Talking Stocks: Shopify Inc.
Updated: Feb 8, 2020
With the advent of online businesses growing each year, the demand for internet e-commerce systems grows simultaneously...and who benefits from this?
Although a relatively new business, Shopify Inc. becomes an extremely attractive purchase once analysis begins to factor in several key components: including their unparalleled potential for growth and recent acquisitions. Many of the largest equity research companies and asset managers have recommended this stock, so without further ado, let’s dig into why.
1. Growing Financials:
In a world where most tech-related companies consistently drown in debt, Shopify descends upon this trend and carries no debt whatsoever. This provides a much more attractive balance sheet to investors, one that proves the competency of management and the lack of cash burn within this company: both being significant plus points.
Additionally, we’re seeing a consistent growth in earnings instead of rapid increases one year and then ridiculous deteriorations in another (usually an indicator of overvaluation): yet another depiction of the financial stability of this business.
Figure 1: Growth in Merchants (Businesses that use Shopify's services)
While the level of growth depicted above is already impressive, the story gets even better as Shopify’s conference call stated that they now serve over 1 million merchants as of Q3 2019: indicating an even further 25% growth from the 800K in 2018.
Because Shopify’s business model includes a subscription fee and a cut of each transaction, higher merchant subscribers directly translates to even greater revenues for this e-commerce company. Surprisingly, despite relatively steep conditions on their services (subscription fees and takings from each payment), customer/merchant statistics are still continuously growing and therefore articulates that the value provided by Shopify services far exceeds the fees and payments charged.
But…when do we expect a problem?
Like all businesses, there are some key areas that should be watched in order to avoid turning these merits into drawbacks:
Key Point: Security. With hacks and breaches becoming almost a daily routine nowadays, Shopify need to be ensuring that their service system is acutely protected. Many financial researchers (especially Seeking Alpha and The Motley Fool) have emphasized the importance of this, as a single breach could facilitate tens of thousands of merchants to move their services elsewhere.
This would translate to millions in lost revenue: a consequence that Shopify cannot afford if they aim to retain their impressive financials.
2. Expansion of Services and Potential for Growth
The growth in consumer base previously described is significant because it implies two things: a) the level of loyalty Shopify customers sustain, and b) Shopify's ability to be the one-stop-shop for consumer needs. The number of online businesses nowadays is almost surreal, but it’s no surprise that these ambitious companies will still have to suffer the growing pains of tech improvements, website building, as well as a lack of capital.
This is where the pervasiveness of Shopify’s arsenal comes into play, as the business have expanded to provide web services, SEO advice and even their own business loan platform, Shopify Capital. The fact that merchants can now receive all they need to operate their online store from one provider maximizes their convenience, and therefore strongly suggests that their loyalty will remain steady. Until now, no online merchant has thought to provide almost all services required under one roof, and this "one-stop-shop" notion is what makes Shopify Inc. a unique business and therefore propels it towards greater potential growth.
Additionally, the fact that Shopify offers all these services (and merchants actually use them) is even more beneficial because it exponentially drives up the switching costs for the merchant/consumer. Consider the level of time, effort, and money it would cost to change contracts, subscriptions, payment software, loan terms and web partners if a Shopify merchant wanted to switch platforms: it would be unimaginable bureaucracy that no time-sensitive business would want to endure. Hence, providing a one-stop-shop for all necessary services has an even greater advantage to Shopify as it directly facilitates both more revenue and the retention of customers.
3. Shopify’s Acquisitions:
As the company grows larger, Shopify has begun acquiring smaller businesses in the sectors that they aim to penetrate. For example, the merchant-based business bought 6 River Systems for over $450 million: a firm that specializes in e-commerce and logistics. This is reflective of Shopify’s move towards shipping and commercial transactions, both of which will give Small to Medium Enterprises (SME) a feasible alternative to Amazon and co. when it comes to the e-commerce sector.
What makes this a smart move is that Shopify are not setting up their own logistics counterpart: they’re buying a business that’s already experienced in that sector and they’re doing so without debt capital. This means that a) Shopify won’t have to spend time and resources recruiting new teams, managers and executives because they will already attain them, and b) they are not bringing upon any new liabilities despite growing their business.
Both of these assertions substantially cut out any wasted time and resources, and also allows Shopify to retain the positive balance sheet that put their business on the map. If these strategies are upheld, SME's will have a potentially cheaper shipping alternative to Amazon, which is likely to bring down business costs and hence increase demand for Shopify's new service. In the long term, it seems as though Spotify will stay on the correct trajectory towards business and stock price growth if such acquisitions are succeessful in providing the expected synergies.
Shopify have consistently been growing their earnings whilst simultaneously limiting any debt spending. This is quite rare for a new business within the tech/commerce sector, and is evidenced in the strength of the company’s balance sheet. Merchant user growth has also been steadily escalating, with over 1 million paying subscribers as of Q3 2019.
The company has identified gaps in the SME market and focused on filling them through providing multiple solutions from their platform: including shipping, web development, and logistics analysis. This allows online business owners to attain all required services from one provider itself, thus creating strong corporate relationships, loyalty, as well as high switching costs for the merchants.
While we're seeing Spotify enhance from the inside, external growth is also apparent here. The company has acquired multiple smaller firms, the most recent being 6 River Systems: done in order to give themselves more ground in the logistics and ecommerce sector. Instead of setting up new divisions themselves, they are buying experienced companies: and although they will have to pay a premium, the time and resources saved along with the potential synergies outweighs the cost.
All in all, it seems as though Spotify are on the optimal path towards augmented growth in both operations and share prices. As long as they consistently retain high security and protect client information, current stakeholders are likely to sustain their interest in Shopify Inc.
Macro Perspective: While this firm’s fundamentals do depict an attractive purchase, stocks are nearing all-time highs at the moment, in which case it’s perhaps more effective to wait until a drop in prices later on. Additionally, based on macroeconomic sentiments, the US-China trade deal still holds doubts and therefore implies that markets will be slightly unstable at the moment. Hence, investors may gain the highest yield from waiting with cash in hand until opportunities arise to pick up this great stock at a lower price.