I like the option of just using a method to extract this data although it doesn't leave much room for formatting and/or creating links which is why I opted for this way.
ASCX control:

<%@ Control Language="C#" AutoEventWireup="true" CodeFile="CategoryListing.ascx.cs" Inherits="Custom_Controls_CategoryListing" %>

<cms:CMSRepeater ID="rptCategories" runat="server" HideControlForZeroRows="true" />

Code behind:

using CMS.SiteProvider;
using CMS.UIControls;
using System;
using System.Data;

public partial class Custom_Controls_CategoryListing : CMSUserControl
{
    public string TransformationName
    {
        get
        {
            return rptCategories.TransformationName;
        }
        set
        {
            rptCategories.TransformationName = value;
        }
    }
    public int DocumentID { get; set; }
    public string OrderBy { get; set; }
    public string Where { get; set; }
    public string TopN { get; set; }
    public string ItemSeparator
    {
        get
        {
            return rptCategories.ItemSeparator;
        }
        set
        {
            rptCategories.ItemSeparator = value;
        }
    }

    protected override void OnPreRender(System.EventArgs e)
    {
        base.OnPreRender(e);
        SetupControl();
    }
    private void SetupControl()
    {
        DataSet ds = new DataSet();

        // checking here to see if we need to limit it to a specific number or not
        if (string.IsNullOrEmpty(TopN))
        {
            ds = CategoryInfoProvider.GetDocumentCategories(DocumentID, Where, OrderBy);
        }
        else
        {
            ds = CategoryInfoProvider.GetDocumentCategories(DocumentID, Where, OrderBy, Convert.ToInt32(TopN), "");
        }

        rptCategories.DataSource = ds;
        rptCategories.DataBind();
    }

    public void ReloadData()
    {
        SetupControl();
    }
}

Usage in a transformation:

<%@ Register Src="~/Custom/Controls/CategoryListing.ascx" TagName="CategoryListing" TagPrefix="uc1" %>
<uc1:CategoryListing runat="server" ID="CategoryListing" ItemSeparator="," TransformationName="cms.blogpost.BlogCategories" DocumentID='<%# ValidationHelper.GetInteger(Eval("DocumentID"), 0) %>' />

The transformation for the CategoryListing control (cms.blogpost.blogcategories)

<%# (DataItemIndex == 0 ? " in " : "") %>
<a href="<%# "~/Blog/Category/" + Convert.ToString(Eval("CategoryDisplayName")).Replace(" ", "-") %>"><%# Eval("CategoryDisplayName") %></a>

I use dynamic URLs for the Blog page that have the Category name in place so they are friendly URLs vs. catID=2 or something usless like that. I also modified the TagCloud webpart to do the same thing and use friendly URLs.

Its a bit dissapointing to me to be able to set "friendly URLs" in the Site Manager but it doesn't apply across all modules (i.e.: blogs, forums, etc.)