Via online business online marketing online business opportunities Shopify Inc.: Overvalued Ads
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Shopify Inc. (SHOP) is a $54.8B market cap eCommerce platform company based in Ottawa, Canada, supporting more than 1M merchants from 175 countries. Gross Merchandise Volume (GMV), representing the total dollar value of orders processed by Shopify, was more than $14.8 billion in 3Q19. The company actively supports more than 3,200 third-party apps in its app store, having added 300 in 3Q19. The company intends to report 4Q19 financial results the morning of February 12, 2020.

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Shopify should be considered a “Growth” stock company, with revenue and market cap growing faster than the eCommerce industry. However, it remains to be seen if the company can grow into its current valuation, given its negative GAAP EBIT margin, negative free cash flow, and equity offerings to maintain its cash balance and make acquisitions. The company does not pay a dividend.

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Via online business online marketing online business opportunities Background

The company was founded in 2004 by programmer Tobias Lütke and Scott Lake to support their snowboard equipment eCommerce business. In 2004 Lütke and Lake could not find an eCommerce platform to support their online snowboard equipment business, so they built their own.

In 2006 they shifted their focus to developing and marketing their eCommerce platform, brought in programmer Daniel Weinland as a cofounder, and raised $200,000 from friends and family for further development. Lake left the company in 2008 to pursue other entrepreneurial challenges and Lütke took over as CEO, a position he has held ever since. The Globe and Mail’s interesting story about Shopify’s founding, initially posted in 2014 and updated in 2018, is worth a read.

Via online business online marketing online business opportunities Largest Shareholders

Shopify currently has 116.75 common shares outstanding, composed of 104.52 Class A shares and 12.23 Class B shares. Class B shares are entitled to 10 votes per share, and Class A shares are entitled to 1 vote per share. Class B shares may be converted at any time at the option of the holder at a rate of 1-to-1.

CEO Tobias Lütke and board member John Phillips are the largest Class B shareholders, and together with an insignificant amount of Class A shares, own 6.7% and 3.4% of the total shares outstanding. Class B shares represent 54% of the voting power, with Lütke controlling 33.8% of the voting power.

Via online business online marketing online business opportunities Shopify is special in six key ways

1) Accessibility

Shopify offers a platform that makes selling online easy and accessible. According to one experienced eCommerce blogger, it took her 19 minutes to create a Shopify online store, add products, and bring the store online. Personally, it took me about three hours to create and configure the Ascendere Associates consulting services store on Shopify, complete with a catalog of digital downloads and a working shopping cart. When I last tried doing this with WordPress eCommerce add-ins about eight years ago it took me weeks of research and trial and error, and I was only able to get it to work with the help of a friend that routinely charged others $10,000 to develop online stores. Shopify, among others of course, has helped lower the barriers to entry in creating online businesses.

2) Shopify Partner Platform

Enter the search term “Shopify” on YouTube and it returns a seemingly endless list of young marketers and entrepreneurs describing how to take advantage of the platform, which is a testament to Shopify’s accessibility. Google trends indicate that the keyword “Shopify is significantly more popular than competitors “WooCommerce” or “Magento.” It is likely that a great many of these people are part of the Shopify Partner Program, which provides access to third-party marketing, customization, web design, and development services, an attractive resource to its merchants. I found several third-party consultants offering to set-up Shopify storefronts for a flat fee of $100.

3) Enables the direct-to-consumer shopping experience

According to CEO Tobias Lütke, Shopify enables the “direct-to-consumer” shopping experience that was severed by traditional department stores and disintermediation. “The products on Shopify are often the things that people really want rather than the ones they need. It’s boutique-y kind of products.” Shopify helps merchants differentiate from competitors that focus their selling exclusively on (AMZN) and Walmart (WMT).

