Description

In a market where every COVID beneficiary has been destroyed (see PTON, ZM, TDOC to name a few) SSTK is one that still remains elevated vs. pre-COVID prices due to temporary tailwinds hiding the underlying issues of the business. In reality, the business indexes to the most competitive part of the industry and is going to continue to lose share from both sides to free and premium offerings. As these trends take hold, SSTK should revert to prices near $42 per share or more than 50% downside from current prices.

Here is a quick overview of SSTK per Company 10-K:

“Shutterstock, Inc. is a leading global creative platform offering full-service solutions, high-quality content, and tools for brands, businesses and media companies. Our platform brings together users and contributors of content by providing readily-searchable content that our customers pay to license and by compensating contributors as their content is licensed.

The content licensed by our customers includes:

Images - consisting of photographs, vectors and illustrations. Images are typically used in visual communications, such as websites, digital and print marketing materials, corporate communications, books, publications and other similar uses.

Footage - consisting of video clips, premium footage filmed by industry experts and cinema grade video effects, available in HD and 4K formats. Footage is often integrated into websites, social media, marketing campaigns and cinematic productions.

Music - consisting of high-quality music tracks and sound effects, which are often used to complement images and footage.

3D Models - following our acquisition of TurboSquid, Inc. on February 1, 2021, we now offer 3D models, used in industries such as advertising, media & video production, gaming, retail, education, design and architecture.

For customers seeking specialized solutions, we also create custom, on-brand content by matching our global contributor network to the unique needs of our customers. This solution allows us to offer customers a fast and scalable way to produce cost-effective content that is in line with the visual footprint of their brand. We typically offer a royalty-free non-exclusive license and the processes we maintain to properly license content and the indemnification protections we provide, allow individuals and businesses of all sizes, including media agencies, publishers, production companies and creative service providers, to confidently utilize such content for their unique commercial or editorial needs.”

To start, it is beneficial to understand why SSTK is a clear COVID beneficiary. As the pandemic began, restrictions placed on content producers made it so many brands / businesses who normally created their own content were forced to purchase stock images / videos. Furthermore, the quick shift to digital led to even more demand for these images and videos. Channel checks indicate that many customers were spending 20-30% more than they had pre-COVID. Given competition for these images and videos, many customers were willing to pay extra for exclusivity in order to ensure they had a differentiated approach in the highly competitive digital ad market.

Recent channel checks indicated stock image and video usage has already declined but still remains elevated to pre-COVID levels. As the Omicron wave ends and content producers are able to return to filming their own content, we believe this will continue to revert.

The second part of the COVID benefits were due to cost cuts. As mentioned above, spending across the industry increased materially during COVID. This coincided with material cost cuts for SSTK. For example, sales and marketing expense decreased 400bps or over $20 million from 2019 to 2020. Similar situation with product development that declined 200bps or over $11 million from 2019 to 2020. It is noteworthy that these levels remained depressed until the recent quarter where both expense lines started to revert towards pre-COVID levels and led to a 600bps EBITDA margin decline y/y. Management indicated it is due to investments in new areas like AI an 3D, yet we think this indicates that the industry is starting to normalize and competition is being felt (i.e. this is necessary spend to not bleed market share).

In addition, in 2020 SSTK reduced its revenue share with content providers https://www.insideimaging.com.au/2020/pay-cut-for-shutterstock-photographers/). Cutting these costs right as demand sky rocketed leads to nice margin gains and part of the explanation for the gross margins increasing >7%. We think this will have a negative impact (discussed later) over time but is a temporary boost for the business that is extrapolated into future earnings projections.

Due to the above, EBITDA went from $100 million pre-COVID to $155 million in 2020 and $191 million estimated in 2021. The street now thinks it’s a secular grower and is modeling HSD revenue growth with margin expansion and hence its valued at 17x 2021E EBITDA vs 10x in the years pre-COVID. Stock has traded off from all time highs of $120 but at $93 still seems very asymmetric. We think this valuation ignores the reality and structural headwinds that SSTK faces:

Why SSTK is a Structural Loser:

To get comfortable with owning SSTK you need to get comfortable with the 100lb gorilla in the room that is Adobe. In recent years, Adobe has made considerable investments in their stock business through organic investment and M&A. Channel checks indicate it is around $200 million vs. SSTK over $700 million. What’s interesting here is Adobe has incredibly strong relationships with the B2B segment because they are all using Adobe’s other applications for video / photo editing. Channel checks indicate that it’s just a matter of time before contract renewals for Adobe will include the stock business. There is clear reason as to why someone would use Adobe as integrated into things like photoshop vs. going onto SSTK. We believe that this will be a continuous bleed on SSTK share as these contracts are renewed and Adobe continues to invest in its content to offer its customers. Given the strength SSTK has seen in enterprise during COVID, this is a huge hit to the business.

The second issue is that SSTK far over indexes to images. From our understanding, the stock image space is a race to zero. Free players are growing significantly on image side – this should lead to continued pricing compression which is SSTKs strongest area. Given that SSTK already cut the revenue share with photographers, this should really start to show. The rise of amateur photography has made it so that the free sites can compete with SSTK. As of now, SSTK is benefitting as they often get traffic filtered to their website so SSTK is able to get high margin leads. What’s interesting here is that as these free offerings scale, they then cut off traffic to SSTK and become competitors. Given that SSTK angered many of its content producers, the continued success of the free offerings is more likely. There is still some differentiation and premium content on the image side but from our understandings SSTK is week on both unique / exclusive content and premium content.

So if SSTK is in position to lose in a race to zero in its core offering, it may be able to capitalize on a new video trend? The reality is that SSTK is weak on video and far behind competition. Many startups have focused purely on video and are far ahead of SSTK in the space. Can they catch up? Maybe, but the reality is the video stock space should largely mature into what the image environment already is – a race to zero with some differentiation on exclusive and premium content which is a weakness for SSTK.

To sum, COVID tailwinds largely covered up these issues and nice use of buzz words like AI and 3D by management has convinced investors that this time is different and SSTK is a secular grower. The reality is that this is a commoditized industry that is likely to see LSD growth at best as competitive forces drive down pricing. Furthermore, SSTK will continue to lose on both ends of the spectrum as it indexes to the mid-tier offerings which will continue to lose share. Adobe will accelerate its domination on the B2B side and the competitive content provided by free providers will take share on more price sensitive consumer and SMB customers. 

As a base case, we believe revenue will revert to pre-COVID levels with competitive factors continuing pressure margins. At $650 million of revenue and 20% EBITDA margins, you get $130 million of EBITDA Given the commoditized nature of the business, the structural headwinds, and the low growth (and likely decline in revenue) a 10x multiple on $130 EBITDA seems more than generous. This equates to a $42 price target, or more than 50% downside.

If you don’t believe the headwinds that we have laid out, feel free to take insiders word for it who have been dumping stock in the open market the entire pandemic.

Further back to show recent acceleration…

Risks:

·         Buyout: We don’t think this is a concern near-term. Bigger competitors had the chance to buy this at much cheaper prices. Maybe PE wants a chance but this would likely be at much lower prices.

·         Net cash and cash flow positive: could make difficult from technical perspective if company continues purchasing shares (especially given high founder ownership who may be incentivized to buy back the shares he and other management are selling in the open market).

·         Cash balance could lead to M&A – could purchase some of the players who are seeing strength in premium content or video.

·         Could be early – given Omicron they still could see a few more quarters of strong growth.

·         Made progress on API, search, and data – maybe they can find new avenues of growth.

Catalyst

- COVID tailwinds reverse

- Competition takes share

- Margin reversion