The Ratings Game: Shutterfly is going to take your school photos now

Shutterfly Inc. made a business of selling physical versions of your digital images, but now the company will create some families’ most treasured pictures as well.

Shutterfly SFLY, +27.64% which has long made it easy for customers to get prints and booklets of their digital photos, announced in a release Tuesday night that it has agreed to acquire privately held Lifetouch Inc., which has been handling school photographs on “picture day” for more than 80 years. Shutterfly will pay $825 million for Lifetouch, which photographs 25 million students a year.

Shutterfly’s stock rocketed 25% higher in midday trading Wednesday, an oddity for a company that is spending so much on a new business. The shares had mostly been treading water for months before the big bump: They are up 31% over the past 12 months, with the bulk of that appreciation coming Tuesday. The S&P 500 index SPX, +0.05%  is up 24% over the past year.

In addition to announcing the acquisition the previous night, Shutterfly reported adjusted earnings for the quarter that vastly exceeded analysts’ expectations. The holiday season is typically the only quarter when Shutterfly posts a profit.

The two companies will combine their manufacturing platforms and benefit from the fact that they have back-to-back “peak” periods. Lifetouch’s busiest manufacturing season is in September and October, right after school starts, while Shutterfly peaks around the holidays.

Lifetouch introduces more than a million new households a year to its services with each new kindergarten class, Shutterfly noted.

“These are precisely the customers Shutterfly most wants to acquire,” Shutterfly Chief Executive Christopher North said on the company’s earnings call. Plus, customers who ordinarily buy photo prints of their children’s pictures might opt to get them on a commemorative mug instead.

Needham analyst Kerry Rice sees the acquisition leading to multiple expansion for Shutterfly’s stock. Rice thinks the deal makes logistical sense, citing the potential for the combined company to cross-sell products more easily and reduce overall marketing expenses given Lifetouch’s natural pipeline into schools.

“Shutterfly’s business was trading at a discount to the value management placed on Lifetouch,” he wrote in a note to clients Wednesday. “Given Shutterfly’s slightly better revenue growth and higher margin profile, we argue that Shutterfly’s business should trade at least at the same multiple as Lifetouch, which would represents modest upside from the current share price.”

He also thinks the deal will help diversify the revenue stream, as Shutterfly’s business will no longer be so dependent on holiday orders. Plus, Lifetouch has long-term contracts with many schools that can help provide “more revenue predictability,” per Rice, who has a hold rating on Shutterfly shares.

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Management at Shutterfly expects “significant” revenue and cost synergies from the deal over time. CFO Michael Pope projected an additional $50 million in adjusted earnings before interest, taxes, depreciation, and amortization by 2020, bringing the combined company’s adjusted Ebitda to $450 million.

“We view the acquisition of Lifetouch positively given its strategic rationale, potential for revenue/cost synergies and valuation,” wrote SunTrust Robinson Humphrey analyst Youssef Squali, who rates the stock a buy. He raised his price target to $70 from $60.

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