Shopify ($SHOP)
Powering E-Commerce One Merchant at a Time
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Today I will be completing an in-depth analysis on Shopify. Within, I will spend time breaking down the opportunity in front of the company, both broadly within the e-commerce space as a whole, as well as more specifically from a value proposition point of view. In addition, I will break down the company’s business model, clearly outline how the company makes money, analyze their most recent earnings report, delve into some KPIs and discuss some bear and bull cases that some investors should be wary of going forwards. As always, the format of this research piece can be seen outlined below, feel free to skip ahead to the sections that you feel will be most useful:
1.0 Introduction
2.0 Opportunity
3.0 Technology
4.0 How Shopify makes $$$
5.0 Financials
6.0 Key Performance Indicators
7.0 Valuation and Competition
8.0 Discussion
9.0 Conclusion
Disclaimer: The information and research contained herein is all my own opinion and should not be used as a substitute for proper due diligence. Please consult your financial advisor and evaluate your financial circumstances before making any investment.
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With all of that out of the way, let’s get started.
1.0 Introduction
Over the course of my approximately 30 deep-dives, I have noticed one recurring phenomenon within a large majority of the associated companies and founding teams. Put simply, great businesses often blossom from struggles the founders had either within their own personal or professional lives. Shopify and its prominent leader Tobi Lütke, as well as the co-founders Scott Lake and Daniel Weinand that he enlisted assistance from, are no different. In the early 2000s, Tobi was working as a software engineer and was suffering from severe dissatisfaction with his job at the time, mentioning that the role was both isolating due to its remote-work nature, and boring, seeing as he was mainly centered around working on the back-end of dull financial software. From this strife blossomed a simple idea, Tobi and co. decided to open an online snowboarding store, a project that he hoped would both revitalize his passion for coding as well as act of a passive-income-generator of sorts. Although this idea would later come into fruition and become profitable at a low magnitude, the problems that were encountered during its inception and operation are what led to Shopify. More specifically, Tobi decided to try his hand at leveraging a series of systems that he hoped would help setup the storefront, ranging from Miva to OsCommerce and Yahoo Stores. The unpleasant user experience that he encountered, as well as Tobi’s later introduction to Ruby on Rails, a powerful and much more user friendly full-stack development framework, resulted in the engineer building an e-commerce tool that could then be used for Snowdevil, the winter-sport storefront itself:
As time went on, and as the associated tools that were created for SnowDevil started to circulate and receive good feedback around the Rails community, Tobi and Lake started to become more interested in fixing the issues associated with e-commerce as a whole. Shortly thereafter, the pair teamed up with Daniel Weinand, another talented and passionate programmer, leveraged a few hundred thousand dollars of their own/family’s money, as well as a small investment from an angel investor in order to continue to build tools for merchants. From there, Shopify was born.
Now a billion dollar company with commendable presence in both Canada and the United States, the United Kingdom, Latin America and Internationally, Shopify’s platform got itself in front the most rapidly expanding sectors in the world, e-commerce. The company’s platform provides merchants with a series of tools that assist with the conception and operation of their businesses, including but not limited to access to various sales channels ranging from web to mobile storefronts, physical retail locations and pop-up shops, social media storefronts, native mobile apps and buy buttons/checkout functionality. In addition, Shopify assists entrepreneurs with managing their products and inventory, processing payments and handling the logistics of an order, provides a series of analytics and reporting functionality, gain access to financing, build buyer and customer relationships etc. Within this deep-dive I will spend a length of time outlining the most nuanced and important features of Shopify platform, which, quite clearly, offers individuals and enterprises tools for everything they may need to run a successful operation.
With this brief description in mind, let’s attempt to quantify the opportunity that Shopify has in front of it.
