Online photo service Shutterfly has agreed to buy the online photo service of bankrupt photography company Eastman Kodak, the start of Kodak's efforts to reorganize as a smaller but profitable company.

The $23.8 million deal for Kodak's Gallery unit was announced after the markets closed Thursday. Shares of Shutterfly (SFLY) shot up more than 20% higher in early trading Friday on the news.

Kodak said the agreement is for the the initial bid in a court-supervised auction process. But Kodak spokesman Christopher Veronda said the company expects that the auction will result in the Gallery business going to Shutterfly for the $23.8 million price.

Shutterfly is a successful but still relatively small online photo service with 2011 revenue of $473.3 million, and income of $35.4 million. It was founded in 1999 by Jim Clark, founder of Silicon Graphics and Netscape Communications. The company declined to comment on the deal.

Kodak (EKDKQ), which filed for bankruptcy on Jan. 19, was once the dominant company in film and photography, and a former component of the Dow Jones industrial average. But it found itself ill-prepared for the shift from film to digital photography that has taken place.

Even with all its troubles its revenues for the first nine months of 2011 came to $4.3 billion. But Kodak suffered a net loss of $647 million in that period, the most recent for which it has reported results.

Kodak files for bankruptcy

Kodak said the sale is part of its strategy to focus on core businesses in which it can be most profitable. Last month it announced it would exit the digital camera business and would instead license its brand name to other camera manufacturers.

The Kodak Gallery business has 75 million customers in the United States and Canada, and their photos will be transferred to Shutterfly accounts, unless they opt out during the transition process.

Kodak has about 1,100 digital patents that it intends to sell as part of the bankruptcy process as it tries to raise cash to remake the company. Those patents comprise about 10% of its patent portfolio, and have the potential to generate $3 billion in the auction process, according to analysts.

But the company faces some legal challenges in that auction process.

First up will be a hearing in bankruptcy court next week on a motion by Apple (AAPL, Fortune 500), which is challenging Kodak's claim to a patent for part of the digital camera included in the iPhone.

Apple's suit against Kodak was put on hold as part of the bankruptcy protection procession. At the March 8 hearing, Apple will be seeking to lift that stay.

Source :money.cnn.com