.
• 2006 Brought Many Challenges. Decelerating revenue growth and EBITDA margin contraction contributed to our coverage universe’s underperformance vs. the indices in 2006. Specifically, our coverage universe saw revenue growth decelerate to 29% from 37% in F’05. Meanwhile, 11 of 18 companies in our universe saw EBITDA margins decline in F’06. As a result, 56% of our companies reported a Y/Y decline in F’06 EPS.
• Our 2007 Outlook Is Bullish. We expect a turnaround in 2007, driven by expanding EBITDA margins, share buybacks, and moderating revenue deceleration. We are modeling 30.3% EBITDA margins for our universe in F’07, up from 28.0% in F’06.
• Continental Europe will be Key. We believe continental Europe will provide strong growth for Internet and Media companies. We estimate current online ad penetration rates in Germany, France, Italy, and Spain are ~2%, compared to the US and UK at ~7%. We believe increased penetration will benefit companies like Google and Monster, which are well positioned in Europe.
• Expect Graphical Ad Weakness. We believe graphical CPMs will decline in 2007 due to a mix shift toward lower CPM social networking inventory and flat to slightly lower pricing of existing ad inventory. As such, we favor publishers exhibiting organic PV growth or those with an opportunity to increase sell-through rates.
• Increasingly Bullish on Search. We are increasing our outlook for global paid search, raising our F’07 revenue estimate to $20.7B (from $17.5B) driven by strong volume trends, better than expected monetization, and strong growth from continental Europe. We now expect the global search market to reach $37B in 2010, growing 25% annually for the next four years.
• Our Picks. The views expressed above translate into Overweight ratings for the following: Google (GOOG), Ebay (EBAY), Monster (MNST), Shutterfly (SFLY)
Read the full 268 page .pdf report here: Nothing But Net - 2007 Internet Investment Guide