2.0 Opportunity
Shopify’s Opportunity is quite evidently tied to the prospects of e-commerce as a whole. Starting off broadly for a second, and similar to what I did for my previous Afterpay research, it is useful to analyze the e-commerce opportunity with respect to total US retail trade, delve into the current e-commerce penetration as a proportion of that value and extrapolate outwards, and then look at things from a global perspective in order to gauge an addressable market of sorts that Shopify can continue to aim their services at. Starting off with the former, amidst steady growth in US Adjusted Retail Spend from 2010-2020 (chosen based upon the latest available US Census Data), we have seen heightened penetration in the amount of said Adjusted Retail Trade occurring through E-Commerce Mediums. Putting numbers to these assertions, US Retail Trade increased from $2.63T in 2010 to $3.91T in 2020, representing a CAGR of approximately 4%:
Trade occurring through E-Commerce Mediums increased at a CAGR of 16% during the same time-frame, starting off as around 6.4% of Adjusted Retail Spend in 2010 and making its way to approximately 19.5% of this value in 2020:
Although E-Commerce penetration was evidently exacerbated by the emergence of the global pandemic, technologically enabled e-commerce habits had already become rampant, and e-commerce sales in the US still increased at a CAGR of 15% from 2010 to 2019, highlighting a rapid pace regardless. Looking forwards into the future, US e-commerce sales are expected to reach approximately $1.33T in 2025, a value that would represent a 28% penetration if we estimate that Adjusted US Retail Spend will be approximately $4.77T by bringing forward the 4% CAGR we saw from 2010-2020. In short, it is highly likely that we see more than a third of adjusted retail spend occur via E-Commerce mediums heading into the latter end of the upcoming decade, an exciting prospect given the sheer volume of transactions occurring here. Moving over to areas such as the APAC region, these locations have seen heightened rates of e-commerce adoption. To put things into perspective, in 2021 the APAC region saw nearly 45% of its total retail sales occurring through e-commerce mediums in comparison to 19% when measured globally and around 13% in the US (non-adjusted value). What one can take away from these figures is the fact that there is substantial runway left in the growth prospects of this sector as a whole. Although the population and logistical dynamics of APAC in comparison to the US and the rest of the world may differ, the future appears to be bright.
Being that as it may, how much of this opportunity will Shopify actually be able to capitalize on? The activity in the space is evidently quite substantial, however, we have to take into consideration how the metaphorical pie is split up between businesses that are reliant on the Shopify platform, and the behemoths of the e-commerce space as a whole such as Amazon, Walmart etc. According to a Digital Commerce 360 Report, nearly $3.23T in Retail E-Commerce Transactions occurred in 2021, with nearly ⅔ of these transactions occurring through the likes of marketplace platforms like Alibaba, Amazon and eBay. As such, roughly speaking, we can expect approximately ⅓ of the E-Commerce activity to be up for the grabs for businesses reliant on Direct to Consumer mechanisms, i.e. DTC, which would be a loose representation of Shopify’s addressable audience’s opportunity.
Although one may think that most businesses are now up to date with the digital age, there is still quite a bit of work to be done. Taking the estimate for the amount of SMBs (approximately 51M with more than 500 employees) that exist globally, and comparing these values with BuiltWith estimates for the total amount of websites available for e-commerce platforms, it is quite evident that there is substantial room for continued penetration, even if one considers the fact that a fraction of SMBs will not require e-commerce presence in order to succeed.
Looking at the presence of Shopify’s websites within the top 10K, 100K, 1M sites (i.e. different arrangements of relevance) as well as across the Entire Internet also allows for us to gauge the competitive positioning of the company with customers that have decided to leverage e-commerce platform products. The below data clearly outlines the fact that across both different relevancies and the interweb as a whole, Shopify sits at the very top as a provider of website/online-storefronts for merchants.
In short, I would like you to take away the following from this section: e-commerce is still a strong trend that has significant runway, both in Shopify’s strongest market, the US, and internationally. In addition, looking at builtwith website data in conjunction with SMB numbers shows there is still an alarming amount of businesses that do not appear to have any form of e-commerce presence, a phenomenon that Shopify should be able to benefit from. Lastly, looking at data for current sites of varying relevances highlights the fact that Shopify arguably has one of the strongest competitive positioning amongst its peers, encouraging given Shopify’s status as a true e-commerce centered offering.
With all of these facts in mind, let’s delve deeper into Shopify’s offerings and see what exactly they offer both merchants.
3.0 Technology
Shopify’s offerings can be split into two main components, Subscription Solutions and Merchant Solutions. Within this section, we will delve into the products contained within each of these cohorts and analyze how Shopify is able to extract value therein, respectively.
Subscription Solutions
The main constituents of Shopify’s offerings lie within Subscription Solutions, of which can be thought of as a gateway of sorts into the Shopify ecosystem. The main subscription plans can be seen outlined below:
The main three prongs of this offering are the Basic, Shopify and Advanced plans. In essence, these plans allow for businesses that are smaller in stature to create an online store, manage inventory and sales channels, leverage different pieces of reporting functionality, access live support etc. Features are broad and cover just about everything one needs to manage a business in our modern age, with the functionality of each plan differing just enough to offer value propositions to businesses of different sizes. In addition, with each subscription, businesses gain access to Shopify Shipping, Shopify Payments, POS and International Commerce, of which I will outline within Merchant Solutions below.
