Shopify - How Small Businesses Can Compete
Occasionally, a company comes along in the stock market where you look at it and go "where the hell was I?" when you see the immense run the stock has gone on. Whether it's Amazon or Apple from the early 2000's, or even a company like AMD from just a few years ago, there's usually the "white whale" company; the one that got away. One such company that has risen to extreme prominence in the last decade is Shopify, effectively the keystone company of the e-commerce revolution. Since it's IPO in 2015, the company is up an immense 5,291%. But that begs the question: Does this company still have the ability to grow? Did it grow too much to fast? Like Bol Bol, is it so big that it's now in its own way? I'm out to answer those questions and more, so let's go!
Top-line Numbers:
2020 FY Revenue: $2.93 billion (+85.63% YoY)
2020 FY Net Income: $319.51 million (+355.93% YoY)
Q3 2021 Revenue: $1.12 billion (+46.43% YoY)
Q3 2021 Net Income: $1.15 billion (+501.06% YoY)
Market Capitalization: $193.46 billion
What Is The Business?
Shopify is the ultimate e-commerce solution for small businesses. Headquartered in Canada, the company specializes in helping small businesses get their stores online, providing them with simple-to-set-up digital storefronts, point of sales systems, marketing, customer engagement and shipping tools. In turn, Shopify generates its revenue in two different ways: a monthly subscription fee paid by the small businesses to use the platform, as well as "merchant solutions" which includes: payment processing fees for transactions enacted via Shopify Payments, shipping fees, partner referral fees and point-of-sale hardware.
How Did They Get Started?
Shopify is a case of being founded by accident. I'll explain: in 2006, Canadian computer programmer Tobias Lutke and his buddy Scott Lake attempted to open an online store for snowboarding equipment called "Snowdevil." Cool. Reportedly unsatisfied by the e-commerce experience for getting a small business set up online,
Lutke took matters into his own hands and built a new platform using existing opensource coding. The platform launched in June 2006 under the name "Shopify." In 2009, Lutke added API support and an App Store within the platform, allowing other developers to design plug-ins for the site, increasing its functionality.
The company exploded in 2010 when they launched their mobile app in the Apple App Store, winning the prize for "Fastest Growing Company" in Ottawa, followed by securing $7 million in Series A and $15 million in Series B funding. Securing the bag allowed Shopify to then roll-out Shopify Payments, which eliminated the need for a third-party payment processor. This let Shopify bring all of those sweet, sweet credit card fees in-house, which in turn drove a Series C funding round of $100 million and grew their user base to 120,000 small businesses. Houston, we have a unicorn. 2014 also saw the company report their first year of over $100 million in revenue, doubling their 2013 numbers. This allowed them to unveil their Shopify Plus solution, which caters to larger e-commerce companies by providing advanced features. On the back of this, the company filed their magical S-1 document and went public on May 21, 2015 at $28 per share.
The Bull Case
E-Commerce Dominance
Shopify is a little like Wordpress: sure, you could use other providers, but why would you? Shopify is the definition of "dominance" in the e-commerce space, and for good reason. It works! They have over 1.7 million businesses on the platform selling their wares, representing 175 total countries. If that sounds like a lot, it is! Their customer base actually accounts for 11% of the total e-commerce market, trailing only Squarespace Online Stores and WooCommerce in the space.
And the story doesn't stop there. The shoppers who purchase products from Shopify merchants actually increased over 50% from 2019 to 2020. According to a company press release in early 2021, Shopify saw nearly 460 million consumers purchase an item from Shopify merchants, which in turn expanded the company's revenue by 47% year over year from 2019 to 2020.
It's also worth noting another quick bit of history. Shopify did trade sideways for about a year after their 2014 IPO, before a massive catalyst gave them a swift kick in the ass to get moving. That catalyst? They defeated Amazon. Seriously. Jeff Bezos saw Shopify coming and attempted to roll-out a competitor service, called Amazon Webstore. This functioned in much the same way as Shopify, but was a little more stripped down and not as "built from-the-ground-up" in the same way Shopify was. In 2015, the sheer dominance of Shopify pulled users away from Amazon Webstore, which forced the closure of Webstore in 2015. Then, they adopted the "if you can't beat 'em, join 'em" mentality by officially naming Shopify as its preferred migration provider. Shopify shares skyrocketed 20% on the news.
