Potential Tough Times for Shutterfly

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2012 was a significant year for Shutterfly (NASDAQ: SFLY). The company currently trades close to the $43 mark, which is approximately 50% growth from the $30 mark in early 2012. This growth in share price was underpinned by a reported 20% growth in paying users and 30% growth in processed orders during 2012. This led to a 35% growth in total revenues for Shutterfly and saw the investors turn bullish on the company’s future.

Need to Drive the Growth in Paying Users

Traditionally, Shutterfly has been involved heavily into acquisitions to add on paying users. Last year, the company performed exceptionally well by adding the number of paying users. The growth was primarily underpinned by the acquisitions of Fujifilm’s See Here and Kodak Gallery. Likewise, the growth in paying users during 2011 was experienced after the acquisition of Tiny Prints. The company still has a massive potential for organic growth as, it holds 18 billion photographs for free on its servers. This may suggest that Shutterfly has an extremely poor conversion rate in spite of having a highly diverse and attractive product portfolio. Going forward, Shutterfly must realize the potential for large growth here without much capital investment. The 18 billion photographs hosted for free are for 35 million registered users for the company.

The company recently announced a cloud based service that would enable it to extract pictures from social networking sites such Facebook for storage and then re-arranged through patented algorithms. Now, the company plans to charge the consumers for arrangement of pictures and other services related to the cloud, nonetheless the storage of pictures and videos is absolutely free. This indicates that there may be a large volume of customers that utilize the free services from Shutterfly; however, the conversion from free user to paying is much smaller. Furthermore, the fee associated with the new cloud based service may result in an overall slowdown of growth in paying users. The slowdown in paying users could impact the company’s net margins, which may lead to a downside in the stock price as we move deeper into 2013.

Keep a Close eye on Snapfish’s Acquisition

Relative to its competitors, Shutterfly has grown exponentially and now is an industry leader by a huge margin. This has been largely underpinned by its aggressive acquisition strategy. The company has benefited a great deal by acquiring some assets from Kodak and Fujifilm. Currently HP’s (NYSE: HPQ) Snapfish poses the biggest threat to Shutterfly in the online photo printing industry. The company is considering Snapfish as a potential acquisition target; however, it remains to be seen if HP exhibits any interest. It is extremely essential that investors keep an eye on the negotiations with HP, as a successful merger will enable Shutterfly to grow its paying user base.

Other Key Players

HP’s Snapfish is a top competitor of Shutterfly. Snapfish is an online photo and merchandise printing segment of HP. Just like Shutterfly, it also offers storage services to its users. HP also acquired HIFLEX in 2011. HIFLEX provides a variety of software solutions for printing. Another player in the printing business that poses a threat to Shutterfly is American Greetings (UNKNOWN: AM.DL). The company is the largest greeting card provider in the world and is headquartered in Brooklyn Ohio. Along with greeting cards it offers several other products in the printing domain. It has a market cap of $518 million and the current stock price is trading close to the 52 week high range.

Falling Margins

As the competition intensifies in the online printing industry, investment in technology and marketing is likely to increase for Shutterfly. Traditionally, the company is known for cost intensive marketing and promotional activities, as it has chosen channels such as TV advertising in the past. In addition to the recent acquisitions, investment in the IT infrastructure to bolster the existing services is expected to deflate the margins going forward. Furthermore, the company will be forced to invest heavily as it prepares to launch the new innovative cloud service. All this is expected to have a snowball effect on the operating margin of Shutterfly, leading to an intense pressure. Besides, the existing competition and new entrants are going to squeeze the margins further.

 Bullish or Bearish?

The growth exhibited by Shutterfly in 2012 allowed the investors in the near term to keep a bullish view on the printing giant. However, it is important to identify if the company holds a sustainable competitive edge or it is only a house of cards. Shutterfly, certainly is a pioneer in the printing industry, nonetheless the company is entering a highly challenging phase. Investors must keep a close eye on how the company strategizes to maintain its current margins, as an upward or downward rally in the stock price will entirely depend on that. 

Ashit Gulati has no position in any stocks mentioned. The Motley Fool owns shares of American Greetings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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