PhotoChannel Networks; Dot Bomb Turned Dot Profitable

September 23, 2006
Volume VII, Issue 73
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PhotoChannel Networks (OTC BB: PHCHF; TSX: PNI)

Today's new idea has profits, profits, profits written all over it. This industry group is going to get extremely hot in a month or two, and investors will be searching for ideas in the space. Guess what- they are only going to find two pure plays, and today's idea is the only one you can invest in now.

It's all about digital photo processing- getting your pictures out of your digital camera and into print. There are currently four ways of doing it:

  • Printing them yourself on a high end home printer (if you've tried it, you know it is extremely expensive and difficult)
  • Plugging your memory stick into a kiosk and waiting for the photos to spit out (not popular)
  • Uploading your images to a web site and mail ordering your prints
  • Uploading your images to a web site, and picking up your prints at a nearby store
Of the four choices above, which do you think analysts project will have the strongest growth over the next five years? You guessed it- uploading to a web site an picking up your prints locally in one hour. It's known as "Online to Retail". Online photo finishing, which was about a $1/2 billion market in '05, is expected to grow to $2 billion by '09.

There are several advantages to "Online to Retail" vs mail order. First and most importantly, it provides the instant gratification we are all used to from one hour photo finishing. Secondly, it's cheaper because there are no shipping costs. And last but not least- retailers can be very aggressive on pricing because photo finishing is a high margin item, and it gets shoppers in the store. Mail order processing doesn't have this advantage. Online to Retail is where the growth will be.

Enter PhotoChannel- The Unseen Back End

You may have used a PhotoChannel solution, but you have probably never heard of the company unless you read the OTC Journal back in 2001 when I first reported on them (pre dot com crash). The stock is just starting to come off a multi year low, and the company is exploding.

PHCHF is a B2B company (remember that buzz word from the '90's?). They provide the technology infrastructure for brick and mortar stores who want to offer Online to Retail photofinishing services. They don't print out the photos. The just provide a private label web site for the store. You upload your images on their servers, they send the order to the store, the store prints them, and you pick them up in one hour. They collect a couple of pennies for every print ordered over their systems.

Check out this list of retailers for whom they provide the "silent back end":

  • WalMart Canada and Sam's Club Canada: 280 stores
  • Costco Canada: 20 stores
  • Black's Photo (Fuji subsidiary): 150 small retail stores
  • CVS: Includes over 5,000 locations in the US all of whom offer 1 hour photo finishing. In addition, CVS has recently acquired Albertson's, SavOn, Osco, and Jewel- all of whom are expected to be outfitted with one hour photofinishing labs.
  • Brooks/Eckard- Recently bought out Rite Aid- the 3rd largest drug store chain in the US- photolabs to come.
Now, going back to the mid week edition entitled "Dot Bombs Turned Into Dot Profits", you might ask yourself why this stock now? What has changed? The answer- CVS- the CVS relationship has vaulted PHCHF to a whole new level, and the arrangement just rolled out this summer.

Prior to CVS selecting PhotoChannel for the back end solution, there were about 500 stores in North America using them. CVS brings over 5,000 retail outlets to the table, all of whom are local "neighborhood" operations. In short, PhotoChannel's business grew 10 fold this summer. I have read one research report predicting that PHCHF turned cash flow positive in August for the first time in its history.

How Do They Generate Revenues?

There is a research report out on the company which was written after the CVS launch. Here's the assumptions provided:

  • Every store they service averages 4.8 orders per day for the remainder of '06, ramping to 9.5 orders per day by the end of '07. The CVS chain is just starting to advertise the service.
  • Each order averages 40-50 prints
  • PHCHF gets about $.02 per print
  • PHCHF serves 5182 stores (this assumes no new relationships by end of '07, which is not likely)
If you quickly do the math, you will find the numbers equate to about 1 million prints per day, which equates to $22,500 in cash- $8.2 million in annual sales, which doubles in 2007.

The research report projects PHCHF will deliver about $5.6 million in '06 and $.02 per share in losses. He then forecasts $12.8 million in revs in '07, and a turn around to $.02 per share in profits.

Potential Catalytic Events For the Stock Price

This is a huge industry, so naturally there is some competition. However, as it stands today, PHCHF is really the only pure play in the B2B space for photofinishing.

