By David Benoit 

An activism fight is developing at Shutterfly Inc.

Marathon Partners Equity Management LLC, a New York hedge fund, is planning to nominate three directors to the board of the online photography service, citing concerns about the company's acquisition strategy and compensation, according to people familiar with Marathon.

The push to shake up the board comes after Shutterfly shopped itself but failed to strike a deal last year, according to other people familiar with the matter. The Redwood City, Calif., company, which has a market capitalization of about $1.8 billion, held talks with private equity bidders Bain Capital LLC and Silver Lake, but the discussions didn't result in a deal, the people said. The talks were reported widely and sent the stock climbing, but the share price has since receded.

Marathon isn't directly pushing a sale of the company, though it wouldn't be opposed to a deal at the right price, people familiar with the matter said. Marathon, with about 5.5% of the company's stock, is a longtime holder in Shutterfly and in July first said it was in talks with the board and management over its ideas for the company.

A spokeswoman for Shutterfly declined to comment Thursday. Shares of Shutterfly rose 19 cents to $47.24 in late-day trading.

In November, Shutterfly struck its own acquisition, spending $14.5 million to buy GrooveBook, a service that sends subscribers monthly books of photos on their phone and was featured on the television show about startups, "Shark Tank."

That deal--the 10th acquisition made by Shutterfly since the start of 2012 according to S&P Capital IQ--concerned Marathon, which believes the series of purchases is distracting the company from its core business, the people said.

When announcing the deal, Shutterfly said the GrooveBook purchase was meant to expand its mobile offerings.

In its fourth-quarter results, announced two weeks ago, Shutterfly reported an 18% increase in revenue, to $483 million, and a 16% increase to its adjusted profit figure. Analysts questioned executives on a conference call about the company's forecast for gross margin in 2015, and the stock fell 4.5% the following day. The stock is down 9% over the past 12 months and up about 15% over the past 24 months.

Along with earnings, the company also announced a $300 million share buyback program.

Marathon also has told the board that it has become increasingly frustrated with the company's executive compensation, the people said. Marathon was particularly upset with the award of nearly $7 million in restricted stock units to Chief Executive Jeffrey Housenbold last November, the people said. The company doesn't typically make its compensation awards in November, filings indicate.

Shareholders have broadly signaled disapproval of the company's compensation with low support for the annual resolution advising the executive pay plan at the annual meeting the past two years. Last year, support for the resolution fell short of 50% of shares voted, and in 2013 it was just over 50%. Proxy adviser Institutional Shareholder Services Inc. has recommended a "no" vote on the nonbinding measure three years in a row, though it said in May that Shutterfly had "demonstrated some responsiveness" to shareholder concerns.

Marathon has about $300 million in assets and is run by Mario Cibelli. It has run activist campaigns against smaller companies including Dover Motorsports Inc., an operator of Nascar racetracks. It has held a position in Shutterfly for nearly seven years, and the stake is its own largest holding. It is the fifth-biggest investor in the stock.

Mr. Cibelli is among the three nominees Marathon will nominate for Shutterfly's nine-person board, the people said. The hedge fund is also nominating Marwan Fawaz, a founder of boutique advisory shop Sarepta Advisors LLC, and Thomas Hughes, a venture capitalist and former executive at Flickr, Yahoo Inc.'s photo storage service, the people said.

Write to David Benoit at david.benoit@wsj.com

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