Just after the market opened on Wednesday Shopify’s share price reached an all-time high of $476.64, putting the online shopping platform’s market value at $54bn.
Investors who have held the stock since its May 2015 IPO have been rewarded with a mind-melting 1,710 per cent return while naysayers, such as Forbes, have been left scratching their heads at a stock that can seemingly only move in one direction:
Today, Shopify represents a buoyant bet on online retail continuing to gnaw away at big box bricks and mortar; the Street’s finest think by 2025 its revenues will sextuple to just under $10bn from 2019’s estimates, with its operating profits exploding from $33m to $1.9bn as it reaches scale.
So is the market right?
In case you’ve never heard of the Canadian company, Shopify provide a range of services — from the back-end infrastructure, to user analytics and payment processing — for over 1m aspiring and established consumer brands. Think of it as a one-stop shop for those who want to start an online retailer selling bespoke leather goods, or aggressively branded coffee.
It’s a sexy pitch: on a macro level online retail’s share of US commerce has been rising steadily, with the latest numbers attributing a 10.5 per cent market share to click-based shopping in 2018. And it won’t stop here, FTI Consulting reckon its share will rise to 24 per cent by 2030. Across the globe, the switch from analogue to digital seems to be accelerating at a similarly heady pace.
On a micro level, Shopify is flying, boasting in its investor deck of having the third highest gross merchandise value of any company in US retail (GMV is retailese for the total of all online sales on a platform):
Shopify’s financials aren’t terrible either. Revenue growth has clipped along at above 50 per cent for the past five financial years, with its gross margin oscillating around 55 per cent.
The flow through to the bottom line, however, has been less spectacular. The average analyst consensus is that, on a GAAP basis, it will take until 2022 for Shopify to post positive net income.
Although, to be fair, its cash flow from operations has been positive for a while, thanks to generous helpings of stock compensation paid to employees every year:
As you can see, the Wall Street wonks expect stock compensation to account for 411 per cent of operating cash flow in 2019, a marginal improvement from 929 per cent the year before. This is, of course, all well and good if your stock continues to grow like duckweed, but an issue if the shares decide to go into reverse, and employees begin to demand cash instead.
Another potential issue is that monthly recurring revenue from its merchant subscription service, a key metric for investors who like to frame Shopify as one of the richly-valued software-as-a-service companies, is steadily becoming a smaller part of its top line — growing 34 per cent in 2019’s third quarter versus 45 per cent revenue growth for the total business.
Although this may not matter much to investors as customers, once up, running and selling, are in effect locked-in to paying Shopify recurring fees for as long as they stay afloat. Giving Shopify both predictable revenue and pricing power, which could be used to offset slowing customer growth.
Yet as subscription solutions sales are growing slower than revenues, the company is increasingly having to rely on its merchant solutions arm to keep up the top-line momentum. To wit, in the first nine months of 2019 merchant solutions made up 57.2 per cent of its sales, versus 54.6 per cent in 2018.
Unlike Shopify’s subscription model, where the revenues are arguably less sensitive to market downturns, merchant solutions sales are generated from fees charged to its customers for services such as payment processing, referrals and transactions on its point-of-sales hardware. This ties the revenue stream to the mood-swings of consumer spending, which tends to sour when the economy heads south.
Perhaps of greater concern is merchant solutions’ profitability: its gross margin in the first nine months of 2019 was 38 per cent, versus 80 per cent for Shopify’s subscription arm. If the revenue mix continues to tilt towards merchant solutions, this will put pressure on future profitability.
Still, running 55 per cent gross margins with near-50 per cent revenue growth is nothing to be sniffed at. So what of the valuation?
Well, this is the nuts part: Shopify currently trades at 25 times 2020s estimated sales. Gaze six years into the future, and this multiple compresses to a still rather pricey 5 times sales by 2025.
Take analysts’ estimated Ebitda figure for 2025, $2.7bn, and the numbers get even more preposterous: an investor today is paying a six-year forward EV/Ebitda multiple of 20x. Using 2019’s estimate, that number is a frankly comical 771x.
It might be possible to justify this valuation if Shopify had strangled the competition, so it could continue to grow unencumbered. But a certain Seattle-based company is looming.
It was recently reported that Amazon is planning to launch its own luxury fashion shopping platform in the first half of the year, according to Quartz, which will:
. . . operate similar to the concession model seen in department stores and speciality retailers, where brands effectively lease space or pay a percentage of sales to run their own mini-shops within the store. On Amazon’s new platform, according to WWD, the companies will have complete control over the look of their online space, which products they sell (or don’t), and any discounts they offer. At the same time, they’ll have access to Amazon’s vast logistics network for fast delivery, as well as its customer service.
It sounds an awful like Shopify, but plugged into Amazon’s unrivaled delivery infrastructure. If the product is a hit, it’s easy to imagine the service being offered to its millions of existing third party re-sellers. Bezos’ empire has never been concerned with sacrificing margin to take market share, and we doubt it’ll be different this time.
We’ll end with this thought. Shopify’s founder and chief executive, the rather agreeable Tobias Lütke, often sports a beret:
Which reminded Alphaville of a European-born chief executive of a hot Canadian tech stock from another era, Jozef Straus of JDS Uniphase:
Here’s JDS Uniphase’s share price chart during the dotcom madness (it now trades as Viavi):
To allegedly quote Mark Twain, “History doesn’t repeat itself, but it often rhymes.”
Now bigger than eBay, Shopify sets its sights on Amazon — FT
How I Built This: Shopify — NPR Podcast