Shopify Inc. (TSE:SHOP) (NYSE:SHOP) is in the early stages of its growth cycle and its $6.1 billion market cap does not appear too outlandish when you consider its market opportunity
SmallCapPower | April 13, 2017: With the increasing advent of mobile technology, consumers have become accustomed to shopping online with mobile devices at their own convenience; anywhere, anytime. On the other hand, merchants require the ability to reach prospective customers easily and without the need for a wealth of technical skills, which is especially true for small and medium-sized businesses. This is where Shopify Inc. (TSX: SHOP) comes in, providing merchants with turn-key end-to-end eCommerce solutions. Shopify (TSX: SHOP) provides an inimitable all-in-one platform for back-office and web development in a subscription-based model with value add-on services. For more information regarding Shopify’s business model, total addressable market (TAM) and peer valuation, click here.
Related: If you have not already, be sure to check out our previous article on High-Growth Canadian Tech Stocks, where our analysts compared Shopify Inc (TSE:SHOP), Sierra Wireless (TSE:SW), and AcuityAds Inc (CVE:AT).
Shopify (TSX: SHOP) has been making new highs since its IPO in May 2015, rallying 140%+ in the past year alone. Is this just the tip of the iceberg? Does Shopify have more room to run? To answer these questions, we will explore the near-term catalysts in Shopify’s horizon as it scales to become a disruptive global eCommerce platform for small and medium-sized businesses (SMB).
Organic Growth Potential
Shopify (TSX: SHOP) is in the early stages of its growth cycle and its $6.1B market cap does not appear too outlandish when you consider its market opportunity. With only a 3.25% market penetration of its local US$14B TAM—even less for its global US$57B TAM—upside potential comes from fundamental growth catalysts including more merchants, solutions, sales channels, partners, and international penetration. Additionally, eCommerce is a relatively early industry and is expected to continue to undergo double-digit growth through 2020, when sales will top US$4 trillion according to eMarketer. Although bricks-and-mortar businesses are already feeling the heat from online retail, eCommerce sales make up only about 10% of total retail sales worldwide today (Figure 1). Expanding middle classes, greater mobile and Internet penetration, growing eCommerce competition, and improving logistics as well as infrastructure will all fuel eCommerce growth worldwide.
Figure 1: Retail eCommerce Sales Worldwide, 2015-2020
Trillions, % change and % of total retail sales
Source: eMarketer
Over the last five years, Shopify (TSX: SHOP) has shown strong consistent growth in revenue of 90%+ Y/Y, and benefits from enviable 81% CAGR in monthly recurring revenues (MRR). Obviously as the numbers get larger, the percentage growth will become smaller. However, the average analyst forward sales growth rate of 51% seems out of whack. Analysts forecast 125-150K new merchant additions in FY/2017 vs. 134K in FY/2016, yet although its strongest season, Q4/2016 saw additions of 53K new adds alone! These numbers exemplify an increasing trend of online business that is not expected to slow down:
- Bricks-and-mortar businesses also want to be able to sell online and Shopify provides the platform with the solutions (think Tesla)
- Brands are going direct to consumers (B2C, think Nestle)
- Celebrities are leveraging their own name to monetize on platforms such as Shopify (think ittybittyballers and Jonas Valanciunas)
- Homegrown success stories (think MVMT watches)
Furthermore, there is significant growth potential for Plus merchants, which refers to Shopify’s large enterprise customer platform ($2000/month) used by clients such as Tesla and L.A. Lakers. Currently, less than 1% of merchants are using the Plus platform, with more than 50% of Plus merchants added in just the past year. All of this is about to change with a new variable pricing model that is designed to improve the scalability and functionality of Plus; designed to move homegrown success stories to Plus. The variable pricing model benefits Shopify when merchants scale to high (>$10mm annualized) Gross Merchandise Volumes (GMV), using price caps to remain competitive to alternatives. Additionally, Shopify is introducing modest transaction fees for Plus merchants that use third-party payment gateways, which will drive higher proportion of Plus merchants to use Shopify Payments over time, creating additional monetization opportunities. Thus, both subscription and merchant solution revenues are likely to increase beyond analyst expectations.
