2536843c-2d08-4b42-8fa9-d362f83f8268_Shopify-Premium-Analysis-for-2021.pdf
Shopify Premium Analysis for 2021
Introduction:
As the market attempts to sort the companies that have temporary covid tailwinds from the more permanent and long-lasting growth, we want to separate Shopify from the pack. You can view our October 2019 analysis here where we discussed the strength of the company’s product-market fit and the catalyst of the Fulfillment Center.
One major update from the last report is that Shopify overtook eBay as the largest online retailer in the United States. When our last report was written, Shopify was the third largest retailer and a sizable portion of our analysis focused on eBay as the one to overtake.
I think we will see Shopify significantly close the gap due to Shopify's global opportunity. Shopify is more localized by allowing the merchant to have a localized domain rather than weaken under one domain as detailed in the October 2019 analysis.
Amazon is customer-centric which sacrifices the merchant-side of the equation. We covered this in 2019 when we stated:
Shopify counts over 800,000 merchants as customers compared to Amazon’s 5 million marketplace sellers. Shopify charges the sellers 2-3% compared to 26.5%. Amazon is also predominantly a United States presence with about 3⁄4 of sales occurring domestically. Shopify does not break out these numbers but it is widely understood to have a global strategy.
As mentioned previously, an important distinction between Shopify and Amazon is that Shopify places the importance on the merchant while Amazon places the importance on the retail customer. While Amazon builds out 1-day shipping, Shopify is building out tools for platforms and tools for merchants.
Amazon’s main value proposition is the convenience, which is why we will likely see Shopify attack this at various angles over the next few years (starting with the Fulfillment Network). Amazon’s e-commerce moat is about the same as Wal-mart’s retail moat; they are behemoths but these behemoths can be disrupted. Amazon took market share from Wal-Mart, and nearly two decades later, we think Shopify is a serious contender to Amazon.
However, it should be noted by not providing the traffic for the merchant, Shopify’s GMV is substantially lower than Amazon’s. We noted this before in the 2019 write-up:
Shopify makes 2.63% of GMV, or $361M of the $13.8 billion. Compare this to Amazon.com who makes 26.7% of GMV ($42.7 billion on $160 billion GMV, in 2018) and eBay who makes 11.7% of GMV ($10.86 billion on $92.6 billion, in 2018).
Percentage of GMV illustrates the power of owning the domain …
How will Shopify catch-up to Amazon? Two specific ways.
1. International Growth: Globally, Shopify has a better chance of penetrating various regions as the merchants (and lack of walled garden) localizes the content and offerings. There is also stigmatism towards Big Tech globally and Shopify works quietly in the background while letting the merchants remain in the spotlight. This will be popular globally — and perhaps even domestically if Shopify can deliver on the Fulfillment Center and close the gap on convenience. Point being, keep an eye on Shopify’s international growth.
The best evidence for this is Shopify’s recent partnership with AliPay. Although this does not meaningfully contribute to revenue right now, it could by next year across the key markets mentioned the press release: The new Alipay payment gateway is available now to Shopify merchants in the U.S., with more markets to come in the future, including Hong Kong, India, South Korea, Indonesia, the Philippines, Malaysia, Thailand, Pakistan, and Bangladesh.
Right now, it’s hard to predict Shopify’s success with AliPay in these regions but it’s easy to see that Shopify is welcomed in geographies where Amazon is not. Therefore, we see global as an important piece to our thesis as merchants who want to reach global audiences will likely choose Shopify over Amazon. We think this is an important competitive edge.
2. The merging of social media and e-commerce as a means for monetization. We’ve belabored the point of Apple’s IDFA changes to first-party vs third-party ads. For social media companies, the answer to weaker data will be to move away from behavioral targeting for ads and move towards direct response and e-commerce. Amazon is weak here as social media companies don’t partner with the behemoth (see below for SHOP’s partnerships). Expect to see additional tailwinds from social media driving more e-commerce traffic.
Market Forces: e-Commerce is eating Retail
There are two market forces driving the success of Shopify right now. The first is the covid pandemic grew ecommerce penetration in the United States from 15% to nearly 35% representing the same level of growth (3X) as the previous ten years combined (5% to 15%). Retailers are now online in an unprecedented number and are able to successfully compete with Amazon.
The more permanent trend will be driven by Millennials and Gen Z with 91% and 89% stating that they shop online, respectively, according to a survey conducted in June. Additionally, data from Morgan Stanley shows Millennials and Gen Z will overtake Baby Boomers as the dominant US spenders in the coming years, meaning the major US consumers of the future will prefer to shop online.
The additional outside force is the remaining addressable market. The statistics above suggest e-commerce will overtake retail while data from Stripe suggests only 5% of global commerce happens online today. This will be compounded by the overall growth in retail.
To summarize, we think the transition towards e-commerce is more permanent long-term than the market is pricing in at this time as retailers have been forced to adopt online stores and younger generations prefer this method.
