Description

Introduction

Getty Images was founded in 1995 and is the leader in providing visual content to creative professionals and publishers.  The company acquires rights to stock footage (still photographs and moving imagery) that it then licenses to newspapers, magazines, advertisers, films, television programs, book and website publishers and others for a fee.  Despite having a wide moat business that throws off large, recurring, and growing streams of free cash flow that is reinvested by an able management team, the company is currently available at a significant discount to intrinsic value due to Wall Street’s focus on issues which are likely to be more short-term in nature.

Liquidity

Getty has 59.8M shares outstanding.  At a recent price of $43.88, the company has an equity market value of 2.62B with an average daily trading volume over the last three months of approximately 1 million shares per day (approximately 2% of float per day).  The shares are therefore quite liquid and are therefore appropriate for building a sizable position.

Business

Getty operates in a relatively simple business.  The company’s photographers and partners create visual content (Approximately 100,000 of Getty’s own images plus approximately 250,000 images by partners in 2005 were added to their creative imagery collection in 2005 alone).  New images are digitized, edited, catalogued and assigned keywords, and then posted to their website(s) where they can be searched, licensed, and downloaded 24 hours a day 7 days a week by customers around the world.

The company sells to a large and extremely diverse group of customers in over 100 countries.  Customers fall into one of four major categories:

1.)    Creative customers – generally advertising and design agency customers who use the imagery to create commercial or advertising and marketing related communications.

2.)    Editorial customers – professionals working for newspapers, books, and magazines, both online and in print.  Usually looking for timely photographs on newsworthy events happening around the world

3.)    Corporate customers – normally corporate marketing and communications departments using images for brochures, employee communications, annual reports, newsletters, websites, advertisements and presentations

4.)    Film customers – for all types of customers who may be producing motion pictures, television ads and programming, trade show and promotional videos, documentaries and other film and video based media.  These customers use both archival film clips as well as still images.

The company acquires its content from a diverse group of contributors (primarily photographers, filmmakers, and illustrators).  Company has research and imagery creating and acquisition teams in major cities around the world who analyze customer requests and patterns and work to identify, source and/or produce the image and visual content that will be in demand by the customer base.

When a customer what to buy/use imagery that it finds by searching company websites, the customer pays Getty to license the image under one of three licensing methods:

1.)    Rights-Managed –  Fee is based on the nature, extent, and frequency of the use

2.)    Royalty Free – Fee is based on the size and resolution of the file (3 to 75 Meg).  Once licensed, the image can be used multiple times at no additional cost

3.)    Subscription – Selected images and collections can be licensed under a subscription model that allows the customer to select what they want based on a recurring subscription model

The company was founded in 1995 and has characteristics of a wide moat network bases business because Getty is a central clearinghouse connecting an extremely fragmented group of content creators (including company employed photographers) and content users (even more fragmented group).  Customers pay significant premiums to the company in exchange for the extremely high quality, timeliness, and relevancy of a vast array of images all from one convenient source.

Getty has many of the characteristics of an excellent business which also means that it has competition.  Competitors include Corbis (owned by Bill Gates), Jupitermedia, and a variety of other smaller private companies.  Getty is the leader and has the leading market share in its business (by far).

Recent Issues

From a high of $93 per share reached in Nov 2005, the price has fallen more than 52% creating the current opportunity for investors who recognize the strengths of GYI’s business model and the attractiveness of its cash flows.  The price declines have occurred because Getty is in a period of transition.  Historically, revenue and profits have been tied primarily to the Rights-Managed royalty model where advertising agencies pay a premium to images based on their intended use.  With the proliferation of the internet, consumption of lower priced imagery has really increased by leaps and bounds.  Consequently, royalty-free imagery (some as low as $1 per image – though of much lower quality and size) has somewhat diminished the prospects for the more expensive rights-managed imagery that was and continues to be so profitable for Getty.  Fortunately, Getty acquired and now owns istockphoto.com which is a largest and fast growing provider of low cost royalty free imagery.

The primary near term issue worrying the market is that revenue growth for Getty has slowed in the last 5 quarters though it is still up year over year as illustrated below:

2005                2006                YoY Change

Q1       $178                $201                12.9%

Q2       $185                $205                10.8%

Q3       $185                $198                  7.0%

Q4       $186

The market may be assuming that this slowdown implies some permanent impairment in the value proposition or business model of Getty.  We disagree and believe that this slowdown is but a temporary blip.  We think Getty is very will position to benefit from a variety of trends that should continue to favor an explosion in the consumption of imagery around the world in all the major customer segments serviced by Getty.  While the average price per image may continue to drop, the long-term revenue impact will continue to be an increase in revenues because image consumption in price elastic and volumes will more than offset price declines.  In the mean time, Getty will continue to throw off huge sums of free cash flow.  The company has no net debt, has lots of cash, and ample avenues to growth – both through organic growth and innovation as well as tuck in acquisitions.

Importantly, the company’s business model has extremely high operating leverage.  A Very large portion of incremental revenue drops straight to the bottom line.  Management still has opportunity to use technology and innovation to drive greater efficiencies in both revenue growth and cost reductions.

Financials and Valuation

As a indication of both business quality and extent of operating leverage, note the financial performance of the company (which was only founded in 1995).  Since it was initially built through acquisitions of existing companies, Getty did not become profitable until 2002 on both an operating, net income, or free cash flow basis.  Since 2002, however, profits have mushroomed:

                        Revenue           Net Income      Free Cash Flow            NI Margin

1997                $100.8             4.0                   (1.7)                             4.0%

1998                  185.1             (29.8)               (20.1)                           (16.1%)

1999                  247.8             (65.3)               (46.2)                           (26.4%)

2000                  484.9             (144.7)             (40.9)                           (29.8%)

2001                  451.0             (77.6)               (27.5)                           (17.2%)

2002                  463.0             21.5                 66.0                             4.6%

2003                  523.2             64.0                 122.7                           12.2%

2004                  622.4             106.7               165.9                           17.1%

2005                  733.7             149.7               199.5                           20.4%

2006 TTM         776.0             143.2               188.4                           18.4%

Note, as an indication of earning quality that Operating Cash flows and free cash flows are actually significantly higher than net income for Getty as a result of accounting amortization charges that are higher than warranted on an economic basis.  Getty has used its money since inception to acquire tuck in or platform companies in its business (like istockphoto recently – generally for cash).  These acquisitions have built business value for the most part.  Given the stock price declines, GYI has been a significant purchaser of its stock in the last 9 months (for the first time in its history). 

These repurchases add to the appeal for a long-term holder as Getty is trading at 16.75 on a forward EPS basis and 13.8X TTM FCF (a 7.2% FCF yield).  This is extremely attractive for a company that should be able to enjoy long-term growth in the high single or low double digits with increasing cash flows.

Disclaimer

This is not a solicitation to buy or sell stocks. Please do your own independent analysis before buying or selling GYI (or any other stock). We have a long position in GYI at the time of this writeup that can change at any time without notice. There are no plans to provide future updates on our GYI buying or selling activities.

Catalysts

Revenue starts to stabilize and increase, company is a good LBO candidate, share buybacks continue.

Catalyst