Shopify Stock: A Bargain Basement Valuation?

Earnings six figures while working four hours a week from anywhere is a common promise made to naïve dreamers who think such a thing is purchasable. Just plunk down $299.99 for the PDF guide and avail yourself of financial independence. That appeal was often made by those who peddled dropshipping as the quickest way to financial freedom some years back. The more people who climbed aboard the idea, the more firms like Shopify (SHOP) benefited. If you’re looking at starting an online business selling physical products, Shopify is the largest ecommerce platform in the United States with a market share upwards of 30%.

Upselling Subscribers

Most of our merchants are on subscription plans that cost less than $50 per month, which is in line with our focus of providing cost effective solutions for early stage businesses.

Credit: Shopify

If we assume “most” is 50% or higher, then most of Shopify’s customers pay them no more than $600 a year to access a platform which is generating gross margins exceeding 90%. From there, Shopify “harvests” these leads and sells them merchant solutions. As you would expect, Shopify benefited from the ecommerce boom that accompanied The Rona, and investors are wondering what growth can be realized in the “new normal.”

Going forward, we expect more normalized growth in gross merchandise value against a more measured macro environment relative to 2021 as a result of post-pandemic consumer spend shifting to services and in-person shopping, as well as inflationary pressures on our merchants and their buyers.

Credit: Shopify

We’re not given any real 2022 revenue guidance in the earnings deck, just vague ambiguities that are characteristic of this company’s investor communications collateral.

What Shopify Does

Shopify divides their business into two revenue segments:

  • Subscriptions– a recurring subscription component
  • Merchant Solutions – a merchant success-based component

Here are some basic metrics for each segment:

 % Of Total RevenuesGross MarginGrowth
Subscriptions28%93%5%
Merchant Solutions72%60%7.5%

While remarkably profitable, Subscriptions as a percentage of total revenues have been decreasing over time as they’re growing slower than Merchant Solutions which are becoming an increasingly important part of Shopify’s business model. Therefore, we need more transparency on the inner workings of Merchant Solutions. We’re simply told that “within merchant solutions, the largest source of cash flows are Shopify Payments processing fee arrangements, which are received on a daily basis as transactions are processed.” Use of the word “largest” tells us nothing when the segment contains numerous categories such as the Shopify Capital, Shop Pay Installments, Shopify Balance, Shopify Shipping, Shopify Fulfillment Network, Shopify Plus, and the list goes on.

We’re told that Merchant Solutions revenues are correlated with a metric called gross merchandise value (GMV) which is the volume of merchandise sold on the Shopify platform ($90 billion for the first half of 2022), but that doesn’t tell us anything about risks. For example, we’re particularly interested in the “Merchant Cash Advances, Loans and Related Receivables” entry on their balance sheet of half a billion dollars. This number coincides with another metric they have under losses on their income statement – “Transaction and loan losses” – which has recently surged as a percentage of total Merchant Solutions revenues.

Bar chart showing Shopify's transaction and loan losses as % of merchant solutions revenues
Credit: Nanalyze

We’re concerned about what sort of exposure is being taken on while extending merchants’ credit when the number of small businesses that fail is likely to sharply increase when there’s a recession. The latest earnings deck tells us they “surpassed $400 million funded to merchants for the first time in a quarter” and that they funded “$3.8 billion in cumulative capital since inception in April 2016.” Understanding what sort of revenues are being generated from these activities would be particularly useful.

Unfortunately, we’re not provided with sufficient metrics to assess the health of Shopify’s business aside from GMV and subscription run rate which is referred to as monthly run rate (MRR). It’s a problem that extends beyond their regulatory filings and into their investor decks.

Shopify’s Investments Create Confusion

The most recent Shopify earnings deck looks like it was built by a team of interns with little ambition. Lazy statements like “More merchants joined Shopify,” or cryptic statements like “online commerce and POS GMV YoY growth outpaced respective markets in the U.S,” offer investors little value. Not a single chart graces the 24 slides of meandering thoughts in the Q2-2022 earnings deck which is finished off by some awkward pictures of diverse people who use the platform which… must make it better somehow?

More meaningful numbers can be found in the latest regulatory earnings filing which shows a $1.2 billion loss last quarter following $1.47 billion in losses in Q1-2022.