Below you can see what product-market fit looks like as Shopify takes over eBay in a banner year for e-commerce.
Fundamentals:
In its most recent quarter, Shopify grew revenue 96% YoY to $767.4 million up from $714.3 million in the previous quarter and $390.6 million in the year-ago quarter. GMV grew 109% which was slightly down from the previous quarter of 119% GMV growth.
Merchant solutions revenue increased 132% YoY while subscription solutions advanced 48%. EPS of $1.13 came in 122% above the consensus estimate calling for $0.13 as the company showed its ability to earn sizable profits. Adjusted operating margins of 17% and is up from 3% in the year-ago quarter.
TTM revenue was $2.5 billion, net income of $196.5 million, and adjusted net income of $342.5 million. Here is the company’s growth over the last few quarters:
Q3 2019 Q4 2019 Q1 2020 Q2 2020 Q3 2020
GMV $14.8 billion $20.6 billion $17.4 billion $16.3 billion $30.9 billion
GMV Growth (y-o-y) 48% 47% 46% 119% 109 %
Revenue $390.6 million $505.2 million $470 million $714.3 million $767.4 million
Revenue Growth (y-o-y) 45% 47% 47% 97% 96%
Heading into Q4, Shopify is on pace to record over $100B in GMV in 2020. The company has over 1 million merchants in 175 countries with a breakdown of United States of America 52%, United Kingdom 7%, Canada 6%, Australia 6%, and 29% rest of the world.
Monthly recurring revenue as of September 30, 2020 was $74.4 million. The company has cash and marketable securities of $6.12 billion and debt of $750.5 million.
The increase in cash was due to $2.03 billion of net proceeds from Shopify’s offering of Class A subordinate voting shares and convertible notes in the third quarter of 2020 and $1.46 billion of new proceeds from Shopify’s offering of Class A subordinate voting shares in the second quarter of 2020.
An early glimpse into Q4 shows Shopify is likely to have a big quarter as the holiday shopping season unfolds. The company announced record Black Friday sales of $2.4B, up 75% from Black Friday 2019.
Over the past two years, Shopify has doubled its share of Black Friday sales. Most impressive is the acceleration of market share gains the company demonstrated this year.
The median analyst forecast for FY 2020 is $2.85 billion (up 81% YoY) and for FY 2021 is $3.74 billion (up 31% YoY). The median analyst’s EPS estimate for FY 2020 is $3.70 to $3.31.
The harder comps for next year is one reason the stock has cooled off but I suspect that we will see stronger forward guidance as the year goes on.
Here is how Shopify’s forward growth next quarter compares to other popular e-commerce companies:
Fulfillment Center
In June 2019, Shopify introduced the Shopify Fulfillment Network, a fulfillment network that will offer timely deliveries, lower shipping costs, and provide a better customer experience for merchants and customers Last year, the company acquired 6 River Systems to help build out its warehouse automation technology.
The Shopify Fulfillment Network is a 5-year build process for Shopify that remains in the product market fit phase. At this point, Shopify is focused on building out the software but management expects to prioritize the build out into 2021.
COO Harley Finklestein remarked in the company’s Q3 Earnings Call:
“our focus in 2020 around SFN is to achieve product market fit, which we plan to continue up to — into 2021. We want to ensure that the foundation of the fulfillment network is strong and the merchants experience is outstanding before we enter sort of the scale phase.”
Shopify is focused on the long-term opportunity and does not expect to accelerate its SFN investment, as they want to take their time on such a large venture ($1B).
Ultimately, the Shopify Fulfillment Network will utilize machine learning to improve supply chain economics and logistics. The company believes a significant portion of US GMV is addressable by the Shopify Fulfillment Network.
This will help Shopify compete with Amazon as a value add for merchants to make deliveries more streamlined and cost-effective, and will also improve the customer experience for buyers by ensuring faster deliveries.
Other tools and services that Shopify provides includes Shop Pay and Shop Email. Shop Pay allows customers to check out faster the next time they shop by saving the email address and credit card information. More than 60 million buyers opted-in at the end of Q3. Keep an eye on this for an indication of strength under-the-hood.
Shop Email lets subscription plans send emails through Shopify’s system rather than adding another vendor for email.
Notable Partnerships including Social Media
Shopify has several major partnerships that differentiate its platform from competitors. One is Shopify’s sales channel integration with Instagram that allows merchants to sell directly to consumers through product tagging. This allows shoppers to discover and purchase products all within the Instagram app, shortening the path to purchase.
Instagram is a crucial component of a successful ecommerce marketing strategy as it is the 5th most popular app in the US. Shopify’s integration with Instagram allows merchants to market their products and sell those products directly through the app.
Shopify is also partnered with Wal-Mart which was recently announced in June. The deal opens Walmart's Marketplace to Shopify's small business sellers, giving these merchants access to sell their products on the 4th largest ecommerce marketplace in the US.
