Remember the first rule of investing in any stock. You must ask the question, “What product does the company solve?” When Shutterly, Inc. (NASDAQ:SFLY) first showed up, it solved tons of problems, and SFLY stock responded accordingly.
Thanks to its appearance in the very early days of the web (1999), it was able to become a first-mover in the space of preserving memories.
However, as time wore one, competitors entered the space. If the problem exists to be solved, others will take a crack at it. Soon, the problem was effectively solved by multiple offerings, and what Shutterfly does now is nothing more than offer a commoditized service.
Yet there’s always been a huge problem with Shutterfly – the company has never really made very much profit because margins have always been very thin.
Back in 2008, two years after its IPO, SFLY stock generated $213 million in revenue that resulted in a net profit of only $3.66 million. In 2012, revenues had tripled to $640 million, and while net profit exploded to $23 million, it was still only $23 million.
Cut to 2016, and revenues hit $1.13 billion, yet net income was a mere $16 million. Margins were only about 4% in 2012 and in 2016 they were down to just a little over 1%.
But it’s even worse. The first nine months of 2017 resulted in a $66 million net loss for SFLY.
And yet SFLY trades at 100x income.
I simply do not understand why this is the case. In fact, looking at SFLY chart from the IPO, it has always been valued at a ridiculous multiple.
Now I mentioned competition, but that doesn’t change the fact that SFLY is really still the top player in online photo products and services. What is miserable is that despite this position, margins are being trimmed. Again, this is because the services and products are now commoditized.
If a company has achieved massive scale and has no growth, it still may generate tons of cash flow to pay a nice dividend, but not in this case.
I’m also rolling my eyes that management drew down debt to repurchase SFLY stock – stock that I just mentioned is ridiculously overpriced. Not only that, SFLY has basically gone nowhere in the past ten years, stuck in a trading range whose bottom level is still representative of a goofy valuation.
There is still yet another problem. Up until this past year, SFLY stock was generating a good deal of positive free cash flow, $146 million of it in 2016. Yet in 2017’s first nine months, free cash flow was negative $105 million.
Even if cash flow were still positive, I see Shutterfly stock as a short just based on this ridiculous valuation and crumbling business. But now that it’s gone cash flow negative, it’s even more obvious.
At the end of 2016, SFLY had $330 million in cash and investments. That is now down to $112 million. If the cash burn continues at this rate, SFLY stock is bankrupt in about a year.
I’m short SFLY stock.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He is short SFLY. He has 23 years’ experience in the stock market, and has written more than 1,800 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.