Shopify Plus and Lite on the other hand can be thought of as the company’s mega and bare-bones offerings, so to speak. Starting off with the former, Plus is catered towards large businesses with more complex and dynamic needs than their SMB counterparts, offering access to features ranging from dedicated account managers, API integrations and exclusive apps, to wholesale channels and exclusive partnerships and more. The latter on the other hand is geared at providing small amounts of functionality to merchants. The plan allows for businesses to sell in person via access to POS lite or add a buy button to their already created website. Although these features provide access to dashboards, reporting, order and product management etc., the key differentiating with this plan in comparison to others is that you cannot build an online store with it, and is essentially geared towards businesses that want to spruce up their e-commerce/in-person operations that are already in place.
To cement all of these ramblings, it is useful to take a look at an exemplary success story that gives a sense of just how powerful Shopify’s platform is. One of the most interesting case-studies that I came across during my research was that of Gymshark, a brand I have grown fond over the last few years. Founded by Ben Francis at the age of 19 in 2012, the UK-based company quickly grew from a garage pipe-dream to a highly coveted brand with strong and dynamic social media presence. By 2015, the company had sustained massive amounts of growth and quickly gauged their surroundings in the attempts of enlisting the services of an e-commerce platform provider. Eventually arriving at Magneto, one of Shopify’s competitors, the shortcomings of this technology were evident and arrived upon almost instantly. Despite paying an absurd amount of money for said services, scaling was problematic, taking almost 8 months to build their website using the platform and functionality was lacking, with the website failing to function on the Black Friday, costing the company hundreds of dollars. As response to these crises, Gymshark migrated to Shopify Plus, creating a digital storefront that is now able to support millions of dollars in sales, create customer shopping experiences to foster engagement and social media campaigns and much more. These success stories are abundant and Shopify is clearly able to not only cater towards an ever expanding array of small businesses, but also some of the largest brands and companies in the world as well.
Merchant Solutions
If Subscription Solutions are the metaphorical cake, Merchant Solutions would clearly be the icing, offering additional features to merchants that extend the capabilities of the company’s subscription plans. Shopify gears solutions at merchants based upon an array of functionality that businesses usually require to successfully run an e-commerce operation, of which can be seen outlined and categorized below:
Shopify Payments
The main constituent of Merchant Solution Revenue is revenue attributable to fees generated by both payment processing and currency conversion, existing under the umbrella of Shopify Payments. In essence, this functionality allows for merchants to accept payments through a variety of different credit cards, across various locales and currency denominations, on their stores all whilst negating the need for a third-party payment provider.
Shopify Pay and Pay Instalments
Starting off with the former, Shop Pay is a piece of technology that is aimed at reducing the friction associated with checking out an e-commerce purchase. According to a study performed by the Baymard Institute, approximately 70% of carts are abandoned! As such, having a solution that stores the email address, credit card, shipping and billing information of a customer, allowing for them to purchase an item with one click, goes a long way at both increasing conversions and improving efficiencies.
The latter exists largely as instalment loans, although not packaged as a trendy BNPL option (although the two exist as largely identical functionality), Pay Instalments essentially allows for customers to split their purchase into four equal and interest-free instalment payments for orders with a size ranging from $50-3000 (USD).
Shopify Capital
Available to eligible businesses (based upon sales hurdle, low profile risk, geographic location), Shopify Capital essentially offers lump sum loans at fixed borrowing costs to companies situated within particular US states or merchant cash advances to businesses within the US, Canada or the UK. In essence, one can think about this offering as a financing program that Shopify gears at customers.
Shopify Balance
Put simply, Balance is a money management and business banking solution offered by Shopify. Merging with one’s e-commerce storefront, the offering has a hassle-free account opening process, allowing for functionality to be setup in a few minutes with no monthly fees, leverages digital card issuance capabilities so a business can have a virtual spending card, offers a dashboard that allows for spending and purchases to be tracked, offers expedient payouts and money transfers, as well as a series of reward functionality ranging from 2% cashback to partner perks and exclusive offers.
Shopify Shipping
This functionality allows for merchants that manage their own fulfillment and shipping operations, all within the Shopify platform. What this equates to is the ability for businesses to leverage discounts that Shopify has arranged with various postal service providers, as well buy and print shipping labels through the Shopify ecosystem rather than doing this through a physical medium and track/manage ongoing orders through the platform as well.