Two of the more commonly known names are Snapfish and Shutterfly. Snapfish provides both B2B and B2C services. The company serves as the back end for WalMart US (#1 in US photofinishing- CVS is #2).

You cannot invest in Snapfish. The company is a subsidiary of Hewlett Packard (NYSE: HP). HP bought the company several years ago. At the time of the purchase, Snapfish already had the WalMart relationship in place. According to industry scuttlebutt, WalMart is a bit unhappy with the relationship which may explain why PHCHF landed WalMart Canada. Snapfish is very active in direct customer online printing and shipping services. This competes directly with WalMart's in store services.

Shutterfly is a different story. They recently filed for an IPO at a market valuation of $350 million. If this is the kind of hot IPO the market is expecting, this will be the catalyst for major price movement in shares of PHCHF. It should be trading in the next month or two. Investors will be looking for sympathy plays, and PHCHF will be the only one out there. This is your opportunity to front run the sector. Be in ahead of the crowd.

Potential for Accelerating Growth - Kodak Caught With Its Pants Down

Here's another potential catalyst for a skyrocketing stock price. Did you know that Kodak (NYSE: EK) is trading at a 15 year low? The stock was $90 in 1998, and today it is barely hanging on to $20.

This former behemoth of the photo processing space has come under major criticism for its failure to participate in the digital photography revolution. Much like the US auto industry, who's complacency led to declining sales sales of gas guzzling SUVs while Toyota was eating their lunch with the hybrid Prius, Kodak was slow to recognize the consumer's willingness to adopt digital imaging.

Kodak's management has a renewed mission to participate. Their bread and butter is chemicals, inks, and paper. OFoto- the Kodak online mail order service, is the largest photo processor in the B2C space. However, Kodak is looking at Online to Retail as a major new source of revenues, and they have the relationships with the big retail chains. What they don't have is the back end infrastructure.

Some sort of arrangement with Kodak and/or Kodak customers is a distinct possibility. Why?- because two of the key board members are former Kodak executives. Keep one eye on the news for potential developments along those lines. An event of this nature would send shares of PHCHF to new multi year highs.

Conclusion- Where's the Stock Going?

Here's a weekly chart of the stock extending back over 2 years. Several items jump off the screen. First, note the stock has traded within a penny or two of $.10 for the last year. Pretty boring. In the Fall of '05 it found its way briefly into the $.15 to $.18 range, but for the most part the stock went nowhere for a very long time.

In the last two months everything has changed. It all happened in conjunction with the signing and the roll out of the CVS Deal. This added over 5,000 local photofinishing locations, and guarantees the company will deliver significant revenue growth over the coming months and years. 

Also, note the volume has been increasing as rapidly as the stock price. The last two months has seen major volume expansion. Investors are rediscovering this idea. Since June 1 the stock has traded over 1 million shares 18 separate days. A number of those days have seen volume levels north of 3 million shares.

I anticipate the renewed enthusiasm for this stock will continue as it climbs the charts. There could be supplies to wrestle with- after all there are about 300 million shares I&O- a substantial number.

The company is starting to garner significant institutional interest thanks to the CVS deal. A reverse split, perhaps 10 for 1 could be in the cards for this stock. In this case, I think it would be a good move. The company is ready to come out of the penny market and garner institutional participation. The money raising dilution should be over as they have $2 million cash in the bank, no debt, and no need for any more capital. They need to bring the stock price up where institutions can own it.

The Great Gables research report, prepared independently on the company, is not publicly available. I have a copy, and can tell you they project a $.40 to $.60 stock price near term based on significant growth, a turn to profitability, 50% gross margins, and $.02 per share in earnings on about $13 million in sales and nearly $6 million in EBITDA profits in 2007. I will try to get permission to post the research report on our web site.

When Shutterfly hits the market, everyone will be buzzing about the online photo finishing sector and looking for the next big thing. Remember this week's edition Dot Bombs turned to Dot Profits- Look for PHCHF to follow the likes of CPNE, AMZN, YHOO, EBAY, and AKAM. After 5 years of struggle their time has come, and it's only just beginning. 

Accumulate this one up to $.22. Looking for the aforementioned target of $.40 to $.60. Consider getting started with 1/3 of what you want to own immediately.

This stock trades on the OTC BB under the symbol PHCHF. However, for our friends to the North, it also trades on the TSX in Canadian dollars under the symbol PNI. All dollar amounts in this presentation are in US dollars.


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