Revenue Growth and Merchant Solutions Expansion
Obviously, 2020 was a remarkable year for the company, but it was also the pandemic when nearly ever store had to (hopefully) temporarily shut its doors. This led many businesses to transition to online stores, which has led Shopify management to call 2020 "the year of discovery" for merchants and consumers alike on the platform. In turn, 2021 has become "the year of absolutely bananas growth" for the company. President Harley Finkelstein stated in the recent earnings call that it took Shopify merchants 15 years to achieve $200 billion in cumulative gross merchandise value (GMV), but only 16 months to double that number. And while their most recent earnings report was pretty disappointing in terms of comparing growth to last year's levels, it still grew revenue 46% in the third quarter to $1.1 billion, with the biggest revenue lift coming from the Merchant Solutions division. The subscriptions business rose only 37% year-over-year, but still pulled in $336 million for the company.
Wait...I said "disappointing" a second ago, right? Well that's because stock analysts, as a whole, are finicky. They pick a number that's basically the over/under in a Las Vegas betting line. If you come in under that arbitrary target some over-caffeinated 24 year old Wharton grad cooked up in their Excel spreadsheet, then fuck you buddy it's time to get hammered. In this case, the earlier stated GMV metric was somehow disappointing to analysts, having only grown 37% to $42 billion, not the $43 billion that analysts were "expecting." And despite missing on the GMV metric, the company still reported GAAP (generally accepted accounting principles) earnings at a MASSIVE $9 per share. They also weren't the only big tech company to whiff on earnings this quarter, either. Apple and Amazon both missed on revenue in a big way, so a slight revenue miss by Shopify was actually viewed as a positive by investors, weirdly.
Historically, Q3 has been a weaker quarter for the company as it comes out of the summer lull and into the holiday season. Earlier this year, Shopify reported a 114% growth rate year over year in their overall revenue, and Q2 saw 40% growth, so the company is still reporting terrific underlying numbers.
Mergers and Integrations
Shopify lives and dies on the combination of merchant service revenue and monthly subscription revenue, which rolls up into a monthly recurring revenue number for them. Ideally, they would like to see both revenue streams grow together consistently. However, as we just laid out, sometimes one outpaces the other, and it's usually the merchant services doing the outpacing. They attract a company, who pays a monthly fee to be on the platform. From there, Shopify wants to see that merchant succeed in selling items at a faster and faster monthly rate. This will likely see the merchant upgrade their monthly tier on the platform to unlock new features, as well as generate more merchant services revenue for Shopify as the merchant in question takes orders via Shopify Payments, uses Shopify Shipping for physical goods or markets via the Shopify platform. This is the ideal state for the business, and they've been executing to perfection. This chart outlines the staggering consistency at which Shopify has been executing on their monthly growth strategy.
In order to lure merchants to the platform, Shopify continues to make key acquisitions and integrations. Earlier this week, they announced the capture of B2B digital commerce design company Eporta, based out of the U.K. The company allows European designers and retailers to both trade directly with wholesalers, as well as allowing these brands to run their own e-commerce solutions, similar to Shopify. This merger indicates a clear want to expand Shopify more aggressively into Europe, and more into the B2B direct space.
New Product Roll-outs
In addition to heightened M&A activity, Shopify also constantly introduces new products to assist merchants in their sales and scaling efforts, thereby increasing their own Merchant Services revenue. In 2016, it was the ability for merchants to implement flash-sales. In 2017, it was the integration with Amazon that allowed Shopify-based merchants to sell their wares on Amazon with no added coding, as well as the introduction of physical point-of-sale systems. 2018 saw the addition of marijuana payment processing in Canada, followed by direct marketing integrations with Facebook, Google and Snapchat to make marketing via those platforms easier and direct from the Shopify platform.
So where does the company go from here? Well if you listen to their latest earnings release, they may have provided a few clues. First, the new product announcements: They announced the introduction of Shopify Markets, which gives merchants an easier time selling across internationally. They're also looking to expand their merchant finance side of the house with the upcoming Shopify Balance money management platform. Finally, they announced another social media integration, this time with TikTok to allow users of the app to more organically find related shopping products that link back to the merchant's Shopify store.
