SSTK - Shutterstock: Margin Of Safety But AI Implications Still Unclear

2023-12-27 10:39:30 ET

Summary

• Shutterstock's stock has declined over 60% from its 2022 highs, but its current valuation at under 12x forward earnings presents upside potential.
• The company is making moves to transform itself amidst AI disruption, including entering high-growth areas like AI-enabled data and generative content.
• Uncertainty remains around the impact of AI and the progress of growth initiatives, leading to a Hold rating until further clarity is gained.

Shutterstock (SSTK) has seen its stock decline over 60% from its 2022 highs as growth has slowed. However, at under 12x forward earnings, SSTK trades at a significant discount and the company is making moves to transform itself amidst AI disruption. I believe the current valuation leaves room for upside, but prefer to wait on the sidelines for more clarity on AI's impact and the progress of growth initiatives before becoming more constructive.

Investment Thesis

Shutterstock operates a leading global marketplace for creative content, serving over 2.1 million customers. The company is pivoting into high-growth areas like its AI-enabled data business, generative content capabilities, and the recent acquisition of Giphy.

Shutterstock's current valuation of ~12x forward EPS provides a sizable margin of safety given SSTK's strong cash flows and debt-free balance sheet. The company also has multiple options to reignite growth. However, uncertainty remains around AI substitution effects and the progress of new growth levers. As such, I rate SSTK a Hold until we gain further clarity.

Company Deep Dive

Founded in 2003 as a stock image marketplace, Shutterstock has since greatly expanded its offerings to become a comprehensive creative platform. Today, the company's extensive content library includes over 757 million images, over 52 million video clips, over 4 million music tracks, and 1.2 million 3D models. Shutterstock has established itself as a leader in licensable creative content.

The company generates revenue primarily by licensing this imagery, footage, music, and 3D content to its vast customer base spanning diverse industries such as marketing, media, production, gaming, and more. These customers leverage Shutterstock's creative assets across a variety of use cases including websites, advertisements, merchandise, publications, broadcasts, presentations, and other business or personal media applications.

Shutterstock utilizes a hybrid business model to serve its global user base, offering both subscription-based plans and pay-as-you-go purchasing options. This model aims to provide flexibility for users across needs and budgets. Approximately 41% of the company's $880 million in trailing twelve-month revenue is recurring subscription-based, which lends stability amidst fluctuations in one-off purchases.

On the supply side, Shutterstock monetizes via a revenue share model with its over 2 million approved content contributors who continuously upload new images, videos, music and 3D models. These contributors earn royalties each time their work is licensed by customers, which incentivizes them to keep expanding Shutterstock's industry-leading content catalog.

While initially founded strictly as a stock content destination, Shutterstock has consistently innovated its platform and expanded its addressable market over the past 20 years. Most recently, the company has invested significantly in high-growth spaces like generative AI, AI data/model training services, SaaS creative tools, and conversational advertising.

Shutterstock's competitive advantages include:

1) Network Effects Between Customers & Contributors - Over 2 million contributors upload content, which attracts more customers. Those customers then license content, which compensates contributors. This flywheel fuels the rapid expansion of Shutterstock's content library.

2) AI & Data - A vast collection of proprietary search, customer behavioral, and content metadata data powers Shutterstock's AI. This enhances discovery and personalization.

3) Hybrid Business Model - Offerings cater to self-serve e-commerce users and custom enterprise solutions. 41% of revenue is also recurring subscription-based.

Shutterstock has consistently innovated its platform and expanded TAM, most recently into high-growth spaces like generative AI, data/AI model training, creative software tools, and advertising via Giphy.

Management has also been active in M&A to accelerate growth, including deals for Pond5, Splash, PicMonkey, TurboSquid, and Pattern89. These provide additional content, customers, and capabilities.

AI Implications

While Shutterstock moves aggressively into AI, it still faces disruption risks. Generative AI can readily produce images, video, and music, potentially commoditizing Shutterstock's core offerings.

Management believes barriers around quality, intellectual property, and lack of photorealism have limited the adoption of AI content instead of stock media. CEO Paul Hennesy mentioned in the Q3'23 earnings call : "Although customers are experimenting and creating images in large quantities, they are not however downloading such images and substituting them for original content and marketing campaigns in any meaningful way". SSTK is trying to be at the forefront by providing its own generative capabilities as quality improves over time.

On the data side, Shutterstock is well-positioned to be a major provider of training data for generative AI models. It has signed deals with leaders like Google (GOOG) (GOOGL), Meta (META), Amazon (AMZN), and OpenAI. But smaller competitors could still erode pricing power, and the longer-term demand is unclear as models become more advanced. However, the legal barriers around properly licensed generative AI content may erode over time if recent court cases set a precedent allowing images from the open internet to be used freely in building generative models. For example, a recent ruling sided with Midjourney, Stability AI, and DeviantArt in a copyright lawsuit, stating AI models can utilize unlicensed images from the internet. If more rulings support this view, it could remove a key advantage of Shutterstock's licensed, rights-cleared image library. Users may opt to create their own AI models trained on freely available data rather than pay for properly licensed generative content. While the legal landscape is still evolving, upcoming court decisions allowing unlicensed image usage could pose risks to pricing power.

Financial Profile

Despite growth headwinds, Shutterstock has a decent financial profile. The company carries minimal long-term debt and has $75 million of cash for flexibility. Shutterstock also offers a 2.2% dividend yield, although I believe that might be at risk as the company invests in transformation. TTM revenue reached $875 million with ~61% gross margins and ~20% EBITDA margins. Free cash flow is also robust at $108 million over the last twelve months.

Valuation

Shutterstock currently trades at around 12x forward EPS estimates of $4.53, with the sector median at around 15x. This seems attractive for a historically 20+ multiple stock.

Shutterstock was likely re-rated lower based on its recent growth struggles. However, the current valuation leaves substantial upside if management can reaccelerate growth.

Catalysts

Potential catalysts for the stock include:

1) Growth reacceleration in the e-commerce segment from increased marketing and new products like Shutterstock Essentials subscription offering unlimited generative AI images for just $9.99 per month.

2) Further monetization of Giphy's 1.7 billion user reach. Management expects it to become a $100M+ ad business over time.

3) Increased adoption of AI-generated content and data model training capabilities as quality improves and enterprise comfort rises.

Risks

1) Continued slowing growth amidst economic uncertainty, tough comps, and rising competition.

2) Generative AI/competitors substituting actual demand for Shutterstock's core offerings.

3) Integration challenges and lack of revenue contribution from acquired assets like Giphy and Pond5.

4) Limited pricing power, smaller deal sizes, and margin erosion within AI data business over time.

Conclusion

Shutterstock operates a differentiated platform at scale in the high-growth digital content space. However, its growth has faltered recently amidst AI disruption worries.

SSTK does trade at a sizable discount currently with solid cash flow and balance sheet flexibility. But uncertainty remains on the impacts to its business from generative AI and progress reviving growth drivers like Giphy.

I prefer to stay on the sidelines until gaining further clarity on Shutterstock's transformation. The current margin of safety and attractive dividend at least provide some downside support in the interim.

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