Despite the market liking the report, we closed the position based on the following:
- Gross Margin slipped from 51% last quarter to 48.30% this quarter. On the call, they discussed the following reasons: “Lower margin merchant solutions, lower margin shop pay, impact of deliverr and increased cloud infra” (This is a paraphrase as the transcript is not avail yet). Merchant Solutions gross margin is 37.2%.
- In the past, Shopify had a 71% GM in 2020 and a 61% GM in 2021.
- Operating margin from (15%) last quarter to (25%) this quarter yet could be more persistent if SHOP will see a weaker GM.
- The net margin of (11%) is actually (21%) if you remove the investments Affirm, Global-E and Silvergate. The (21%) gives a better idea of business operations. In this case, I removed the $173M gain in equity listed.
- Free cash flow of ($228M) this quarter up from ($136M) last quarter. For our purposes, this is a red flag in the report given the market’s sensitivity to a rising rate environment. We’ve detailed this a few times especially with cloud that worsening FCF will cause us to redirect.
- Shopify did improve this SBC outlook from $750M to now $575M for the year. This may reflect the new comp program and more employees electing cash. However, it's a notable variable into the foreseeable future (if stock does well, dilution will rise if employees go with more stock, which is a likely outcome).
- Stock based compensation for the quarter was $149.9 compared to SBC of $139M last quarter. This implies $100M +/- on SBC next quarter given the FY guide.
There was a nice revenue beat and nice EPS beat. Key metrics are mixed with the lower margin Merchant Solutions driving the growth at 18% last quarter and 26% this quarter. However, the predominant key metric Gross Merchandise Volume ticked down from last quarter at $46.9 billion to $46.2 billion this quarter. Monthly Recurring Revenue dropped from 13% to 8% this quarter. It was stated on the call that SMBs were (3%) on MRR. I don’t have the transcript but that is what was said by an analyst.
Something to watch for is if Deliverr is dilutive to the company beyond gross margin. I don’t have enough visibility and management did state some of the GAAP OpEx was affected by litigation costs of $97M and severance of $30M (again, don’t have the transcript) yet this is something to watch out for if it was dilutive to GM.
These decisions are hard but it’s our investing discipline to not remain in stocks with worsening margins and worsening free cash flow. 2023 is remarkably uncertain in many regards and we feel it will be easier to navigate the macro uncertainty if the underlying business supports both revenue and bottom-line growth.