• Brett Schafer

Not So Deep Dive: Shopify Stock



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Show Notes


(Ryan) What they do: Shopify is a commerce platform that enables merchants to start and grow their businesses. So pretty much anyone can set up an online store with Shopify’s no-code solution and begin to sell their products. And you can sign-up and use Shopify for 14 days without needing to pay, but after that once a merchant wants to start selling they have to subscribe to one of Shopify’s pricing plans. (There’s Basic $29/month, Shopify $79/month, and advanced $299/month). They also have Shopify Plus which is for enterprise clients. As customers scale, they tend to upgrade. So that’s what they call their Subscriptions Solutions Revenue.


Then they have their merchant solutions revenue, which is an additional feature to help merchants operate their business day-to-day. These include payments, shipping, fulfillment, loans. But the majority of it comes from Shopify Payments. They have a fulfillment network as well for merchants to utilize, but the functionality is pretty similar to any 3rd party fulfillment service they’d use. One big difference though is it makes it cleaner on the merchant’s side. But there are lots of more features that I haven’t touched on, like the Shopify stuff designed for physical retail.


(Ryan) History: According to their annual report, the company was first incorporated in 2004 but didn’t officially file their articles of amendment until 2006. That’s when they first established the name “Jaded Pixel Technologies”. The idea for the business initially was to be an online snowboard shop, but in the process, Lutke, who was a developer, realized that building a website was really hard at the time. They were trying to build it on Yahoo stores, but apparently, there were just tons of problems and virtually zero customizability.


He did end up building his online snowboarding business called Snowdevil, but in the process, he built the framework for it as well. So first he launched Snowdevil, then shortly after he launched what would eventually become Shopify. Here’s what it looked like:


They changed their name to Shopify officially in 2011, then came public in 2015.


(Brett) Industry/Landscape/Competition:

  • In 2021, e-commerce revenue is supposed to be $4.89 trillion worldwide (Statista)

  • However, $2.1 trillion of that is China, which Shopify will likely not have much exposure to, so TAM opportunity is also a lot less

  • Also, Shopify makes money on a small take-rate of e-commerce sales, so the opportunity is only a fraction of this larger industry

  • Competitors:

  • Direct: Bigcommerce, Wix, Squarespace, Weebly, WooCommerce (Shopify is the clear leader)

  • Indirect competitors: Amazon, Wal-Mart, Target (big-box competition)


(Brad) Management and Ownership:

  • Toby Lutke

  • was a co-founder and has been with the company since 2004. Became CEO (was CTO) in 2008. 90% Glassdoor rating

  • Harley Finkelstein is the company’s president (since 2010). No other notable experience but his 11 years with the company speaks for itself

  • Scott Lake is another Co-founder and was CEO until 2010 (co-CEOs from 2008-2010)

  • Looks like he’s now doing his own thing as the Founder of a Venture fund

  • Daniel Weinand was the other co-founder and the Chief Culture Officer until 2017

  • Founded a music studio after leaving and his most recent LinkedIn experience says “composer”

  • CFO is Amy Shapero

  • Since 2018

  • Former CFO of Betterment (online financial advisor with $13B in AUM) and Sailthru which is another private SaaS company for CRM

  • Former CFO at Spot Trading as well

  • VP of I banking at Goldman Sachs

  • Former Manager at EY

  • New CTO is Allan Leinwand

  • Former SVP of Engineering at Slack

  • Former CTO of ServiceNow and the VP of Cloud and Infrastructure

  • Current Board Member at Anaplan

  • Former CTO Jean-Michel Lemieux until July this year and now “self-employed”


Shopify please start publishing Proxy statements. But here’s the info I was able to find:

  • Tobias owned 0.2% of class A and 65.56% of class B for 34% of the company voting power

  • Klister Credit Corp-owned 31.4% of class B for 16.2% of company voting power

  • CEO of Klister John Phillips has a board seat. He and his wife own 100% of Klister.

