Marathon bid for Shutterfly signals end of an era

Over the last year, Shutterfly management has faced activist shareholders who are pressing for greater stock performance from the leading online photo-product company. Shareholders are understandably concerned about lower net income returns, low stock performance and increased expenditures. Last fall, Silver Lake Partners said it was planning to spend $2 billion to take private the Redwood City photo giant. Shutterfly management even themselves explored taking the company private last summer.

Clearly, there are problems in Shutterfly Land. I viewed these previous machinations as normal turmoil around a stock market with unreasonable expectations of a photo company. Face it, the stock market has never really understood photo companies. Most of the really successful photo output businesses are privately held, quietly going about their business.

In recent years, however, shareholders have grown tired for waiting for SFLY to be more responsive to current trends, like mobile imaging. This lead, in part, to Shutterfly’s much-publicized purchase of “Shark Tank” darling GrooveBook; at least it looked as if management was trying something new.

Marathon Partners Equity Management LLC, which owns about 5.5% of the Shutterfly common stock, has nominated its own slate of director candidates in an effort to instill changes at the top:

“We believe the vast majority of Shutterfly stockholders are gravely disappointed with various aspects of the [Executive Compensation] plan due to its inability to strongly align stockholder and management interests, including:

• “lack of incentives encouraging long-term stock ownership by executives;
• “excessive awards based upon revenue and EBITDA growth as opposed to metrics that more directly increase stockholder value, such as free cash flow per share and earnings per share; and
• “lack of accountability for the results of acquisitions and investments.”

Shutterfly has responded with a proposal for a Universal Proxy Card, which commits to expanding the Shutterfly board to appoint Marathon’s Mario Cibelli and a second “mutually acceptable” nominee. Clearly, Shutterfly management thinks the Marathon is in it for the long haul (pun intended).

In researching the Marathon complaints, I realized how far the online photo-printing business has changed since 1999, when Shutterfly, Snapfish, Ofoto and slew of other startups braved the bubble to challenge the entrenched photofinishing business controlled by Eastman Kodak Co. and Fujifilm. At that time, Kodak and Fujifilm were cash-rich giants and HP and Epson were betting on affordable home printers; there was no guarantee these upstarts would survive into the new century. There was a fall-out over time, as more competition and consumer choice expanded the market and new innovations like print-to-retail and mobile printing took hold. Ofoto sold to Kodak (then Shutterfly), and Snapfish to District Photo (then to HP and, more recently, back to District Photo).

Is Silicon Valley relevant to photo output?

In the 1999-2000 era, online photofinishers needed to custom-build a lot of their own equipment. I was fortunate enough to tour Shutterfly and Ofoto plants in that time, and marveled how home-grown the technology was. There were no off-the-shelf online imaging technologies today; to be in online photofinishing, you had to employ dozens of engineers. Photofinishing equipment was modified to accept digital files. Website code had to be handcrafted from the ground up. Color science was invented on the fly.

Fast forward to today, where many of these technologies are readily available from vendors like HP, Xerox and Eastman Kodak, or white-label providers, like Centrics, Photo Finale, District Photo, RPI, ColorCentric and more. If you want to be in the photo printing business, you can make a few phone calls and line everything up (assuming you have the cash and the patience to develop the necessary marketing prowess). The world has changed, and the online photo printing business doesn’t revolve around Silicon Valley anymore, much the same way the photo industry doesn’t revolve around Rochester, N.Y.

In this insightful analysis by Jason Kaplan at Seeking Alpha, the various points of the Marathon proposal are addressed, particularly the composition of the board and the compensation of Shutterfly CEO Jeff Housenbold (which is $16.5 million or 1.2 “GrooveBooks”).

One point of Kaplan’s article, however, stood out: “Competing with tech giants in Silicon Valley for programming talent is expensive. While the company cannot transition out of SF overnight, I believe it should begin to consider adding programming talent in other, less expensive and less competitive areas of the country. This company does not need to be competing with Google, Facebook, Salesforce, etc. for talent. The whole Silicon Valley culture has incorrectly been absorbed into this company and it has cost shareholders dearly.”

Shutterfly has recognized this, in part, by locating production facilities around the country, but hasn’t done so with its corporate and technical facilities. Shutterfly’s home address in Redwood City is a stone’s throw away from the giant Oracle complex. But when you’re no longer a tech-driven company, as one could argue that Shutterfly isn’t any longer, do you need to be in the tech epicenter? It’s quite possible the way for Shutterfly to shake itself from its doldrums is to reinvent itself away from Silicon Valley. That way, buying some gimmick like GrooveBook won’t be the way to seem relevant.

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