In a previous article, we discussed the potential competitive advantage (or lack thereof) for Ancestry.com. Today we examine a similar situation with Shutterfly.com. For those unfamiliar with the company, SFLY is an internet-based repository and publisher for users to capture, store, and print photos. Its technology allows customers to upload, edit, and organize these photos. I actually think it’s a fine service and a tribute to how far we have come with the technology. My question is more to how sustainable is their position in this very competitive segment of the market.
In my opinion, the existence of competitive advantage is extremely difficult to determine. Perhaps it is because it is difficult to quantify or measure. Yes, one can examine trends in return on capital or return on equity. If these profitability measures are high and exceed cost of capital, it is said a competitive advantage exists. It tends to be a fairly abstract concept where we often tell ourselves a competitive advantage is in place when it truly is not. A very common error among investors is thinking their investment has this advantage when it does not. The fact is that very few companies have a long term competitive advantage.
This leads us to Shutterfly. The company is profitable, although extremely seasonal. The bulk of their profits are earned in the fourth quarter – nothing wrong with this. It is growing its top and bottom line. Furthermore, although it appears that ROE is marginal, its free cash flow margin is actually quite favorable. The balance sheet is loaded with cash with no debt. Below is a snapshot of the financials. All sounds attractive.
Financials:
Book Value/ Share | Debt/ Equity | Return on Equity (%) | Return on Assets (%) | Interest Coverage | |
12/09 | $8.30 | 0.00 | 2.7 | 2.2 | 55.5 |
12/08 | $7.43 | 0.00 | 2.0 | 1.6 | 9.5 |
12/07 | $6.88 | 0.01 | 5.6 | 4.6 | 58.0 |
12/06 | $6.38 | 0.02 | 3.8 | 3.2 | 28.6 |
12/05 | $2.64 | 0.08 | 45.7 | 31.8 | 13.4 |
12/04 | $.43 | 0.41 | 36.2 | 12.4 | 9.3 |
The problem is that many are competing to enter this market place. I recently noticed that my cable provider will allow customers to upload, store pictures, and even create personalized albums. Not to mention other desktop applications which provide similar features. Their investment in technology may be superior to competitors, but I don’t believe it can’t be duplicated. In the current technological cycle (meaning the evolution of internet based services) holding on to proprietary content is difficult if not impossible. Monetizing this content is rapidly marginalized. It does appear that they have taken on competitive challenge for awhile and survived. If their technological lead should disappear, so will profits. Perhaps, the Shutterfly brand is enough to keep competitors at bay. But in a world of tech savvy consumers, this seems like a risky bet. Whether this company deteriorates or thrives is a complete mystery to me – which is my point. There are simple too many question marks about Shutterfly’s future.
Disclosure: none.