  • Investing Firm involved early on in Shop

  • A group of 12 company insiders owns less than 1% of class A and 97.7% of class B for 50.6% of the voting power



(Brett) Valuation:

  • Market cap of $188 billion, ticker SHOP

  • They are not losing money and have a lot of cash/equities so an EV is more appropriate

  • EV is closer to $177 billion

  • EV/s of 42

  • EV/GP of 77

  • Mentioned in SEC filings a few different headwinds and tailwinds to gross margin, so hard to tell where GM will head over long-term

  • Only about 2 million options/RSUs outstanding vs. 125.6 million total shares outstanding, so the dilution rate shouldn’t be bad


(Ryan) Earnings:

  • Over the last 12 months, they’ve generated $4.2B in revenue

  • In the most recent quarter, total revenue was growing 46% YoY

  • About 30% of that comes from subscriptions and the remainder is from merchant solutions

  • And their monthly recurring revenue, so I believe this excludes merchant solutions was about $100M

  • Q3 GMV was about $42B, up 35% YoY

  • TTM OCF was about $489M, so ~12% OCF Margin

  • The total gross margin for the first 9 months of the year was 55.3%. That’s up YoY, largely due to the increase in GM from merchant solutions

  • Net income looks really high for the quarter because of an unrealized gain on equities that they own (I think this is from their pre-IPO stake in Global E)


(Brad) Balance sheet and liquidity:

  • $7.52 billion in cash, equivalents, and marketable securities

  • Looks like it has around a billion in convertible senior notes with a 0.125% interest rate and some strong conversion rights for the holders

  • Looks like it also raised north of a billion this year with a class A share offering.


(Ad)


Anecdotal Evidence:

  • (Ryan) Yeah I’ve bought stuff on the AllBirds website which is powered by Shopify. And they actually just went public.

  • (Brett)

  • (Brad) Think it’s safe to say I’ve accessed countless websites powered by Shopify


Future growth opportunities:

  • (Ryan) Using the basic website design template to expand into other categories aside from commerce. Shopify is all about enabling the creators and I think they could do the same thing for other markets. Things like blogging (buying substack), restaurants (i know they have a solution, but it doesn’t seem like they’re focusing much effort there), or just other small businesses that don’t require selling goods.

  • (Brett) The Shop App. Has 4.8 stars on Play Store and for good reason. It is pegged as an order tracking app, which it does well (it automatically added an order I had when I logged in with Google and automatically added my card and shipping address when I made an account). However, the most important thing long-term may be the search/shopping function that feels very similar to Amazon (looks a bit like a better Wish.com). This is a great way to counterposition vs. Amazon by aggregating all the Shopify customers.

  • (Brad) Enhancing the commerce utility that they can provide. True partner. Thinking its APIs can handle things like channel management and logistics (similarly to Olo doing more than building a website) I think Shopify can do a lot more for their users.


Highlights and lowlights:

  • (Ryan) Highlights: Incredible business model. I like management. There’s clearly some stickiness the longer that a business has been with them. Lowlights: They are coming off of an unsustainably high e-commerce year. I think there is also a little bit of wasted money with Studios and their retail stores, but I’m being nitpicky with those.

  • (Brett) Highlights: Recurring revenue + reliance on payment volume allows it to be resilient and ride the e-commerce tailwind all at once, Shop App seems amazing, love their capital allocation strategy, and management checks out but I know everyone already loves them. Lowlights: Margin uncertainty and fulfillment strategy ($1 billion in spending a year seems weak) are two big lowlights for me.

  • (Brad) Highlights: This is an iconic company. Saw a future world-changing trend and trailblazer it. Growth has been phenomenal for a long time and management is nothing short of elite. Lowlights: I wonder how far along into this success story we already are. We all eluded to Shopify needing to do more in the future and there’s no guarantee these new features will gain the traction its website builder has clearly gained.


Bull Case:

  • (Ryan) Build out tools to attract websites of any type. Wix said they would power 50% of all websites within 5-7 years. If that can be Shopify instead, I think a $75-100 billion revenue opportunity is achievable. With 20%-30% FCF margins, you’ve probably got a solid return. But the bull case is very different today than it used to be.

  • (Brett) Going through what the price is expecting, if revenue grows at 30% CAGR for 10 years it will be $57.9 billion annually. On a 20% FCF margin (unsure whether it would be higher or lower) that is $11.6 billion in annual FCF. So this tells me you have to expect a premium multiple in order to get good returns here.

  • (Brad) Shopify does a whole lot more for their customers than they currently do. Pay, logistics, maybe cross-border commerce with the Global E investment


Bear Case:

  • (Ryan) If it gets to $25B in free cash flow, which is like a 100x from here, and it trades at a big tech multiple, say 35x FCF, you’ve got a 3 bagger. That’s a pretty rosy future and the reward doesn’t seem to justify that.

  • (Brett) Multiple compression. Plain and simple.

  • (Brad) This is becoming a mature company.


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Disclosure: The author and podcast guests are not your financial advisors. Ryan Henderson and Brett Schafer are general partners and portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this show.


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