Gamble of the Week: how to profit from digital cameras

Have you bought a new camera recently? If so, then my guess is it was digital. Not only are digital cameras more feature-rich than their film-based cousins, but many shops, such as Dixons, have stopped stocking traditional film-based products.

This trend has led to a seismic shift in photo processing: it's expected that in the UK this year there will be more digital photos developed than alternatives (ie, analogue). Digital printing is cheaper, more flexible and produces sharper quality pictures. Another important feature to note is that, although consumers are being more selective regarding which photos to develop, they are also taking lots more snaps, thus maintaining the overall size of the market in volume terms.

Double-digit growth

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

In 2005, the UK digital-photo processing market was worth approximately £75m. This is forecast to double over the next four years. Digital-camera penetration in the UK is still only 50% complete, which, along with the adoption of camera phones, will underpin future growth.

Leading UK software developer for private-label digital printing

Pixology is the UK market leader in software for retail digital printing, and services four of the top five UK retailers: Asda, Boots, Jessops and Tesco. Tesco have recently signed a four-year deal, valued at more than £1m, while Jessops is rolling-out further software in its shops. Pixology's strengths lie in retail and kiosk processing, which accounts for about 70% of digital print volumes. Home printing, due to its higher cost, represents about 15%, with the balance attributable to online orders.

Patented technology at a rock-bottom price

Although currently loss-making, management are targeting break-even in 2006 as recurring revenues increase. At 39p, the business is valued at only £8m. In my opinion, this is incredibly cheap, especially as it had £5.5m of cash at the year end and has unrelieved tax losses of £11m. Pixology's technology is patent protected and it also owns some clever software, called IRISS, which removes the problem of red-eye in flash photography. IRISS has recently been embedded into Olympus's new range of digital cameras. Finally, Pixology has just launched a new in-store gift-kiosk service, which lets consumers create personalised gifts such as posters, greeting cards, mugs, mouse mats and puzzles from their favourite photos. This appears to be a sensible strategy as it moves the business into higher-margin products.

Potential takeover target

Unsurprisingly, given Pixology's low valuation, takeover speculation is in the air although nothing concrete has yet materialised. But what are the downsides? Clearly, being a small company in a highly competitive industry, the firm is a risky investment. Moreover, there is continual pricing pressure within the standard six- by four-inch image sector, causing UK retailers to drop their prices to as low as 5p per print. Obviously, there is a chance that Pixology will not move into profitability, although its healthy cash balance will at least allow it to weather most storms in the immediate future. Additionally, Pixology's US business is currently sub-scale and could become a drain on resources if it's not beefed up.

Recommendation: BUY at 39p

Although definitely not for the faint-hearted, Pixology is attractively valued and in my mind well worth a punt as part of a larger diversified portfolio.

Paul Hill's personal portfolio has gone up by 483% over the last five years. to find out more about his specialised share-tipping service, click on the linl below.