Shopify Fulfillment Network
Adding on to the aforementioned Shipping functionality, Fulfillment Network takes it a step further, allowing US and Canada based merchants to essentially completely outsource fulfillment as a whole. Delving deeper, this offering streamlines fulfillment, returns and storage, allowing for businesses to distribute their products across the Shopify fulfillment network, select which products they would like to send/outsource inventory storage for and sit back while the service package, prepares and delivers products while offering insights such as order tracking etc.
Shopify Email
This marketing tool allows for merchants to easily create and manage email marketing campaigns, requiring no coding knowledge to create memorable and branded experiences.
Shopify Markets
This tool allows merchants to sell their products to customers that are situated in different countries, all from the comfort of one signal storefront. In essence, this tool provides functionality that leverages routes objects in order to create locale-aware URLs, allows for revenue to be generated within a customer’s location, after applicable duty fees, taxes and currency conversion fees have been deducted. This offering also goes hand in hand with Global-E’s cross-border third-party service offering, if the merchant desires to leverage said features.
POS
This software offering allows for merchants to convert any hardware device they have, whether that be an android phone or iPad, as examples, into a fully functional POS terminal. Working in conjunction with additional hardware offerings such as the company’s card readers and retail stand merchants can easily accept payments via in-person mediums.
Shopify App Store
Lastly, merchants can leverage and developers can create applications for the Shopify App store. Ranging from apps that provide product review functionality, to add-ons that bolster subscription programs and landing page functionality, the app store evidently caters towards a plethora of needs that one may come across/desire when running their business.
Now that we have an idea of what exactly Shopify offers merchants, let’s find out how exactly all of these pieces intertwine and how Shopify makes money from all of it.
4.0 How Shopify makes $$$
Subscription Services
The company primarily derives Revenue in this area from the sale of monthly subscriptions (yearly commitments available upon request) to each of their various subscription tiers. The cost of the three main prongs, i.e. Basic, Shopify and Advanced are as follows:
Basic: $29/month
Shopify: $79/month
Advanced: $299/month
Shopify Plus and Lite on the other hand have the following pricing models:
Plus: $2000/month or 0.25% per sales transaction if sales exceed $800,000 in a given month.
Lite: $9/month
Merchant Solutions
Shopify Payments
Fees for payments differ based upon one’s subscription plan.
Basic and Lite: 2.9% + 30 cents for online credit transaction. 2.7% for in-person or online debit, 2% transaction fee if using a third party processing provider
Shopify: 2.6% + 30 cents for online credit transaction, 2.5% for in-person or online debit, 1% transaction fee if using third party processing provider
Advanced: 2.4% + 30 cents for online credit transaction, 2.4% for in-person or online debit, 0.5% transaction fee if using third party provider
Plus: Custom Arrangements
Shopify Pay Instalments
Shopify earns revenue from Pay Instalments as a % of the total order value (undisclosed exact amount).
Shopify Capital
Shopify earns revenue from the loans or merchant cash advances they offer customers. Loans are often given with 12 month terms and six repayment cycles, with the customer owing Shopify the loan plus a predetermined/fixed borrowing cost. Merchant cash advances are given as lump sumps of money that are given in exchange for a fixed fee, of which Shopify then recoups as a % of daily sales until the amount is repaid.
Shopify Balance
This tool, geared at giving merchant’s heightened financial capabilities, primarily earns money through small fees charged with each use of their aforementioned cards.
Shopify Shipping
Shopify earns money in this area, primarily, from the sale of shipping labels and referral fees from shipping providers, garnered at the time of transaction.
Shopify Fulfillment Network
Shopify earns money in this area by charging customers for the use of their SFN services. Pick and pack fees are charged for each order fulfilled, transportation fees are charged for each shipment made, storage fees are calculated based upon the total volume in cubic feet multiplied by the associated per cubic foot flat rate used to store one’s products, and special projects are charged for at an hourly rate ad-hoc.
Shopify Email
Users subscribed to a Shopify plan can send up to 2500 emails for free each month, with each additional email after that allotment costing $0.001 USD/email.
Shopify Markets
Shopify generates Revenue in this area when duty and import taxes are converted for buyer orders as well as when international payment processing occurs.
Shopify POS
POS Lite is included, for free, within all Shopify Subscription Plans, POS Pro is $89/month. Shopify also earns money from the sale of their tap and chip card readers, card reader docks, retail stands and other hardware accessories.
