Personalized items business accounts for almost 80% of our valuation for Shutterfly (SFLY). These products include photo books, greeting cards, wedding invitations and stationary. In FY 2012, the company registered about 20% growth in the number of paying users and 30% growth in the number of orders processed. The two drivers support about 35% growth in revenues from the business during the period. This performance has seen the market being bullish about the company's prospects, which has pushed the stock to about $43, up almost 50% from the $30 levels at the start of January 2013.
In this article we take a look at the factors that support our $38 Trefis price estimate for Shutterfly.
A Cloud-Based Tool Can Drive Growth in the Number of Paying Users
Last year, the number of paying customers to Shutterfly’s personalized items service grew at about 20% to about 7 million. The growth was largely inorganic, driven by the acquisition of customers from the now defunct Kodak Gallery and Fujifilm's SeeHere. A similarly large growth in 2011, was majorly on the account of acquisition of the assets of Tiny Prints.
The company currently hosts about 18 billion photographs on its servers for free for about 35 million customers. It estimates that about 80% of these customers are females in the 25 to 50 age group. At first look, these figures point to Shutterfly's failure in converting a majority of its customers into paying customers despite its varied product portfolio. However, it also points to a large potential for organic growth for the company that can be achieved without large capital investments.
Shutterfly seems to be at work in realizing this untapped potential. In the recently held Morgan Stanley Technology, Media and Telecom Conference, Shuttefly's CEO Jeffrey Housenbold pointed to its experiments with a cloud-based service, which could be used to pull in customer's photographs from varied sources such as Facebook and Picasa, for storage and then organized through proprietary patented algorithms. Its recent acquisitions, ThisLife, and Photoccino have proved helpful in this regard. It plans to launch the cloud-based tool later this year. The utility of the tool is promising and we expect a rush to sign up for the service.
While the storage of photographs and videos on Shutterfly's cloud is expected to be free of cost, the company plans to charge for the sorting algorithm and other services attached to the cloud-based tool. The attached fee leads us to expect that the number of people signing up for the free media storage on Shutterfly's cloud to be much larger than members paying for the service. We expect the attached fee to slow down the initial adoption and hence estimate the number of paying customers to grow to about 8 million in the near term. The relatively smaller number of paying users for the service is expected to pressure the company's margins in the near term.
The Company's Open to the Idea of Acquiring HP's Snapfish
Shutterfly pioneered this industry in 1999 and since has grown at impressive rates. In comparison, other similar ventures from the likes of Yahoo, Sony, HP, Kodak, Cannon, AOL, Microsoft, Apple have not had similar success. Last year, the company acquired assets from Kodak and FujiFilm, and is open to acquiring more. It currently estimates HP's Snapfish to be its biggest competitor and that it is about 5x or 6x bigger than Snapfish.com. The company is open to having a look at the Snapfish business for acquisition if and when HP decides to jettison it. We believe that another acquisition will help the company better our estimates for the growth in paying users. We will be looking for any news in this regard in the coming months.
Margins to Take a Hit as Company Invests in New Products
In order to maintain its position as a market leader, the company has been investing heavily in technology and marketing. Also, its recent acquisitions have resulted in increased investments in IT infrastructure. We believe that the company will keep on investing into technology and marketing as it launches new cloud based tools. Similarly, the company has been marketing its services through television which is a cost intensive activity. We believe that it will continue doing so in the near term. This will result in its operating margins being under pressure in the near term. In the long term, we expect the competition to catch up, which could see the company cutting its margins to stay competitive.
We have a $38 Trefis price estimate for Shutterfly, which stands nearly 10% below its market price. Personalized photos, cards, and albums account for most of its value.
Disclosure: No positions.