Yahoo Must Acquire Shutterfly

I have covered Shutterfly (Nasdaq: SFLY) a few times here already. I have had my eye on the company for a while, and have pegged it as an acquisition target for Yahoo, especially. Last week, amidst market doldrums, I managed to pick up a chunk of SFLY at a good price, and have already seen some gains. My initial reaction to Shutterfly’s IPO was that it was too soon and going out with too little revenue. However, Shutterfly has consistently delivered.

When I reviewed their service from a Web 3.0 perspective in July I gave them fairly good marks for their overall package.

The company’s 2007 approach relies heavily on customer satisfaction (78% of past revenue derived from repeat customers), and successful marketing via positive word of mouth and brand awareness. From Shutterfly’s perspective plenty of demand still exists, with only 6% of digital camera owners using online services. I happen to agree.

They are also doing a good job with partnerships finally, which was a weakness I had identified earlier. At the beginning of 2007, Shutterfly partnered with David’s Bridal, a leading bridal retailer, allowing Shutterfly to offer its range of photo product to the booming wedding industry.

In addition, Shutterfly made its product distribution easier to the average consumer by linking with Target, enabling Shutterfly to expand its service channels and cross sell products to the millions of Target customers. You load your photos via the Internet, order, and both pay and pick up the prints at your local Target store. This is actually cheaper than having Shutterfly ship them to you.

Q3 Consolidated revenue for the period increased 54% to $32.6 million (up from $29.9 million in Q2) versus $21.2 million in Q3 2006; however, Q3 operating expenses increased to $15.4 million from $11.3 million in Q3 2006. And the company posted a net loss of $3.3 million, worse than the Q3 net loss of $2.7 million in 2006. On a per-share basis the losses have narrowed because there are now 24 million shares outstanding versus the 4 million from the same quarter 2006.

Guidance for Q4 would be $90.5 million to $93.5 million, an increase of 38% to 42% as compared to the fourth quarter of 2006, and total annual revenue is expected at $180-183 million, an increase from Q1 projections of $167-170 million for 2007. The preliminary guidance offered for 2008 showed revenues in the $240-255 million range, up from an estimate $200 million first projected in Q1.

Total market cap currently is $739.87 million and current price is just under $30.02/share.

The company strategy and partnering examples above are working in terms of growth. 45% of revenue comes from personalized products and services while 55% comes from photo printing. Customer numbers have grown YoY 35% to 844,400 in Q3. And the average order value and average number of orders have both increased YoY by 15% and 33% respectively.

Competition is quite serious in the Photo Printing and Merchandising segment, but as I said, the market is early and under-penetrated (only 6% of digital camera owners using internet photo services). Marketing expenses will continue to be significant for the company for a while still, both to combat competition and to educate the market. However, momentum should continue for a while.

My strong belief is that Yahoo should buy Shutterfly and combine it with Flickr, which would give Shutterfly access to a much larger customer base, and Flickr a key position in an important monetization angle – photo merchandising and printing.

Jerry Yang, are you listening?