Shopify App Store
Shopify primarily earns money within their app store through revenue share agreements with developers that list their applications therein. Share agreements are either 20% of in-app revenue or, for larger developers, if desired, 0% for the first $1M in sales and 15% thereafter. In addition, the company also generates revenue through advertisements placed within the app store.
Now that we have a better understanding of how Shopify’s business makes money, let’s delve deep into their most recent financials and peer under the hood so to speak.
5.0 Financial Analysis
Income Statement
Revenue
Shopify’s FY’21 Revenue came in at approximately $4.6B, representing a 57% increase YoY.
Although we saw top-line growth rate normalize itself in comparison to previous full-year reporting periods, of which clearly benefited from pandemic-induced tailwinds, it will be interesting to see how e-commerce as a whole trends going forwards, especially as macroeconomic difficulties and the return of hybrid shopping habits (i.e. mix between e-commerce and brick and mortar favouritism) appear to loom around the corner.
Revenue, as alluded to earlier, can be split into two main components, Subscription Solutions and Merchant Solutions. The former came in at $1.34B for FY’21, increasing 48% YoY as a result of the increase in the company’s MRR (Monthly Recurring Revenue) attributable to more merchants using the company’s platform. The latter on the other hand came in at $3.27B, increasing at a faster rate than its counterpart at 62%, primarily attributable to the strong growth in Shopify Payments of 58% YoY as well as overall increase in activity associated with referral fees, shipping, Capital activity, SFN, advertising on the app store etc. Quite clearly, Shopify Payments is one of the biggest drivers of business success going forwards, and will likely continue to be that way for the foreseeable future. In addition, we’ve seen Merchant Solutions as a % of Total Revenue consistently making up a bigger piece of the metaphorical pie in comparison to Subscription Solutions, coming in at 71% of Revenue for the year:
Lastly, we can take a look at the distribution of Revenue to various International Locations.
Although progress has been made in the company’s expansion into EMEA, APAC and Latin America, Shopify still derives the majority of their Revenue from the United States, followed by Canada. Heading into 2022, the company has stated that they are planning on ramping up marketing efforts overseas, a phenomenon that should be tracked for progress within International Revenue Distribution in coming quarters.
Cost of Revenue
Cost of Revenue came in at $2.13B, representing a 54% YoY Growth rate, increasing at a slower rate than Top-Line, respectively. Despite that fact, COR has remained in a relatively fixed range, staying in between 44-46% of Revenue over the course of the last few years.
Similar to Revenue, COR can be split into two main cohorts. Subscription Solutions COR, consisting primarily of billing processing fees, infrastructure and hosting costs, increased 37% YoY, coming in at $264M. Merchant Solutions COR, of which primarily contains transaction costs from Shopify Pay, but also includes costs ranging from the amortization of Shopify’s 6RS acquisition, costs associated with SFN etc., increased 56% YoY, coming in at $1.866B. Both of these figures as a % of Total COR can be seen outlined below, quite clearly displays similar phenomenon to Revenue Cohorts as a % of Total Revenue:
Operating Expenses
Total Operating Expenses came in at approximately $2.21B for FY’21, representing a 52% increase YoY. The company has also been demonstrating signs of Operating Leverage, with OPEX as a % of Top-Line coming in at 48% in comparison to 64% seen a few years ago:
Operating Expenses, broken down into its respective constituents, can be seen outlined below:
S&M is showing signs of efficiencies with the value decreasing relatively speaking over the course of the last few years and R&D, G&A and T&L expenses have all been coming in very narrow fixed ranges over the course of the last few fiscal years.
Margins and Profitability
Gross Profit came in at approximately $2.48B, representing a 61% YoY Growth Rate.