4) Scalability and innovative new products

According to Shopify, its eCommerce platform is designed to grow with merchants as they scale over time. In addition to providing an online selling platform, Shopify has been growing its payments business, increasingly lending to merchants, and recently announced it would expand into fulfillment services. The company is increasingly providing capital to its merchants. Over time, these new revenue streams could become significant. In 3Q19 it provided more than $140M in advances, up 85% from $76M in 3Q18.

Most of Shopify’s clients are small- and medium-sized businesses paying on average $50/month, with three plans priced at $29, $79, and $299 per month. The company also provides large-scale enterprises with custom pricing. According to a web designer, Penguin Books, Budweiser and Tesla are some of Shopify’s largest clients. Some notable launches in 3Q19 on Shopify Plus, its enterprise eCommerce platform, included SpaceX, the BBC, and brands from LVMH (OTCPK:LVMUY), Heineken (OTCQX:HEINY), and The Unilever Group (UN).

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Source: Shopify 2019 Investor Day

5) The largest or second largest eCommerce platform by market share

Depending on the methodology used, Shopify is estimated by a variety of sources to be the largest or second largest eCommerce platform by market share. For example, after web hosting provider Pagely, Shopify is the second largest with a 20% share while eCommerce dropship manager Oberlo indicates that Shopify is the largest at 31% share. It seems that most sources tend to indicate WooCommerce as the market share leader, followed by Shopify, and then others such as Magento, BigCommerce, Wix, and Weebly.

6) Leveraging significant long-term global eCommerce industry growth

According to Shopify, retail eCommerce sales worldwide were $1.3T in 2014 and are projected to reach $4.9T in 2021, representing a CAGR of 21%. Shopify’s revenue has grown from $205M in 2015 to an estimated $1,556M in 2019, representing a CAGR of 66%, and its market cap of $55B represents a compound annual growth rate of 112% from its May 2015 IPO. Looked another way, Shopify’s revenue has grown 3x the market and its valuation has grown more than 5x.

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Shopify is clearly an accessible, popular, and inexpensive eCommerce platform that is growing faster than global eCommerce market. The key question for investors is, will its rapid revenue growth continue and help the company generate meaningful margins and cash flow that would support its growth beyond its current valuation?

Via online business online marketing online business opportunities SHOP stock trading at an excessive 500X 2020E EBITDA

The majority eCommerce platform companies seem to be privately held or operate as subsidiaries of larger companies. Magento and Weebly are subsidiaries of Adobe Inc. (NasdaqGS:ADBE) and Square, Inc. (NYSE:SQ), respectively. Ltd (WIX) is the only other multibillion-dollar market cap stand-alone eCommerce platform we are aware of. Below is a list of eCommerce and SaaS companies we think are interesting peers.

With the peer group average EV/EBITDA multiple at 59.2x 2020E EBITDA, it is obvious very few of these SaaS companies are trading on near-term expectations, implying that investors must be anticipating high long-term growth. SHOP itself is trading at 500x the 2020E consensus EBITDA estimate of $105M. Shopify’s trailing free cash flow margin of 4% on its own does not support this multiple.

In looking for some justification as to why SHOP may be trading at such a high multiple, we note that investors often fail to appreciate that multiples should only be used as rules of thumb in valuing companies. For example, at 19x 2020 EBITDA could seem overvalued. However, as we noted in 2011 and again in 2018, AMZN deserves to trade at high near-term multiples because it has a long history of proving its ability to realize significant incremental revenue growth from investments in capital spending and R&D. Can the same be said of Shopify? In our opinion, the answer is “no,” as we explain in more detail later in this report.

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Via online business online marketing online business opportunities Is a partner or competitor?

