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June 29, 2006

A snapshot of Shutterfly

Tim Mullaney

What, you expected a better pun in the headline than that?

The online photo service Shutterfly.com filed for IPO yesterday, and it looks, hmmm...sharp but not too sharp.

It had $84 million in 2005 revenue. It made $28.9 million in net income, but before you break out the checkbook to buy shares, $24 million and change came from a one-time tax benefit and a "change in accounting principles." For the last three years, it has basically been a 55% gross margin business, which gives them plenty of room to make money if they can make their technology and marketing spending scale. But so far they really haven't -- operating margins have stayed in the 6-7% of revenue range even as the company has doubled in size, so that 2003 operating profits of $2.1 million grew only to $4.4 million by last year, even as sales went from $31 million to $84 million. That's pretty ho-hum for a growth company just passing the tipping point into profitability. Actually, it's very ho-hum as tipping-point stories go.

The Wall Street Journal, in breaking the news earlier this week that Shutterfly wants to either go public or sell itself, quoted a source saying the company makes $20 million to $25 million before interest, taxes, depreciation and amortization. I assume that means it expects to earn that much in 2006, since bankers usually talk about forward earnings. But the interesting thing here is that relatively heavy capital spending for a company this size is keeping Shutterfly's free cash flow from growing any faster than revenue. FCF went from $5.7 million in 2004 to only $7.7 million last year. So how it's going to get to $20 million or $25 million by year-end is a mystery, especially since Shutterfly burned cash on operations during the seasonally slow first quarter. Better hope for a big Christmas.

The Journal also reports that Shutterfly wants a valuation between $400 million and $500 million. That's a multiple between 52 and 65 times last year's free cash flow. Which is funnier than a picture of your Uncle Fred at his college reunion. Unless there's a reason operating leverage is suddenly going to spike, ain't gonna happen. That's a premium number for a regular-unleaded income statement.

And I say this as a very, very satisfied Shutterfly customer.

Later on, we'll talk about the facts that Shutterfly has a lot of competition and that there's not much of a difference between Shutterfly and rivals like Snapfish who are also very good. And I have to think a little more about how Shutterfly might also be affected by people's adoption of in-home printers for digital photos. I don't know a lot about those issues. But the combination of the price and the numbers points to a distinctly lower valuation than you've read about. My guess is that the search for more operating leverage will mean Shutterfly hooks up with a competitor. But we'll wait for the roadshow before locking down on that argument.

11:31 AM

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