Gross Margins came in at approximately 54%, similar to what has been showcased in previous years, as outlined below. These Margins may continue to compress slightly, given that Merchant Solutions are becoming a bigger contributor to Top-Line, of which have lower GMs than their Subscription Solution counterpart, as outlined below:
Moving along, Operating Income came in at approximately $269M, an increase of 198% YoY, with the aforementioned improvements in operating leverage resulting in Operating Margins creeping more into positive territory. Net Income increased 812%, coming in at approximately $2.915B. This increase was primarily due to approximately $2.7B in unrealized gains made by Shopify for their investments in Affirm and Global-E. These unrealized gains have likely decreased substantially given the poor price action we’ve seen in both of these equities of late. EBITDA increased 90% YoY, coming in at approximately $445.2M, improving EBITDA Margins YoY as outlined below:
Balance Sheet
The structure of Shopify’s Assets, as of the end of Q4’21, can be seen outlined below:
Shopify’s Assets are primarily liquid, with Current Assets consisting predominantly of approximately $5.3B in Marketable Securities, $2.5B in Cash and Equivalents and $470M in Merchant Cash Advances. Long Term Assets on the other hand consist primarily of $4B in Equity and Other Investments and approximately $360M in Goodwill. The structure of the company’s liabilities can be seen outlined below:
Liabilities are skewed towards being illiquid, with Current Liabilities consisting primarily of approximately $460M in Accounts Payable/Accrued Expenses and $220M of Deferred Revenues. Long Term Liabilities on the other hand consist predominantly of approximately $900M in Senior Notes Liabilities, followed thereafter by Deferred Revenue, Lease Liabilities and Deferred Tax Liabilities.
Cash Flow Statement
The change in Shopify’s Cash from Operations, Investing and Financing over the course of the last few years can be seen outlined below:
Cash from Operations improved approximately 18.7% YoY, coming in at approximately $504M. Cash from Investing was an outflow of approximately $(2.35)B, attributable primarily to an outflow of approximately $7.34B into the purchase of marketable securities, offset by an inflow of $5.75B attributable to the maturity of marketable securities. Cash from Financing came in at approximately $1.65B, attributable primarily to the Proceeds from Public Equity Offerings and Exercise of Stock Options. The company’s Free Cash Flow improved slightly YoY, however FCF margins decreased from 24% in 2020 to 15% in 2021. As always, we can gauge how much an impact SBC adjustments have on this value, as outlined below:
With SBC adjustments taken out of consideration, the company’s FCF is slightly negative, albeit barely. With the company stating that they will be ramping up CAPEX in the coming quarters as a result of SFN expansion I find it highly likely that we see similar phenomenon in the upcoming year.
6.0 Key Performance Indicators
Starting off with, MRR, or Monthly Recurring Revenue, this value represents the product of the number of merchants with subscription plans at the end of the period and the average subscription price during that same time period. Coming in at approximately $102M for FY 2021, an increase of 23.4% YoY, this value has increased at a whopping 28% CAGR since 2017, evidently aided by the pull-forward of e-commerce growth we’ve seen over the course of the last two years:
Another important metric is the company’s Gross Merchandise Volume, i.e. the total dollar values of orders that are facilitated through the platform, indicative of the amount of activity that is occurring through the Shopify platform. This value came in at approximately $175.4B for the year, representing a 47% YoY increase and an extremely high 33.6% CAGR since 2017. The change in this metric can be seen outlined below:
With Shopify Payments becoming a large driver of business success, we can gauge the penetration of this service, i.e. the amount of merchants on the Shopify platform that leverage its services. The amount of GMV facilitated using Shopify Payments has increased 59% YoY and at a 53% CAGR over the last five years, coming in at $86B in GMV going through Shopify Payments for 2021:
We can also delve into how the penetration changes with regards to Geographic location. Canada’s penetration was 92%, the US saw 88% and Other Countries 84%, in comparison to 92%, 90%, and 83% in the same regions last year. Quite clearly, this service has high penetration in its strongest end-markets. In the coming years, International Presence should increase with the company’s heightened marketing efforts in these regions, a phenomenon that will likely increase overall penetration as a whole.
In short, the businesses key metrics are healthy to say the least. These metrics should continue to be monitored in the coming quarters in order to track the impact of potential macroeconomic headwinds and e-commerce normalization as a whole.
