Shopify, The Commerce Giant For The Smaller Commerce Platform

Saying that Shopify is the commerce giant for the smaller commerce platform may be a bit of a simplification, but hey, their name stems from “simplify” so I think I can get away with it. Shopify also does a lot more than just offer a platform that allows smaller commerce companies to build their website, from what I hear, this is often seen as what Shopify does. Although historically correct, it’s not anymore. So what does Shopify do? Let’s dive straight into it!

What does Shopify do?
At the core, Shopify offers merchants a platform where they can build their online presence, which it has done and built out quite successfully. Over the past 10 years, revenues have grown from $105 million, to $7.06 billion. An average of ~64% per year. The last 5 years have seen about 45% growth on average, and in the past 2 years about 24% per year. These are very big growth numbers and later we will see how the company does this.

So let’s then look at how the company operates and what they offer, because that might be slightly important to know as well. So as they say it in their own words:

“Shopify tries to be convenient to customers by offering a multi-channel front-end, a single integrated back-end, and infrastructure for data-informed decisions. So what do those things mean?”

“A multi-channel front-end. Our software enables merchants to easily display, manage, market and sell their products across more than a dozen different sales channels, including web and mobile storefronts, physical retail locations, pop-up shops, directly to other businesses ("B2B"), social media storefronts, native mobile apps, buy buttons, and marketplaces. More than 90% of our merchants have connected their Shopify stores to two or more channels. Beyond our pre-configured channels, the Shopify application programming interface ("API") has been developed to support custom storefronts that let merchants sell anywhere.”

“A single integrated back-end. Our software provides a single integrated, easy-to-use back-end that merchants use to manage their business and buyers across multiple sales channels. Merchants use their Shopify dashboard, which is available in more than 20 languages, to source and manage products and inventory, manage cash, payments, and transactions, fulfill and ship orders, discover new buyers and build customer relationships, leverage analytics and reporting, and access financing.”

“Infrastructure for data-informed decisions. Our software is delivered to merchants as a service, and operates on a shared infrastructure. This cloud-based infrastructure not only relieves merchants from running and securing their own hardware, it also consolidates data generated by the interactions between buyers and a merchant's products, providing rich data to inform merchant decisions. With a highly qualified team of data science personnel, we expect to continue to support our merchants in making data-informed decisions with critical safeguards in place to ensure privacy, security, and compliance.”

Okay, so that makes complete sense right? Let’s say it in a bit of an overly simplified way. Shopify offers a platform on which merchants can set up their commerce business, both for online, as more recently also offline with Point-Of-Sale (POS) systems. When this platform is installed, customers genuinely stay on their platform, but more on that later, and when they stay on the platform, Shopify offers additional solutions that rake in additional revenues. This is where we see the difference between subscription revenues, and solution revenues.

What does the sales geography look like?
As of December 31st ‘23, Shopify served merchants from 175 countries. The customers can be further divided into 54% from North America, 24% from EMEA, 14% from Asia Pacific, and 5% from Latin America. This means they are very much diversified over different markets and regions which is very good, so that when one area slumps a bit, others may show strength.

Who are the executives?
Tobias Lütke
Tobias Lütke co-founded Shopify in September 2004. Lütke has served as Shopify's CEO since 2008. Previously, Lütke acted as the Company's Chief Technology Officer ("CTO") between September 2004 and April 2008. Lütke also worked on the core team of the Ruby on Rails framework and has created many popular open-source libraries such as Active Merchant. Lütke also serves as Chair of our Board of Directors, and sits on the Board of Directors for Coinbase.

Tobias Lütke Resumé

Harley Finkelstein
Harley Finkelstein is the President at Shopify and has been with the Company since 2010. He oversees Shopify's commercial teams, partnerships, brand and external affairs. Prior to his current role, Mr. Finkelstein served as Shopify's COO and has founded numerous startups and ecommerce companies. He currently is an advisor to Felicis Ventures. Mr. Finkelstein holds a bachelor degree in Economics from Concordia University and a J.D./M.B.A. joint degree in Law and Business from the University of Ottawa.

Harley Finkelstein Resumé

Jeff Hoffmeister
Jeff Hoffmeister is the CFO at Shopify and has been with the Company since 2022. He previously worked in Morgan Stanley's Technology Investment Banking group for 22 years in their New York, London, and Boston offices. His prior roles at Morgan Stanley included Head of Americas Technology Banking team and Head of Technology Investment Banking for EMEA. Mr. Hoffmeister began his professional career at PwC, serving in their auditing division. Mr. Hoffmeister currently serves on the Board of Directors of a private company. Mr. Hoffmeister holds a Bachelor of Science in Business Administration from Georgetown University and a Master in Business Administration from the University of Virginia Darden School of Business. He also holds a license as a certified public accountant (CPA)

Jeff Hoffmeister Resumé

Jessica Hertz
Jessica Hertz is the General Counsel at Shopify and has been with the Company since 2021. Hertz oversees Shopify's global legal, communications, policy, and trust teams. Prior to joining Shopify, Hertz served as Deputy Assistant to the President and Staff Secretary to President Joseph R. Biden Jr. Prior to her work for the Biden administration, Hertz was General Counsel for the Biden-Harris presidential transition team, and held positions at Facebook and at the law firm of Jenner & Block LLP. Hertz holds a J.D. from the University of Chicago Law School.

