Higher CPMs and strong growth in global consumer spending will contribute to a 34 percent EPS rise among major internet names in 2008, according to JPMorgan analyst Imran Khan. Kicking off the new year in bullish fashion, Khan has laid out a long, detailed report, explaining why internet stocks will outperform the broader market over the coming year, as they did in 2007. In addition to the positive earnings drivers, expect plenty more M&A, as free cash flow among the five biggest internet names is expected to swell. Among the names he likes: Google (NSDQ: GOOG), Yahoo (NSDQ: YHOO), Expedia, Omniture, Shutterfly and Monster. Key themes:
— Higher CPMs: ‘Muted’ growth in 2007 will give way to better numbers in 2008, as the rise of focused ad networks will help publishers realize higher profits from their inventory. Khan notes that 80 percent of online inventory currently sells for $1 CPM, suggesting it wouldn’t take much to see improvements. As a corollary, internet traffic is aggregating, via acquisitions and partnerships, into fewer hands, which could give publishers more pricing power. Meanwhile, offline ad inventory is expected to be low, in part due to political spending on TV, pushing more advertisers towards the internet. More after the jump.
— Global consumer strength: The US consumer may be looking wobbly, but the picture continues to grow brighter on a global level. The rise of a global consumer class, as well as higher broadband penetration, should benefit internet names with an international reach. Already, non-US revenue is coming close to eclipsing domestic receipts for some names, including Google, which will soon make the crossover.
— M&A: In 2007, cash-based acquisitions accounted for 23.4 percent of free cash flow among the major internet names. With free cash flow expected to grow from $8.8 billion to $12.5 billion, it follows that we’ll see a lot more of this activity. Khan expects the big caps to keep buying in the social media space, though he predicts they’ll take a wait-and-see approach: waiting until a startup gets big with the public before snapping them up. Also, more online ad deals are likely, but after the flurry of activity last year (DoubleClick, aQuantive, etc.), 2008 may look quieter on this front. Other M&A drivers include: traffic acquisition, geographical synergies, broadened user insights and technology gaps.
— Social networking: Although there are no public pure plays in this area (yet), Khan takes a look at the ‘big six': MySpace, Facebok, Bebo, Orkut, Friendster and Hi5. Among his predictions: privacy issues begin to fade away, while better user targeting starts to lift those notoriously low CPMs.