According to some experts it may be only a matter of time before Shopify builds an online marketplace like, Walmart, or perhaps more relevantly, Etsy, Inc. (ETSY). According to Yaniv Sarig, CEO of Mohawk Group Holdings (MWK), a microcap CPG eCommerce platform that leverages proprietary real-time data and machine learning technology, “There is a tremendous amount of value to be had from acquiring a customer, because once acquired that customer is likely to make repeat purchases. In order to maximize the lifetime value from any given customer, I think it would make sense for Shopify to eventually build a search and recommendation engine that would provide a single point of access to all its distributed online storefronts. This is in a way already what the Amazon Marketplace is doing.”

At the moment, Shopify considers more of a partner than competitor. CEO Lütke pointed out on Shopify’s 3Q19 conference call that the company offers Amazon Pay to customers and merchants, and when something is bought on it is often a Shopify store that handles the fulfillment of the order. In 2015, shut down its Webstore platform and took steps to make it easy for its Webstore merchants to migrate to the Shopify platform.

Via online business online marketing online business opportunities Sale of stock rather than positive free cash flow is maintaining high cash levels and supporting acquisitions

At the end of 3Q19 ended September 30, Shopify held $2,667M of cash and short-term investments and $111M of capital leases. Cash and short-term investments were up from $2013M in 2Q19 and $1,578M in 3Q18.

Last-12-month capital spending was $50.9M in 3Q19, up from $43.3M in 2Q19 and $31M in 3Q18. The company closed on three small acquisitions in the first 9 months of 2019. In October 2019 it closed its $450M (approximately 60% cash and 40% stock) acquisition of 6 River Systems, its largest acquisition to date.

LTM free cash flow to the entity was negative $(149)M in 3Q19, down from $(117)M in 3Q18, with an improvement to negative $(115M) projected for 3Q20.

The increase in cash on its balance sheet was primarily due to the issuance of stock. Over the last 12 months, the company generated $1,128M from the sale of stock, including $1,083M in proceeds from the issuance of Class A shares and $45M from the exercise of stock options. Weighted average basic shares outstanding increased to 113.1M in 3Q19, up 6% from 106.6M in 3Q18. The negative free cash flow and increase in shares outstanding, while not excessive, is certainly is not a favorable trait. No matter how it is explained, issuing shares tends to be a sure sign that management thinks the company is overvalued.

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Shopify’s October 2019 $450M acquisition of eCommerce fulfillment mobile robotics solutions provider 6 River Systems is intended to help merchants provide fast and affordable shipping. The acquisition is not expected to materially impact near-term revenue because “…most of its revenue is recognized over the multiyear lifetime of each contract and also reflects the reduction of acquired deferred revenue under purchase accounting.” The company expects 6 River Systems to add $25M of incremental expense in 4Q19, including $10M of cash operating expense, $7M in stock-based compensation and $8M of amortization of acquired intangibles.

Via online business online marketing online business opportunities Impressive revenue growth continued in 3Q19, but positive margins and free cash flow seem years away

3Q19 revenue grew 45% year-over-year to $390.6M, with Subscriptions Solutions revenue growing 37% to $1,655.6M and Merchant Solutions revenue growing 50% to $225M. According to Shopify, growth was driven by GMV expansion to $14.8B, up 48% y/y with international being the fastest growing component. Shopify Payments penetration of GMV grew 42% in 3Q19 from 41%, primarily due to Shopify Plus penetration and international growth and new products such as multi currency payments. 3Q18 EBITDA was negative $(26.9)M versus negative $(25.2)M in 3Q18.

LTM revenue was $1,416.9M, up 48.8% from $952.2M in 3Q18. The LTM gross margin was 55.6%, in line with the 55.8% posted in 3Q18 and 55.6% in 2Q19. Capital efficiency ratios such as ROA, ROC, and ROE have always been negative.

Via online business online marketing online business opportunities Guidance for 4Q19 results on February 12, 2020 is likely to be beat

For 4Q19 the company expects revenue of $472-482M, a GAAP operating loss of $(47)-(57)M, and adjusted operating income of $10-20M. Full year 2019 revenue is expected at $1.545-$1.555B, a GAAP operating loss of $(158)-$(168)M, and adjusted operating income of $27M-37M. The company intends to report 4Q19 results the morning of February 12, 2020.