Jessica Hertz Resumé

Kesra Nejatian
Kasra Nejatian is the Vice President of Product and COO at Shopify and has been with the Company since 2019. Prior to his current role, Nejatian served as Shopify's Vice President of Product, Merchant Services, and Commercial. Prior to joining Shopify, Nejatian co-founded and served as CEO of Kash, a payment technology company, and also served as Product Lead for Payments and Billing at Facebook. He is a graduate of Queen's University's School of Business and the University of Toronto, Faculty of Law.

Kaz Nejatian Resumé

How is Shopify Growing
Growth for this business is incredibly strong. As mentioned, over the past 10 years, revenues have increased by 64% per year. The same can be said for share price appreciation. This is staggering, as the share price is still far from recovering from covid bubble highs. Over the past 10-year period the share price has gone up by about 3350%, Over the past 5 years the share price increased by “only” 114%. I believe this is due to the pull-forward from covid commerce, and then having to adjust afterward as things normalized.

So what does the growth look like on the income statement?

FY’23 Income Statement

So looking at the FY’23 income statement shows us an increase of 23.5% in subscription solutions, as well as a 27% increase in merchant solutions. Furthermore, we see costs of subscription solutions increase by 6% and merchant solutions by 27%. This means that the subscription solutions grow margins extremely fast, whilst, for the merchant solutions, margins stayed the same. We also see an impairment for the sale of the logistics business. A good thing they got rid of it, but less ideal for the way they did it, as the acquisition was announced after Q1’22, and the sale after Q1’23. They sold that business for a 13% stake in Flexport, after acquiring it for $2.3 billion.

Looking at the Q1’24 income statement gives us mostly the same view, although there are slight differences.

Q1’24 Income Statement

Here we see that on the income side, subscription solutions have grown the most, as it grew 33.8% YoY. The merchant solutions grew by 19.9%. As for the costs of revenues these grew by 13% for the subscription solutions, and by 14.4% for the merchant solutions.

So what things stood out when we look at the balance sheet? We will skip the FY’23 balance sheet as the change there isn’t as interesting, but go straight to the Q1’24 balance sheet.

Q1’24 Balance Sheet

What stands out from the balance sheet is that shareholders’ equity is down slightly, something that can be attributed to the equity and other investments. Not really that big of a deal if you ask me.

But this growth has to be created somehow, so what drives the growth? That’s actually quite simple and to explain it, I want to point towards the following slide for from the investor day. It shows that for midmarket companies, defined by Gross Merchant Volume between $2 to $20 million, Shopiy lands 43 new customers, for every 1 customer they lose. With such ratios, it’s not really that surprising how they grow as fast as they do.

Bull and Bear Arguments

Increasing TAM, when we look at the slide from the investor day presentation below, we can clearly see an increase in the TAM of Shopify. As much as this is a good thing, it’s only as valuable as their ability to grab parts of it. The advantage of this statement is that Shopify has focussed on getting good at what they do, before taking the next steps and expanding. 

Improved Capital Structure, In Q2’23 Shopify divested the logistics business. This is a business that in my opinion isn’t very good to be in as it’s a highly complex business to operate. This is also seen in the Free Cash Flow Margin which has gone up from 1% in 2019 to 12% in 2023. During Q3’19 Revenues were eaten up by operating expenses for 65%, in Q3’23, this was down to 45%.

Bear Argument

The main competitor of Shopify is Amazon as that is the only bigger e-commerce platform in North America. this is not an ideal opponent. Shopify also tried to be more like Amazon with the acquisition of the logistics business. It’s good that they got rid of it, whilst the lower shipping times are still available for select commerce customers.

Conclusion

Shopify stock is down 20% YTD, but this does not mean that it is currently cheap. The company has a bunch of positive characteristics, but also many negative ones. In order to do a very simple valuation, we will look at what kind of PE the company can command. But first, for the good qualities. Shopify is growing very fast. It is still growing very fast, even at the size it is currently at, as in Q1’24, revenues increased 23%, or 29% for the adjustment for the divested logistics business. The company also draws in many more customers than it loses as we have seen from the slide above. So what are things I do not like about the company? Well, that’s quite simple, the lack of profitability. They sometimes posts profits, while in other quarters they don’t and it really irregular. The same goes for Free Cash Flow. Lütke said during the investor day that they want to focus of profits, and this also showed in the fact that they laid off about 23/24% of the employees, but it’s still very irregular as I will show below.

Shopify EPS per Quarter

Shopify FCF per Quarter

So then let’s look at valuation. This might be a bit more difficult than saying we look for a justifiable PE, because we see a lack in net income for the company. So, what is the next best thing? We can look at the PS ratio? And maybe compare it to the Price to Book as well, in order to confirm the conclusion we can draw.

But as Shopify is currently at a PS ratio of 10.3, we can see in the historical chart of that figure that it is currently cheap. Is it really undervalued by the metric? Maybe not that much but it is on the cheaper side, because if we take the bear market of 2022 out of the equation, the last time we saw the PS ratio around 10, was back in 2016. As for the Price to Book, in order to get to a comparable level, we have to go back to Q4’2019. So historically speaking the stock is cheap where it is, but does this make it undervalued?

I would say that a PS ratio of 8 would make the stock undervalued based on a historical average for the stock. As the company has done $7.413 billion in sales over the past 4 quarters, this would mean the stock would have a market cap of about $59.3 billion. This would put the stock in the mid, to high 40’s. Will it get there? time will tell, but in that area I’d find the margin for error large enough to consider it a very good buy. As this is not financial advice, I have a disclaimer you can find below.

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