Next is the mention of "retail happens everywhere" by Finkelstein. Eagle-eyed investors will notice that, as opposed to every other company that issues their earnings from their headquarters, Shopify issues theirs from "Internet, Everywhere." I think this really highlights where the company sees themselves expanding into next. A study released this year by Shopify, but cited by The Motley Fool, digs into some interesting spaces. Shopify claims as a result of this study that live-stream shopping events (so we're right back to QVC. Got it.) will account for $25 billion by 2023 in the U.S alone. This pairs nicely with the "click-and-collect" commerce (think Pinterest's "one tap" pins) will top $64 billion. They also believe that personalization in sales will account for an additional $3 trillion in revenue by 2030. This hints at the direction Shopify could be thinking of moving in, whether through product roll-outs or aggressive M&A. Either way, I wouldn't bet against them.
Incredible Track Record for Their Companies
This part is actually pretty unbelievable to me. While currently establish companies like Pepsi, Kylie Cosmetics and Gymshark use Shopify to facilitate their e-commerce needs, the platform is mostly made up of small businesses looking to hit it huge. In some cases, this happens. Shopify's founder and CEO posted a tweet this week that I almost didn't believe:
Shopify has single-handedly facilitated three MAJOR success stories: Oatly, FIGS, and the recently public Allbirds, all who are now consumer staple public companies. Just extraordinary.
The Bear Case
Valuation
As I mentioned earlier, then gross merchandise value is starting to slow down. Keep in mind, that's relative to the ridiculous rate it was moving in from 2019-2021, but it's still "slowing." It's the Disney Plus problem I highlighted a few weeks ago: 2020 was such an unbelievable outlier for growth that the acceleration set up unachievable year-over-year comps, resulting the appearance of slowing growth.
The valuation of this company is also pretty wonky. While the company is amazingly profitable, it still trades at 57 times trailing price-to-earnings, and a sky-high 200x what analysts expect for next year's growth. However, the multiples do get more attractive as you begin to look several years ahead in analyst expectations, resulting in a five-year forward P/E of around 2, giving you potentially insane value if the stock continues to grow at a 30% annual clip. Lofty, but certainly doable for this company based on their sterling track record.
Finally, their Q3 earnings were a little bit of a lie. While they beat on their earnings per share metrics, they followed the big tech earnings trend this quarter by falling off a cliff on an adjusted basis. You also probably noted above that their net income for this quarter was actually higher than their total quarterly revenue. That's due to the options Shopify had in Affirm exercising, creating $2 billion in value for the company. Not a bad investment.
Competition is Growing (Etsy)
One thing that could potentially impair that growth is the rise of Etsy, a chief competitor to Shopify in the personalized small business space. Etsy's growth has been similarly meteoric, skyrocketing over 2,000% over the last five years. The company is similarly aggressive in the product rollouts, merchant solutions and acquisitions, putting themselves in position to challenge Shopify in the space. And while I don't believe that the space of small business e-commerce is zero-sum, I do believe that Etsy is primed and ready to steal market share in the next few years.
C-Suite Turnover
An absolutely critical part of evaluating any company is to keep an eye on the corner office. Leadership is an important part of the company, not only from a capital allocation standpoint, but from a culture point of view. Can they create an environment in which they can attract and retain top talent? Well earlier this year, Shopify lost half of its C-Suite, seeing their chief talent officer, chief legal officer and chief technology officer all leave simultaneously. While Lutke said that all were leaving for separate reasons, the timing is really strange. And even if all of the reasons are above board, the transitions can be striking for multiple departments at the same time, potentially creating a different type of company culture that could take this company in a different direction. Having personal experience in companies that see large C-Suite turnover, the changes can have a brutally detrimental effect on a company.
The Bottom Line
Shopify is a genuinely incredible company. Despite their multiple-thousand percent run up since becoming a public company, I still believe that they have much more room to grow. The spaces they are evolving into, as well as the rapid expansion of their merchant services segment, is driving this company towards what I call "monster status:" Untouchable in their space, a trend-setter and inventing new growth levers to pull. Shopify is a clear winner for me, and a company I'm excited to see grow over the next few years.
Short-term: Long.
Long-term: Long.
The following article is for entertainment purposes only, and should not be interpreted as investment advice. The article represents the opinion of the author, so please do your own research. For individual situations, please contact an investment and/or tax professional. The author does not have a financial stake in Shopify Inc.