Via online business online marketing online business opportunities We are not aware of any long-term guidance or targets for overall company

During Shopify’s 2019 Investor Day in June, CFO Amy Shapero did not provide long-term guidance or targets for the overall company. However, she did describe the company’s next major growth initiative which is focused on its Shopify Fulfillment Network. Other initiatives mentioned during its investor day included the introduction of 3D model support, improving the checkout and payment experience, a multi-language APIs, and improvements to Shopify POS for bricks and mortar retailers, including a new loyalty app and camera-based inventory search.

The company expects to spend $1B on capital spending and operating expenses on its Shopify Fulfillment Network over the next five years, with incremental revenue largely offsetting the costs so that the initiative is largely cash neutral. It expects the bulk of its net return from its various success-based investments to come after 2023. Our interpretation is that investors should not expect meaningful free cash flow growth from this initiative until 2024 or after.

According to Shapero, the Shopify Fulfillment Network will “…offer merchants a streamlined fulfillment experience with deep machine learning tools, including demand forecasting, smart inventory allocation across warehouses and intelligent order routing. In so doing, we think we can improve supply chain economics and delivery for merchants, making delivery faster and cheaper than it is today… Merchants’ need for fast, reliable, affordable fulfillment is clear and growing.” Poor fulfillment leads to cart abandonment, lost sales, and low customer satisfaction. The company thinks that by offering competitive fulfillment rates, this will lead to higher cart conversion, which should accrue value to Shopify over time.

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Source: Shopify 2019 Investor Day

Via online business online marketing online business opportunities A news driven story that may have peaked in the short term

The annotated chart below indicates SHOP has surged in price following positive financial results and favorable events, such as the release of its “State of Commerce Report” on June 5, 2019 and its Investor Day on June 19, 2019.

The stock declined following the announcement of its acquisition of 6 River Systems on September 9, 2019 and an equity offering announced on September 16, 2019.

Following its December 3, 2019 announcement that “Shopify merchants break records with $2.9+ billion in worldwide sales over Black Friday/Cyber Monday weekend,” the stock surged 41% from $330.84 to $469.39 by the February 3, 2019 close.

It seems that investors are anticipating a big 4Q19 earnings beat and guidance that will drive 2020 consensus estimates significantly higher in 2020. It is difficult to imagine any meaningful margin expansion in 2020, or an accelerating of already high revenue growth in 2020, so I would be a seller either before or immediately following the release of 4Q19 news and updated 2020 guidance.

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Via online business online marketing online business opportunities Our blended DCF price target for SHOP is $268, 49% below the recent stock price of $469.

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Shopify has for years proven it can innovate and create new products that retain and attract new customers. We think there is a good chance for this innovation and success to continue, which is why we assume our Best Case scenario with a target of $499 has at least a 30% chance of occurring.

Our Base Case scenario assumes continued solid revenue growth and a long-term EBIT margin that falls somewhere between’s and Etsy. We think this scenario is the most likely and assign a probability of it occurring at 60% with a target of $193.

Our Worst Case scenario assumes that competition in the saturated eCommerce platform market will intensify and Shopify’s entry into fulfillment will depress margins, though we think this outcome is much less likely and assign it a 10% probability.

The consensus price target of $396, composed of the mean of 29 institutional analysts, seems way too high to us. Our revenue forecasts are higher than consensus, but we think consensus is overly optimistic on the company’s ability to expand margins over time. It is also possible some analysts are incorrectly applying non-GAAP EBIT forecasts in their DCF valuations.

For our DCF forecast for Shopify, Inc, we assume a 6.9% cost of unlevered equity an asset beta of 1.20, and a market risk premium of 5.5%.

The table below, “Actuals, Guidance, Consensus, and our Base Case forecasts,” shows how our Base Case forecast differs from consensus.