7.0 Valuation and Competition
Shopify is uniquely positioned to continue to offer an irreplaceable value proposition to merchants. We have already discussed earlier how Shopify is likely to continue to capitalize and extract value from a large chunk of the metaphorical e-commerce pie, even after we discount the amount of value that is likely to be directed at various different marketplaces rather than DTC enablers such as Shopify. Assessing the competitive nature of the investment landscape is bolstered when one examines NTM valuations, consensus top-line 2022E-2024E Revenue CAGR and the price action we’ve seen of late, as highlighted below:
Shopify is quite clearly valued richly relative to other e-commerce peers and has seen some of the strongest sell-offs, as well as a rapid bounce over the last week. Being that as it may, the company has been able to maintain profitability on an EBIT level, something a fair amount of its high-flying peers cannot replicate and is also anticipated to demonstrate the second-highest top-line CAGR, next to GlobalE, despite operating at more than 10X the scale. Competitively speaking, the likes of WIX and SQSP were able to be included in the above comparison since they are publicly traded, however, this does not take into consideration the likes of Magneto, WooCommerce, Weebly etc., all of which have a relatively commendable presence within the e-commerce space as a whole. The built-with data shared earlier clearly outlines the fact that Shopify has the highest adoption rate both across the entire ex-china internet e-commerce landscape, and if one starts to delve into user reviews and comparisons, it is clear that the company benefits from product superiority, with giant companies alluding to this very fact in their own testimonials, using the aforementioned Gymshark scenario as an example in Magneto vs. Shopify’s case. Put simply, when one compares Shopify’s platform with other “full-stack ecommerce platforms”, the inherent rapid scalability as well as newly featured fulfillment/shipping capabilities, allows Shopify to provide extremely useful services to businesses looking to leverage its very low time-to-value. Other companies that provide the ability to build-out websites and leverage some e-commerce plugin functionality, such as Wix, again pale in comparison to the Shopify platform. Built-out features may work for a time, but again, the data tells all and Shopify clearly reigns supreme.
8.0 Discussion
I would like to spend time in this section addressing some of the biggest bear arguments that have been made against the company in previous months, of which I believe are actually bull cases if one delves deeper, and also address my biggest concerns I have going forwards as a shareholder of Shopify and someone that is excited about the long-term prospects of the sector as a whole.
Starting off with the former, many have touted the fact that Shopify will fall victim to high churn rates, a statement that has some validity, but also one that fundamentally underestimates the power-law driven dynamics of their subscription model as a whole. According to the US Bureau of Labour Statistics, approximately 20% of new businesses fail during the first two years of being open, 45% during the first five years and 65% during the first 10 years, resulting in an astonishing fact that only 25% of new businesses end up making it to an age of 15 years+. Technology is only exacerbating failure rates, a phenomenon that can be observed in the average age of companies contained within the S&P 500, a value that was 61 years in 1958 and is now less than 18 years. Looking at a 2018 seeking alpha report that delved into Shopify domains paints a more specific and similar picture. Of approximately 134,500,000 domains analyzed, approximately 753,000 were shopify-related domains, with the distribution of said domains grouped by age outlined below:
Relatively self-explanatory, the age of businesses using shopify domains evidently skews towards those in their infantile stages. Looking at the churn rate of different aged domains (see article if you want delve further into the calculations) we arrive at the fact that their is clearly a high churn in Shopify businesses, an occurrence that anyone familiar with the company should not be surprised at:
Being that as it may, I view this is a right-tail exposure occurrence rather than the opposite. Put simply, businesses operate off of power-laws, with the majority of failing and a small handful achieving enormous success. E-commerce businesses are no different, thus churn in the users leveraging Shopify’s platform is to be expected. VC companies operate in a manner by where 6% of the investments drive over 60% of the returns, and given that Shopify generates the majority of their GMV from Shopify Plus, their platform operates in a similar manner. The majority of the businesses will be using Basic and Shopify plans, and many of them will fail, however, if even a small group of these businesses eventually becomes successful, and upgrades to the Plus plan, Shopify benefits enormously. With the company continually growing MRR and adding new merchants, their continual exposure to right-tail business growth events, as well as a ceiling arguably nowhere in sight for merchant penetration, I believe this is a net-positive, and Shopify’s results have largely painted a corroborating picture.
Moving on, many have touted their concerns surrounding the billions of dollars in capital expenditures that are likely to occur from this point onwards to approximately 2024, used for building out the SFN. I share my concerns with these efforts, but stepping back for a second to think about how Shopify has treated their relationship merchants as a whole, this is likely to be a net-positive. Mentioned earlier was the competitive nature that exists between marketplaces and DTC enablers such as Shopify, a phenomenon that creates a real need for SFN services, particularly for merchants that wish to differentiate their business outside of the constraints of the amazon ecosystem, as an example. The SFN is in essence, an aggregator of third-party-logistics providers and merchants, greatly reducing the complexity on the third-party-logistics side of merchant acquisitions, and offering merchants on the smaller end of the spectrum access to services that would not be obtainable were they to seek them out outside of the Shopify ecosystem. This creates an interesting dynamic, one that is likely to continue to flourish. This value proposition is also further bolstered by Shopify’s recent acquisition of Shippo, a company that acts as a technology layer of sorts, connecting the services of different shipping providers (both US and internationally) in order to offer merchants seamless to printing shipping labels, checking shipping rates, track shipping rates etc. In short, these products greatly reduce the complexity of merchant’s leveraging functional, efficient and expedient shipping services for their product, and quite clearly align with the entire value proposition of Shopify’s platform as a whole, reducing the difficulties associated with running a business. What remains to be seen is if SFN will be able to scale as efficiently and as quickly as Amazon. Looking at the growth in Amazon’s square footage over the years, I find this unlikely, especially given how Amazon was at the forefront of the e-commerce trend, but only time will tell.
