2023-08-25 05:13:03 ET
Summary
- Shutterstock has been underperforming on revenue growth in the last 2 quarters, leading to significant sell-offs after earnings and ultimately, a -22.8% return year-to-date.
- The company is also facing disruption to its core business from emerging AI technologies that can readily generate stock media.
- Management is aware of this, however, and Shutterstock is actively investing in generative AI capabilities to hedge against disruption and has established a solid product set for the changing market.
- Given the company's solid financial footing, it is well-positioned to pivot.
- Considering all of this and the new products in detail, I am optimistic that SSTK will return to revenue growth and subsequent share price appreciation.
Overview
Shutterstock ( SSTK ) hasn't been having a very good year. While the company has outperformed against consensus EPS expectations across the last 3 quarters, it only hit parity on revenue projections for Q1 2023 and subsequently missed revenue expectations last quarter.
This weakness on revenue growth appears to have driven a severe sell-off after Q1 results were released, one which brought the stock's price return below the NASDAQ Composite as well as the S&P500 for the year. The 2.6% miss against revenue expectations in Q2 drove further depreciation in Shutterstock shares, ultimately landing the stock at a -22.8% return YTD. It's worth noting that Q2 '23 results saw revenues grow less than 1% and that gross profit declined 2.1%.
Generative AI Inflection Point
Shutterstock's situation is made significantly more complex by the emerging AI secular trend. Shutterstock's core business, namely providing stock media content such as photography, audio, and video clips, is ripe for disruption by nascent large language model technologies. Recently developed AI technologies have proven that they're able to readily generate multimedia content, often without requiring technical expertise on the part of the user.
If stock content becomes that much more automated and commoditized, this could spell trouble for Shutterstock's business. It is unclear if recent revenue headwinds that the company has been facing are a result of this. I am inclined to think not. I believe that this stems from an overall slowdown in the 'creative sector', something being pushed along by the Hollywood strikes and concomitant slowdown in media production overall. Nonetheless, disruptions to Shutterstock's business from AI are certainly on the horizon and could hamper revenue growth much more significantly in the near-term.
Management happens to be aware of this and has been actively investing in generative AI capabilities. Shutterstock was one of the first companies to sign a deal with NVIDIA (NASDAQ: NVDA ) for making use of NVIDIA's new Picasso large language model. Picasso is a generative AI technology, delivered via the cloud, that generates visual content (2D and 3D) through text prompts from the user. This partnership involves a jointly-developed product that's trained on Shutterstock's data.
All of this marks Shutterstock as being at an inflection point. Facing rapidly slowing revenue growth, as well as a core risk to its business model, it must adapt in order to return to growth. Given its trajectory this year it is fair to surmise that investors would continue to unload the stock if it continues to underperform on revenue growth. At less than 1% y/y growth last quarter, it's quite possible that this slips into negative y/y revenue growth this year. On the other hand, it is actively hedging itself against disruption by investing in generative AI capabilities - something that could reverse this recent trend and drive significant upside.
Forward Outlook
While the current outlook for this stock is highly uncertain, I will walk through its foundations and posit my view for how things should progress. The first thing that we should note here is that Shutterstock continues to be on firm fundamental footing, share price volatility aside. Even with weak revenue growth last quarter, Shutterstock delivered solid earnings per share. This has long been a profitable company and should continue to be so.
Cash from operations also remained positive, albeit trending downwards y/y. Given the company's business model, and lengthy track record of cash flow generation, I'm expecting this to hold up.
This solid earnings and cash flow picture is further reinforced by what appears to be a quality balance sheet. Shutterstock has minimal debt (less than ½ of 1 quarter's revenue) and also maintains a negative net debt position.
This puts Shutterstock in a good position to execute on a pivot. It doesn't have to reinvent itself while struggling with significant debt payments or a disconcerting balance sheet. I am expecting it to remain solvent, profitable, and cash flow generative for at least the next year.
With that being said we can establish a forward outlook for how its business should perform. This should come down to its evolving product set as well as its strategy. I think it's best to assume that top line growth in its core offering should remain flat for the next 2 quarters, give or take 5%. As such the question becomes one of whether Shutterstock can make up for this elsewhere.
First worth noting is that there has not yet been uptake for AI-generated content amongst Shutterstock's customer base - this was stated point-blank by management on the latest earnings call.
Seeking Alpha Q2 '23 SSTK Transcript
Indeed, management believes that a lot of this comes down to copyright concerns and the fact that outputs are still not truly 'photorealistic'.
Seeking Alpha Q2 '23 SSTK Transcript
Thankfully, the firm has been on its front foot with this as well. As of last quarter Shutterstock has provided its enterprise clients with an indemnification clause in conjunction with its set of offerings. This removes any kind of legal liability that customers may face in making use of AI-generated content. While the long-term legal context for generated content remains uncertain, this appears to be a good quick fix that could get customers buying. I would expect to see results from this very quarter.
Seeking Alpha Q2 '23 SSTK Transcript
The other product developments to be aware of include metadata licensing, advertising, and Shutterstock's Creative Studio.
Metadata licensing is exactly how it sounds. Shutterstock has a massive library of media content that is labeled. This is a golden trove for training large language models, and the company is aware of this. As of last quarter they have formally established this as a product line, dubbing it the 'data engine'. Going forward it will be broken out as a line item on its income statement. In the emerging age of large language models, large and labeled datasets are valuable indeed - and Shutterstock is slated to benefit from this.
Seeking Alpha Q2 '23 SSTK Transcript
As to advertising, there is less detail at this stage. Shutterstock expects to monetize its recent Giphy acquisition this by the end of the year.
Seeking Alpha Q2 '23 SSTK Transcript
Shutterstock's Creative Studio is also a product area worth paying attention to. Referred to as the 'creative engine', this is an integrated set of tools designed to enable media production.
Seeking Alpha Q2 '23 SSTK Transcript
The target market includes both creative media production a la Hollywood as well as commercial media production a la Madison Avenue (entertainment & marketing). The target market includes both creative media production a la Hollywood as well as commercial media production a la Madison Avenue (entertainment & marketing). It's fair to believe that utilization on the creative side has been hampered by ongoing turbulence in the entertainment sector. Additionally we have the previous statements by management as to how copyright concerns are limiting uptake on the marketing side of things.
While Shutterstock appears to have handled the copyright situation, turbulence in the creative sector is ongoing and is set to continue for an uncertain period of time. Given the conversation there, it is also possible that AI-enabled tools such as the ones provided by Shutterstock are ultimately regulated out of Hollywood. I wouldn't bet on it, however. It's quite possible that this creates a body of pent-up demand that will then act positively for this product area at Shutterstock.
Conclusion
What's clear is that Shutterstock is a company in the midst of change. What's good is that management is intimately aware of this and also appears to have a robust forward-looking vision about how to compete in the new landscape. I am bullish on Shutterstock's product set and am optimistic that they are on the right side of AI. This reorientation is furthermore enabled by the firm's track record of profitability and cash flow generation, along with its quality balance sheet. The core risk to this thesis is a simple one - the new products don't gain traction in the marketplace while Shutterstock's core business continues to generate middling results.
I am inclined to be optimistic, however. While I believe it may take several quarters for Shutterstock to return to revenue growth, I believe that it will. This will then pave the road to higher profits and earnings per share, which should drive the share price back up. In order to allow shifts in the market to play out, I am calling it a buy with a 2 year horizon.
For further details see:
Shutterstock: AI-Enabled Products Will Reignite Growth