Bar chart showing Shopify's last four quarters of revenues and earnings
Shopify’s last four quarters of revenues and earnings – Credit: Yahoo Finance

The earnings volatility seen above relates to an investment Shopify made in Affirm (AFRM) back when they were the latest high-flying buy-now-pay-later (BNPL) stock to go public. Following an exclusive partnership with the company, Shopify was granted warrants to buy up to 20.3 million shares in Affirm. That position valued at $2.04 billion at the end of 2021 is now worth $366.6 million and – based on the quarterly report data – appears to represent about 15.7 million shares. Here’s how Shopify’s investment in Affirm has performed over the past year:

Yahoo Finance chart showing how Shopify's investment in Affirm has performed over the past year
Credit: Yahoo Finance

When times get tough for the American consumer, it’s not good to have exposure to buy-now-pay-later loan providers that have never been legally required to vet the customers they loaned money to. That’s one of the criticisms we had about Upstart (UPST), another fintech firm heavily reliant on the American consumer’s ability to repay debts.

The other investment Shopify made was in an international e-commerce provider called Global-E Online (GLBE), a holding that has also lost a great deal of value since the beginning of this year.

Revenues from Shopify's investments Affirm and Global-E Online
Credit: Shopify

Holding two large positions in a pair of volatile stocks creates problems for investors. It’s not just because they collectively lost 75% of their value so far this year, because that’s what volatile tech stocks do. The problem is that investors get an obscured look at quarterly results and need to back out the impact of these investments every earnings call. It creates noise and added work to monitor a firm that’s already difficult enough to follow. We’re also not convinced that BNPL firms like Affirm will be able to thrive in today’s bear market, or even survive for that matter.

Would We Buy Shopify Stock?

Over the past year, Shopify stock has lost 76% of its value compared to a Nasdaq loss of 18% over the same time frame. With a present-day market cap of $45 billion, the company has a simple valuation ratio of 9 which implies it was significantly overvalued and is reverting to the mean. This discount is tempting many investors, but we’re not taking the bait.

This Canadian firm does a poor job of providing investors with sufficient metrics to gauge health, and we’re unable to discern even the simplest metrics, like geographical concentration risk or customer concentration risk. Nowhere are we told anything about the number of customers using the platform on either the subscription side or the merchant side. We’d like to know how much money is being made off the $3.6 billion they’ve loaned merchants over the years, or how many clients they’ve been able to migrate to Shopify Plus. Concise messaging would go a long way towards making this company appealing to investors who demand a bit more from investor relations teams.

Conclusion

Shopify isn’t trading at bargain basement prices and it’s not clear what metrics investors should use to monitor health aside from GMV and MRR. We need further breakdown in the Merchant Solutions segment to understand their revenue exposure to loans which can then be compared directly to loan losses. In today’s bear market, many of these entry-level businesses will pull an Amy Winehouse and we need some metrics to assess churn. Shopify had its day in the sun and now they need to do a better job of explaining their business model to investors aside from the poorly constructed investor decks being churned out now.

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2 thoughts on “Shopify Stock: A Bargain Basement Valuation?
  1. This statement is accurate re BNPL, BUT it’s wrong re UPST…

    “ it’s not good to have exposure to buy-now-pay-later loan providers that have never been legally required to vet the customers they loaned money to. That’s one of the criticisms we had about Upstart (UPST), another fintech firm heavily reliant on the American consumer’s ability to repay debts.”

    It is outperforming FICO in bad times as well as good. Essentially, the AI platform vets the customer and his/her “ability to repay debts,” and it does so better than FICO. Since the yield on its debt packages are quite high, I expect it will find reliable funding partners (its major problem), but that’s an aside…

    I just wanted to correct your vetting statement Re Upstart.

    Aside from that (and it’s not really relevant to the core subject here)… excellent article! A few key points deepened my inclination to give Shopify a pass.

    Thanks very much.

    1. Very good point raised here. Our comment was more around the fact that firms are not legally obligated to do any credit-related vetting prior to extending BNPL credit. It should be expected that AI would outperform traditional FICO scores, but will either method keep customer from overextending themselves? For example, there has been talk of consumers going around and exhausting BNPL terms across multiple providers because they can. When it comes time to pay the piper, and consumers fall upon hard times, the loss ratios might increase sharply. Generally speaking, we’re very suspicious about extending consumers credit because they won’t hesitate to take that rope and hang themselves with it, at least according to what history has shown. Thank you very much for the quite astute correction.

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