Where Are Shutterstock Shares Going?

Shutterstock shares have fallen more than 30% this year on valuation concerns by investors. However, the company has built a sound business model that looks likely to deliver healthy growth for years to come, so investors can use this pullback to gain fresh entry points.

May 12, 2014 at 10:30PM

Shutterstock (NYSE:SSTK) is one of the momentum stocks that have been hammered in this year's tech sector sell-off. The company's shares are down 31% year-to-date. Shutterstock is a rapidly growing young business that is solidly profitable and has built what looks like a durable business model consisting of an online marketplace for videos, photographs, and other images. The company was founded in 2003 and went public in 2012. It operates in the same space as Getty Images, Google Images and Yahoo!'s Flickr, and an ongoing arrangement with Facebook (NASDAQ:FB) continues to support the company's future growth prospects.

Investors seem to have fallen in love with the company's dandy business, and shares still look quite pricey even after the 31% plunge. Shutterstock finished fiscal 2013 with revenue of $235 million and net income of $26 million. Shares trade at a 12-month trailing P/E ratio of 93, which implies that a lot of spectacular growth has been baked into the share price.

Solid business model
Shutterstock is the brainchild of Jonathan Oringer, who has said that he got the idea of starting the company after noticing that stock, or canned, photos were too pricey. He bought a camera and took 30,000 photos with it, and Shuttertsock was born.

Shutterstock licenses photos and videos from 50,000 individuals, most of whom are amateur photographers who get paid a mere $0.25 per image use. The process of screening uploaded photos to find suitable ones that meet the company's stringent requirements is handled by its 345 workers and 100 contractors.

The company's standards are quite high -- only 20% of applicants in 2013 got the nod from the company, while 70% of submitted photos were approved. Shutterstock has more than 30 million photos and 1 million videos in its library, and the site is available in 20 different languages.The ubiquity of smartphone cameras guarantees that the company is in no danger of running out of new photos from its rapidly growing stream of eager contributors.

Big opportunity
About 900,000 small businesses regularly use Shutterstock's images for advertising and marketing purposes. Shutterstock charges these businesses $2.35 per image download. Heavy users are offered the option of paying a one-time yearly subscription fee of $2,599. The company sold 100 million downloads in fiscal 2013.

The service is certainly popular with users, if the company's high revenue retention rate is any indication. Revenue retention refers to the amount of business that repeat customers bring to the company compared to the previous year. Shutterstock's revenue retention in 2011, 2012, and 2013 was 102%, 100%, and 99%, respectively.

Growth for the company seems assured. The market for pre-shot, or canned, images is slated to reach $6 billion by 2016. The online segment of the business is expected to grow at 15%-20% annually. Ad spending by small businesses -- Shutterstock's key market -- will reach $16.6 billion by 2015.

Shutterstock struck a big deal with Facebook last year. The social media giant added Shutterstock to its Ad Creator, which allows marketers to select images for their marketing campaigns from Shutterstock's 25 million free stock images.

Previously, advertisers on Facebook were required to supply their own images for their ads and upload them one at a time. A big company running lots of ads simultaneously could easily run out of good images to rotate through its campaign. Advertisers can now use the 'Stock Images' tab in Facebook's Ad creator, thanks to the Shutterstock API. From here, they can search through 25 million high-resolution images to use in their ads. Marketers are allowed to use up to six Shutterstock images in their group of ads.

Although advertisers use the Shutterstock images for free, Facebook must pay Shutterstock royalties for the images whenever its marketers use them. Studies have found that Facebook photos attract 84% more clicks, 104% more comments, and 53% more likes than the average post. That's the kind of attention that advertisers want, and why Shutterstock images can be of great use to Facebook marketers.

While it's rather hard to get the exact figures of how much Facebook pays Shutterstock as royalties per image use, the fact that Shutterstock still pays its contributors normal royalties for images licensed via Facebook means that Facebook must pay considerably more royalties than what Shutterstock pays its contributors. With more than 18 million small businesses using Facebook pages, the revenue potential for Shuttlestock from the service is considerable.

Disruption by Getty?
At first glance, news that Getty Images is giving away 35 million photos for free seems like a potentially disruptive move for Shutterstock. But, a deeper look reveals that Getty Images' freebies can do little harm to Shutterstock's core business.

The free photos from Getty Images come with a caveat -- they cannot be used for commercial purposes. According to Shutterstock's chief executive, Jonathan Oringer, 99.9% of images downloaded from the company's website are intended for commercial use. Investors, however, seem to have overlooked this fact, and the company's shares tumbled 10% when Getty Images made this announcement.

Online media is growing by leaps and bounds, and digital communications have become more pervasive. Meanwhile, Shutterstock appears to have carved itself a respectable niche in the online image licensing business. Although analysts see 30% top-line growth for the company in the current fiscal year, unexpected opportunities, such as the Facebook deal, can help the company easily exceed that mark.

Although shares still look pricey, perhaps now is a good time to buy and take advantage of the 30% pullback.

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Joseph Gacinga has no position in any stocks mentioned. The Motley Fool recommends Facebook. The Motley Fool owns shares of Facebook. 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.

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