Data Driven Opportunities
Over the course of 2016, Shopify (TSX: SHOP) has processed over 35 billion transactions. This is yet another opportunity for Shopify to capitalize on as this ‘big data’ could fuel the next big wave in Shopify’s operational improvements. Currently, the Company has leveraged the data with an in-house data analytics team to improve underwriting of cash advances and order acceptances, reducing false positives by 90%. Shopify has already facilitated and directly monetized these data services using Shopify Capital, a cash advance and business loan service for entrepreneurs. Looking ahead, Shopify is seeking to pass down the ‘big data’ benefits directly to merchants (i.e. transaction fraud) through more reporting and analytics to help merchants grow their business. Increasing Gross Merchandise Volumes (GMV) has a direct impact on Shopify’s bottom line as it benefits from increasing transactions: payments, shipping, buy buttons and other merchant solutions. After all, Shopify’s success hinges on the success of its customers.
Partner Integration and GMV Growth
Recently, Shopify has facilitated a deeper integration through partner sales channels, shipping services, and mobile payment apps, which are bound to boost GMV and take rates. The benefits and synergies for Shopify are endless, as it not only enables its merchants to sell over other popular platforms such as Amazon, Facebook, Messenger, and Pinterest, but also accept payments from apply pay, Android pay, and many other prominent names worldwide.
As of December, Shopify is Amazon’s preferred partner for Amazon Webstore owners, which is designed to ‘seamlessly connect Shopify store owners to the millions of customers searching for products to buy on Amazon’ (Shopify Q4/2016 financial report). The partnership leverages Shopify’s storefront suite while taking advantage of Amazon’s well known distribution system, a win-win situation for merchants. The agreement attributes no direct-to-Shopify revenues as it is a pass through (no charge) transaction; any Amazon GMV is not counted towards Shopify GMV. However, the increasing GMV may hasten merchant growth to Shopify’s higher margin Plus services and increase click-traffic to the Shopify store website.
Shopify Still Has Room to Run
Shopify has 377,500 merchants in 175 countries with Q4/2016 ending cash balance of US$392.4mm and no debt. The Company has the potential to attain profitability as it bears fruit from its strategic partnerships and adds more merchants to its platform. Presently, Shopify is still early in its growth cycle and is heavily invested in growing its business through products and services—chat bots, virtual reality, POS—that will help its merchant base grow to become Plus subscribers. Shopify is a disruptive leader in the eCommerce space and as mentioned earlier, Shopify’s success hinges on the success of its clients.
Shopify’s GMV has doubled Y/Y in 2016, and this uptrend is expected to continue in 2017 with its strategic partnerships and sales channels. Since our previous article, Shopify has retreated and is currently trading at 6.4x 2018e EV/Sales, which is still a premium to high-growth software companies average of 5.1x. However, it is worth noting that Shopify’s revenue growth of 51% over the next two years is much higher than the high-growth software range of 15-35%, which justifies its valuation. Shopify even appears more attractive when you consider analysts have implied a very conservative forward growth estimate, which pales in comparison to Shopify’s precedent 90% rate.
Perhaps a DCF would be more appropriate to value Shopify as it is in a scaling high-growth business that has yet to experience a normalized run rate. Nonetheless, Shopify Inc. (TSE:SHOP) has an excellent product/market fit with an inimitable eCommerce platform that justifies its premium valuation. Shopify is an industry disruptor akin to NetSuite and Salesforce, which were both thought of as overvalued, until they delivered outsized performance and came to be industry leaders in their respected industries.
Disclosure: Neither the author nor any of the principals at Small Cap Power, or their family members, own shares in any of the companies mentioned above.
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