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Base Case Price Target is $193, 60% probability

Our Base Case forecast assumes revenue grows at a 31% compound annual growth rate to $23.8B in 2029 from an estimated $1.56B in 2019. We think this is a reasonable Base Case growth rate assumption given that company revenue has been growing more than 2x projected global eCommerce industry growth of 20% and is likely to taper over time.

This forecast assumes the company attains positive GAAP EBIT in 2022, growing to $2.4B in 2029 as the EBIT margin eventually expands from a projected -9.5% in 2019 to 10% by 2027 and stays at the level. This 10% EBIT margin target is below eBay’s and Etsy’s EBIT margins of approximately 21% and 14%, respectively, and above’s EBIT margin of 5.1%.

We think a long-term Base Case target margin that falls somewhere between that of Etsy and makes sense given that Shopify may be considered a disaggregated version of both the “boutique-y” Etsy and of the fulfillment-intensive In this Base Case scenario, we assume free cash flow turns positive in 2022, and grows to $1.6B in 2029.

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Worst Case Price Target is $26, 10% probability

Our Worst Case assumes annual revenue growth slows to 15% by 2029 either due to slowing industry growth, increased competition, or both, representing a 10-year CAGR of 26%. In addition, we assume that GAAP EBIT margins never meaningfully expand, first turning positive in 2025 and peaking at 2.5% in 2027. In this scenario, we assume free cash flow first turns positive in 2027 and reach $157M by 2029.

This surely is a Worst Case forecast in that it is hard to imagine global eCommerce slowing, or Shopify not being able to generate operating leverage from revenue growth that would still be the envy of companies in any other industry.

However, a pessimist would note that barriers to developing eCommerce platforms is low, and Shopify’s entry into the lower-margin fulfillment industry likely indicates that eCommerce is already fully saturated by a wide range of marketing and selling platforms. In addition, the company has little experience in managing capex-heavy and lower-margin fulfillment centers, and the presumed cross-selling opportunities and customer stickiness by entering the fulfillment market may not materialize. There is no reason why FedEx Corp (FDX), United Parcel Service Inc. (UPS), or, and some other more experienced freight shipping and fulfillment center company can create a seamless service for small- to medium-sized businesses.

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Best Case Price Target is $499, 30% probability

Our Best Case forecast assumes revenue grows at 45% each year through 2022, eventually slowing to 25% in 2029 for a 10-year CAGR of 36%. It also assumes the GAAP EBIT margin expands to 17.5% in 2027 from a projected-9.5% in 2019 – well above Etsy’s and’s current EBIT margins and approaching eBay’s of 21%. In this scenario we assume free cash flow turns positive in 2020 and grows at a 68% CAGR to $4.4B in 2029.

This scenario assumes the company finds ways to extend its current revenue growth through continual development of new products and emerging cross selling opportunities, as well as finding new ways to capture revenue from the expanding Gross Merchandise Volume of its merchants. Ten years from now, it is possible that the key revenue generators of this company come from its payment and lending products, with continued innovations in its eCommerce platform and fulfillment network continuing to grow its customer base and capture share of the overall eCommerce market.

So far, the company has proven it is adept at finding new opportunities, attracting new customers — especially enterprise customers. In addition, it is possible any future recession will only benefit the company in the long-term since part of its success has been due to the emergence of a new class of people which were forced into the entrepreneurship in the last recession. If the company can find ways to expand its margins while continuing to innovate, cross sell, and move downstream into lower margin, more capex-intensive eCommerce fulfillment we think achieving this Best Case scenario is reasonable.

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Via online business online marketing online business opportunities Risks

Ascendere Associates LLC makes no guarantee on the accuracy of the data, estimates, assumptions or forecasts in this report. This report is for informational purposes only, and is not a recommendation to buy or sell any security. Investing in any stock entails a high degree of risk, including the risk of total loss.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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