Moving on, there are two last ramblings I would like to impart on you before concluding this deep-dive. The first has stayed on my mind ever since Ben Thompson published an article detailing his thoughts on the connection between Shopify and Facebook’s advertising in late February. In essence, Facebook, which is essentially an advertising platform, oftentimes acted as a funnel of sorts, redirecting users to the associated Shopify store quite effectively. Since the Apple App Tracking Transparency initiative rolled out, as i’m sure most of you are aware, advertising targeting has suffered, specifically since most users have now opted out of sharing hosts of data. As a result, merchants have evidently suffered, seeing as their ads are nowhere near effective, an occurrence that has resulted in advertising dollars flowing out of the Facebook ecosystem towards other sources. What is one company’s downfall is another’s gain and Thompson made an interesting point, particularly how Shopify could become a advertiser buyer at scale, leveraging knowledge of conversions in order to run probabilistically targeted campaigns that have high precision and also offer the ability to aggregate cohort data over time in order to understand the connections between different merchant products and consumer purchase patterns. In conjunction with Shopify Audiences, a metaphorical dip the toes in the water scenario within this aforementioned domain, as well as the fact that Shopify has branched out into fulfillment, it is clear the company is willing to experiment with a host of different offerings that add value to both their business and to merchants as a whole, an encouraging factor for shareholders seeing as it points towards a dissatisfaction in stagnation as a whole and may result in remarkable businesses opportunities similar to what Amazon stumbled upon with AWS.
In addition, it is worth pondering the risks associated with Shopify Payments, particularly since this business segment is starting to drive large amounts of the company’s success of late. My biggest concern, of which is clearly outlined in the company’s 40-F statements, is the fact that the company is solely reliant on a single supplier, Stripe, to provide the technology they offer through Shopify Payments. This agreement, of which renews every 12 months, is a glaring tail risk that I believe is quite obviously irresponsible given the scale that this business segment operates at and the troubles that would arise if the relationship were to sour. Though a difficult feat, it is worth pondering whether or not Shopify would be better off directing capital at developing their own functionality in-house or splitting functionality between different payment providers. Though this may be me reading too much into things, it is still something to keep an eye on nonetheless.
Lastly, it is worth pondering the emergence of two new risks that materialized during my time editing this newsletter. The first was the announcement of Wix’s partnership with Amazon Fulfillment Services, as outlined by the following PR:
I believe this throws a wrench in the spokes of the competitive dynamics I outlined earlier, albeit slightly. Even after this news, I believe that Shopify still quite clearly offers both better and more abundant services to merchants, however, there is an unquestionable amount of value in a merchant being able to leverage a fulfillment network in Amazon’s that trumps the likes of UPS and Fedex, as example. As such, shareholders in the company should continue to monitor these happenings alongside the progress of SFN to ensure that this relatively new initiative doesn’t falter under this headwind.
Secondly, Tobi’s twitter presence of late has been questionable at best. Being careful to not take away from a brilliant individual that has transformed the very fabric of e-commerce, a tweet yesterday garnered quite a bit of attention from investors:
Stepping back for a second, I’m not a huge fan of a CEO that twitter blasts on a consistent basis, especially when the contents of said tweets have a pertinent connection to the employees of their company. Examining the content the tweet for a second, I find it hard to believe that employees with skin in the game via SBC are not slightly concerned when their company goes through a 60%+ YTD haircut, a phenomenon I believe holds true when we see continually increasing SBC relative to the increase in Shopify’s scale:
In short, everyone makes mistakes, however, quite frankly, I would like to tweets of this nature cease to come into existence in the future.
9.0 Conclusion
In conclusion, Shopify is an amazingly interesting company with a bright future and its hands in a variety of lucrative ordeals. I will be continually monitoring its story out of pure interest as well as to gauge the general trajectory of the e-commerce sector as a whole. Thank you for reading my research.
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any insights on the structure of Shopify's partnership with Stripe? What's the profit sharing like and why are they adamant on only using Stripe.
Great Inversions!