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Shutterfly: Sustained Growth of an Internet-Based Personalized Photograph Model Is Questionable

October 24, 2011 | About:
Overview

Shutterfly (SFLY) is the Internet-based service company which enables consumers to share, print and preserves memories by leveraging the company’s technology, manufacturing, web-design and merchandising capabilities. It provides a variety of personalized photo-based products and services that make it easy, convenient and fun for consumers to upload, edit, enhance, find and share to preserve memories. SFLY was incorporated in 1999 and began to be listed in September 2006 in Nasdaq.

Business

A majority of the company’s revenue comes from producing and selling professionally bound photo books, greeting cards, stationery, personalized calendars, etc. And sales are generated substantially inside the U.S., with highly seasonality. As reported, more than 50% of total revenue fell in the fiscal fourth quarter.

The business can be divided into three categories: Personalized Products and Services (PPS), Prints, and Commercial Print Services. Out of three, the PPS including photo book products, greeting cards and stationery, calendars, etc., took the highest component in the overall top line of the business, ranging from 61-71% during the past three years. Then the Print category accounted for 27-39% of the total revenue for the last three years. The smallest contribution came from Commercial Print Service, around 1-2% of net sales only.

Operating Performance

Unless the business model or the industry environment changes significantly, the indication of the future business can be roughly estimated by taking the normalized earnings/cash flow over a 5-10 year span. From 2004-2010, the business has kept growing its top line consistently, from $54 million in 2004 to $308 million in 2010, achieving the compounded annual growth rate of 33.7%. The operating income is fluctuating and positive, as is the net income.

USD million 2004 2005 2006 2007 2008 2009 2010
Revenue 54 84 123 187 213 246 308
Operating Income 4 5 8 11 4 9 25
Net Income 4 29 6 10 5 6 17


The sudden rise in net income in 2005 was largely due to the benefits of income taxes, so it is largely a non-operating item. If we took out that part, then the net income of 2005 would be around $4 - $5 million, bringing the average six-year net income to around $7.5 million.

Profitability

2004 2005 2006 2007 2008 2009 2010
Net Margin % 6.81 5.63 4.7 5.41 2.14 2.38 5.57
Asset Turnover 1.82 1.41 0.91 0.96 0.97 0.98 1
Financial Leverage 1.19 1.22 1.25 1.26 1.28
Return on Equity % 9.35 6.27 2.56 2.92 7.07


It is not a high-margin business, as we can see here; the net margin fluctuates in the range of 2-6%, mostly around 4-5%. Not until 2006 did the stockholders' equity turn positive. Before that, SFLY had negative equity, which is why the level of financial leverage and the return on equity was negative until 2006.

Cash flow

The good thing about SFLY is that the business has kept generating growing positive operating cash flow and free cash flow for the last six years.

USD million 2004 2005 2006 2007 2008 2009 2010
Operating Cash Flow 13 19 23 42 47 54 76
Free Cash Flow 6 8 3 7 29 40 62


The growth of free cash flow within six years, from 2004 to 2010, has achieved the compounded annual growth of 34.2%.

Financial Health

The balance sheet of the company seems to be quite strong. The debt/asset ratio stays only nearly 10%, with no interest-bearing debt. Historically, it is quite a liquid enterprise with the level of cash for six years fluctuating in the range of 38-74% of the total assets. With the huge amount of cash on hand, this year, SFLY has used it in acquiring Tiny Prints, the personalized card and stationery seller for $141 million in cash and 3.9 million shares, valuing the whole Tiny Prints at $333 million. That has reduced the cash level and increase the amount of goodwill in the balance sheet, which now stands at more than 54% of the total assets. The market capitalization now is around $1.7 billion. Adjusting cash, the enterprise value is at $1.57 billion.

Valuation

Discounted Free Cash Flow Valuation

The assumption for the growth is the key to discounted free cash flow valuation. We would assumed the growth of free cash flow over the next five years is around 12% per year, and after year five, the free cash flow would grow 1% per year to infinity. The discount rate we would set around 15%, as the switching cost in different competitors is not very high, and it is subject to technology changes.

Year 1 2 3 4 5 6
FV 69.44 77.7728 87.10554 97.5582 109.2652 3678.595
PV 60.38261 58.80741 57.2733 55.77922 54.32411 1590.358
Valuation 1876.925
Number in USD million

With those assumptions, the valuation of the business would stay around $1.8 billion, just a little bit higher than its current enterprise value.

Relative Valuation

Historically, for the last five years, SFLY has been subject to wild and high valuation, ranging from 26 times to 92 times earning multiples. And it is currently staying in the top range of nearly 92 times earnings, whereas the average five-year P/E is around 53. With cash flow multiples, SFLY is trading at 36 times whereas the average five years is only 8.7x.

Insider Activity

According to GuruFocus, the company’s executive kept selling shares over the past three months. That is never a good sign for any stocks with consistently large number of shares being sold out by insiders.

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In addition, following the recent prospectus in May filed by the company, it was said that certain stockholders registered to sell up to more than 4 million shares of common stock, issued in connection with the acquisition of Tiny Prints.

Conclusion

Even though with nice performance over the past six years of good growth, I do not think this is good a enough stock for value investors to take in big percentages of their total portfolios. The balance sheet became less strong after the Tiny Prints acquisition. The valuation is at sky-high on an individual basis as well as historical basis; earnings yield is only around 1%, whereas cash flow yield is 2.8%. In addition, it is a business that is subject significantly to changes in technology and customer loyalty. That makes me less confident in the predictability of the business. Last but not least, an insider has kept selling the shares out, which even dampens my confidence to this stock at this price. While there is a lot of blood on the street right now, value investors have a lot of choices out there to consider. If any investor would like to take it into their portfolio for personal taste, please put it in the much diversified one.

This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.

About the author:

Anh Hoang
Money manager into global equities, especially with US and Vietnam markets. CFA level 3 candidate. Lecturer for Stalla - CFA course in Vietnam

Visit Anh Hoang's Website


Rating: 3.4/5 (10 votes)

Comments

younessi
Younessi - 2 years ago
Out of curiosity, how did you get to your DCF valuation numbers, in particular, valuation beyond year 6, using the assumptions you outlined (i.e. 12% FCF growth for the first 5 years, 1% thereafter, and 15% discount rate throughout)? The resulting number looks way high for the set of assumptions as you laid out.

Also, how did you get the beginning FCF number? did you take out the maintenance CAPEX, and if so, what is your assumed maintenance CAPEX needs?

Thank you.

Please leave your comment:


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