Shutterfly (NASDAQ:SFLY) is one of the largest companies in the otherwise fragmented photo retailing market, with a domestic (U.S.) market share exceeding 50%. Revenues have increased at an annualized rate of 27% since FY07 and totaled $784 million at by the end of FY13. Growth in its core business as well as its inorganic channels have contributed to this strong top line performance from the company since going public in September 2006.
We expect Shutterfly to maintain its dominant position in the U.S. market, and estimate its revenues will expand at a robust rate over our review period. Concurrently, we have a Trefis Price Estimate of $49, which is approximately 20% higher than its current market price of $41.
In this article, we highlight a few industry-specific risks that can limit Shutterfly’s growth in the future.
Risks Associated With Shutterfly’s Business
1. Smartphone Base Growth Can Disrupt Photo Printing Businesses
We believe Shutterfly’s success is mainly a result of the rapid adoption of digital point-and-shoot photography devices during the 2000s. The company was founded in 1999, when film-based photography equipment were being replaced worldwide by digital photography equipment. At the moment, the photography market is at a transitional phase, with digital photography equipment being replaced by smartphone devices. While smartphone device shipments expanded from 139 million shipments in 2008 to 968 million shipments by 2013, digital camera shipments declined from 127 million units to 86 million units during the same period.   
While the weak economic environment played a significant role in smartphone adoption, rapid advances in smartphone camera technology are increasing the share of images captured from smartphone devices rapidly. With more images accessed through smartphones, the number of orders from Shutterfly’s desktop portal should gradually contract going forward. This could impact Shutterfly negatively in terms of its customer base and revenue growth. To counter the imminent decline from desktop related websites, Shutterfly launched its mobile applications across all three major operating systems, viz. Android, iOS and Windows 8. Last fiscal year, the mobile platform accounted for approximately 6.5% of Shutterfly brand revenues, which is relatively low. We currently forecast Shutterfly’s user base to expand from 8 million customers in 2013 to 15 million customers by 2020, driven by greater adoption in the mobile platform and offsetting the declining contribution from desktop.
On the flipside, the rising usage of smartphones for image capture could result in declining user conversion even on the mobile platform. This is because most users could prefer to have images captured through their smartphones on their devices instead of getting them printed on photo paper. The ease of access and growing memory reserves in smartphone devices should facilitate this trend, which reduces consumer interest in having physical prints going forward. This risk associated with Shutterfly’s business could depress our current valuation for the company. If Shutterfly’s user base grows only to 11 million users by 2020 due to lower adoption of its mobile platform, we can see a 20% downside to our Trefis price estimate.
2. Higher Mobile Adoption And Greater Competition Can Contract Pricing
Shutterfly competes with online digital photography services companies such as Snapfish (an HP company), American Greetings’ Webshots, Vistaprint, SmugMug etc. In addition to online retailers, the company also competes with many offline standalone photography services companies and other retail chains such as Wal-Mart, Walgreens and CVS that offer in-store photo printing services. Although Shutterfly has a 50% market share in the U.S. photo printing market, it operates in an industry where the customer has low brand loyalty. Products with the lowest price point have the highest demand from customers.
In case the competition intensifies in the U.S. market, Shutterfly needs to resort to higher promotional discounts to protect its customer base, resulting in lower revenue recognition for the company. So far, the company has been able to leverage its market leadership position and launch new products at aggressive prices across its brand portfolio regularly. Despite limited pricing power, the company has been focused on improving customer order value by cross-selling various products in its portfolio as a bundle. This has increased the company’s average order value (AOV) from $31 to $40 between 2009 and 2013. We currently forecast Shutterfly’s AOV to increase to $46 by 2020, driven by the company’s cross-sell initiatives.
However, the shift from desktop to mobile platform is expected to reduce the company’s ability to cross-sell its products. A user typically spends lower time on a mobile session than a desktop session due to the targeted nature of the platform. This reduces cross-sell opportunities for Shutterfly. If the company is unable to grow its AOV going forward due to lower mobile conversions (as presented above), we could see a 10% downside to our price estimate.Notes:
- Gartner Press Releases, 2008 and 2013 [↩]
- Digital cameras in decline, though interchangeable lens segment sees growth, Futuresource Consulting, November 2013 [↩]
- Digital Still Cameras Market to Grow in 2010, But Decline Soon to Follow, IHS iSuppli, January 2011 [↩]