Early indications show that Walmart Marketplace seller additions have increased 3x from January, demonstrating that Shopify merchants are eager to take advantage of this new opportunity.
A third major partnership Shopify has is with Facebook, recently announced in May. In Facebook’s expansion into ecommerce, they partnered with Shopify to launch Facebook Shops. Facebook Shops is a free tool designed to help merchants create customized online storefronts for Facebook and Instagram. This partnership allows Shopify merchants to control customization and merchandising for their storefronts inside Facebook and Instagram while managing their products, inventory, orders, and fulfillment directly from within Shopify.
Shopify is also partnered with TikTok which was announced in October. Shopify’s new channel integration with TikTok allows sellers to connect their TikTok for Business account and feature in-feed shoppable video ads within Shopify.
Shopify merchants can easily download the TikTok channel app from Shopify’s app store and begin to run and optimize TikTok marketing campaigns straight from the Shopify platform. For now, the TikTok channel is available in the US, but sellers in other North American countries as well as Europe and Southeast Asia will be able to access the service in early 2021.
TikTok was the 2nd most downloaded free app in 2020 with a surging young audience that ecommerce companies covet. Shopify merchants are now able to tap into that global audience.
These partnerships represent a tremendous value-add for merchants and prospective merchants, giving Shopify a big advantage over competitors. At this point, an entrepreneur looking to sell products online is likely to choose Shopify for the reach the company offers, as well as the tools Shopify is frequently releasing (SFN, Shop Pay, Shop Email, etc).
Valuation
SHOP continues to trade at a premium – 32x 2021 revenue, which has remained relatively stagnant over the last five months. In comparison to peers, many of which have seen their valuations continue to climb, Shopify has become more attractive.
In July, SHOP briefly had the highest forward multiple among SaaS stocks. It is now outside the top 10.
Here is the adjusted valuation EV/1-year forward revenue when adjusted for the 3-year growth rate. This helps to put the valuation in better perspective for Shopify.
Below is how Shopify compares on sales efficiency which measures the output of sales and marketing compare to annual recurring revenue. A ratio above 1 indicates a sustainable business model.
Also, here is a comparison looking at consensus projections 2 years out. We feel that Shopify can easily clear these 2-year projections.
Analyst Statements:
SHOP has 14 buy/outperform recommendations, 18 hold recommendations, and 3 underperform/sell recommendations.
Wedbush analyst Ygal Arounian raised the PT of Shopify to $1,300 from $998 in September. “We continue to like the short-term trends and Shopify’s position to capture them, but this call is a longer-term one in addition to those trends, driven by Shopify’s position to capture share of the total retail [addressable market] as it builds out its retail OS,” he wrote.
KeyBanc Capital Markets analyst Josh Beck, who has an overweight rating on the stock, raised the PT from $1,150 to $1,250, said the Shopify Fulfillment Network, which was launched last year, "is a full-fledged, tightly integrated fulfillment solution for Shopify merchants and includes order/inventory management solutions, branding and data controls, and access to scalable, flexible warehousing space to sell across multiple channels."
Morgan Stanley analyst Keith Weiss said “We see SHOP growing the merchant base from 1 million today to 4.6 million by 2030 (Subscription Solutions reaching $4.2 billion), while also expanding the take rate and further powering the Merchant Flywheel (GMV reaches $737B, Merchant Solutions grows to $21 billion),” he said.
12/4 – Cleveland Research Initiated Shopify with a Buy. The analyst expects Subscription Solutions and Merchant
Solutions to experience growth better than consensus expectations in FY22
12/2 – Susquehanna Initiates Shopify at a Hold stating, “The company’s two revenue units of Subscription Solutions and Merchant Solutions have different revenue drivers and can be compared to (mostly) pure-plays in the market. For each business unit, we use a price-to-sales growth valuation given SHOP's high revenue growth levels vs. peers. We value Subscription Solutions at $200 per share and Merchant Solutions at $750 per share."
12/1 – Credit Suisse Rates Shopify Neutral with $1,100 PT, stating “Our $1,100 target price and Neutral rating for SHOP is based on our DCF analysis and implies a 2021 EV/Revenue multiple of 33x. While we remain positive on SHOP given numerous LT drivers, including: the secular shift to eCommerce, Shopify Plus, International, and adoption of additional merchant services (such as Fulfillment) we see risk reward more balanced at these levels.” 11/19 – Jefferies Upgrades to Buy from Hold stating: "We have a greater appreciation for SHOP's ability to deliver robust growth for the next several years and reach ~$10B of revenue in 2025 powered by a structural pull forward in e-commerce activity and better monetization of gross margin value."
10/30 – Argus Rates Shopify Buy with $1,200 PT stating “Although SHOP has run up sharply year-to-date, the company has a strong runway for growth in the small to mid-sized merchant market, which is only lightly penetrated.”