Shopify, a developer of an online marketplace for small and medium sized businesses, reported 2015 fiscal year end financial statements recently, and although its shares are currently trading below the IPO price, we’ve uncovered three reasons why investors might be tempted to open up their wallets.
Alex Cutulenco | Ubika Research Analyst | February 18, 2016: Shopify (TSX: SH) (NYSE: SHOP), a Canada-based developer of an online marketplace for small and medium sized businesses, reported 2015 fiscal year end financial statements on Wednesday. The Company has more than 243,000 active Shopify storefronts with 150+ countries using its platform, processing Gross Merchandise Volume (GMV) of $7.7 billion.
Shopify reported $205mm in revenues (5% beat over analyst estimates of $196mm), along with a slightly better EPS loss of ($0.30) (5% beat over analyst estimates of 0.31 loss/share). Its stock price jumped as much as 20% following the announcement, before ending the day about 8% higher.
Prior to analyzing this stock’s potential upside, it is important to understand its Revenue Model:
Subscription Revenue:
Revenue from subscription solutions is generated through the sale of subscriptions to its platform as well as from the sale of themes, apps and registration of domain names. Shopify offers a range of plans that increase in price depending on additional features and economic considerations, such as Shopify Plus (the Company’s higher-end subscription service).
Key Performance Indicator (KPI) for this division is Monthly Recurring Revenue (MRR), since clients enter into a monthly subscription fee. As of December 31, 2015, MRR totaled $11.3mm, an increase of 73% over last year.
Merchant Solutions:
Shopify generates merchant solutions revenues from payment processing fees from Shopify Payments, which has been adopted by approximately 83% of merchants in North America. In addition, the Company also generates merchant solutions revenue from transaction fees, Shopify Shipping, referral fees from partners, and sales of POS hardware.
KPI for this division is the level of GMV, since merchant solutions revenues are directionally correlated with the level of GMV. GMV grew 105% to $7.7 billion in 2015.
Upcoming 3 Catalysts:
- Merchant Solutions Will Drive Additional Recurring Revenue Growth
Within the merchant solutions offerings, the Company introduced Shopify Payments in the United Kingdom in November 2014, and in Australia in November 2015; vs. introducing the solution in the U.S. in August 2013. Since Shopify Payments was launched so much sooner in the U.S., it is no surprise that this geographic region has a higher adoption rate of 83% of its merchants; vs. 67% adoption in the United Kingdom and 18% in Australia.
This high level of adoption leads us to believe that with enough time, the UK and Australia will see much higher adoption rates in the near future, leading to greater revenue upside.
- Investors are Concerned about Profit Margins
Ever since the introduction of Shopify Payments (and other merchant service solutions), gross margins have worsened.
Figure 1: Shopify (TSX: SH) (NYSE: SHOP) Gross Profit margins
Source: Company Financials (as at Dec. 31, 2015)
The drop in profitability is resulting from the associated costs arising from offering such merchant services. Gross margins on subscription revenues are just naturally higher than that for merchant services because of associated third-party costs of providing these solutions.
Although Shopify Payments is an inherently lower gross margin solution, investors should focus on the larger picture: Shopify has built an additional monetization strategy, and it’s profitable. The net impact to shareholders is still positive, and it seems that investors are more focused on the overall drop in margins, as opposed to realizing the marginal increase in overall profit arising from this new revenue source.
We would also like to point out that when the Company begins rolling out Shopify Payments in other geographic markets, this will also add to overall revenues and reported profits. A largely intuitive growth strategy for the Company that is yet another catalyst for share price appreciation.
3. Shopify Has Hordes of Cash and is Itching to Spend it: Acquisitions?
Shopify has one of the strongest balance sheets we’ve seen, with Cash and Marketable Securities at $190mm, Working Capital at $165mm, and Shareholder’s Equity at $195mm. The Company’s liquidity is so overwhelming that it uses its excess cash to buy low-yielding marketable securities, as seen by the $111mm purchase of marketable securities in 2015.
This excess cash is not just sitting pretty. The Company’s management fully understands the amount of power it possesses, and what can be done with this cash. In our opinion, Shopify is searching for either: (1) an acquisition target that will add to its product offering, with the possibility to further monetize and upsell to current merchants; (2) acquire certain patents/technologies, which may also serve a similar purpose as described in Option 1.
Shopify has been keen on monetizing its merchants as much as possible. This is primarily the case with the launch of Shopify Payments in August 2013, with the Company seeing significant growth in revenues generated from merchant solutions after the launch. In today’s tech world, recurring revenues and growth in users (merchants in the case of Shopify) are the key KPIs. With acquisitions, we can be sure of the Company’s efforts to try and upsell/cross-sell to existing merchants.
In Conclusion …
Shopify is currently trading below its IPO opening day close of $25.68 (C$31.25 on the TSX). With a positive earnings beat, overwhelmingly good growth in Revenue and KPIs, as well as such a large amount in cash, leads us to believe that the stock has much more upside to its current price.
All financial data in USD.
Alex can be reach at: alex@gravitasfinancial.com
Read more analyst insights from Alex Cutulenco
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