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Shopify (SHOP) Stock | NYSE: SHOP | TSX: SHOP.TO

E-Commerce Excellence

Shopify offers an e-commerce platform primarily to small- and mid-sized businesses. The firm has two segments: subscription solutions and merchant solutions. The subscription solutions segment allows Shopify merchants to conduct e-commerce on a variety of platforms, including a Shopify-hosted website, physical stores, pop-up stores, kiosks, and social networks.

Shopify powers e-commerce. Its mission is to democratize e-commerce and make omnichannel business accessible for all, regardless of size or geographical location.

Growth

100

Valuation

0

Quality

90
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Where Are We Now

Updated on: 11/13/2021

Conviction Score

8

Shopify is a beast of a company with a share price that has undoubtedly followed suit. Insane or not, the growth opportunity is still massive today. However, the company’s valuation is at nosebleed levels. While we think Shopify is an incredible founder-led growth story, we are cautious with the valuation as the stock hits new all-time highs.

  • Subscription solutions and merchant solutions are both growing like weeds and contributing to overall growth around 50% versus last year. Similarly, gross merchandise volume and gross payments volume grew at 35% and 45%, respectively, since last year.

  • New products, new revenue. Shopify launched a bunch of new services and partnerships, including Shopify Markets, Shopify Balance, TikTok Shopping, Shopify Fulfillment Network, among many others. There are almost too many to list.

Investment Thesis

  1. Shopify has built the online platform for businesses small and large to facilitate e-commerce. There are tools, services, and a third party marketplace for merchants to thrive with its online store.

  2. Shopify has been an explosive growth story with no signs of slowing with the rise of e-commerce penetration globally.

  3. To expand on its online payment network even further, Shopify introduced an ad-on called Shop Pay. It will continue to exercise optionality by providing e-commerce solutions to applications to facilitate shopping on-app through Shops.

  4. The business trades at extremely expensive valuation multiples and multiple compression is a risk to returns moving forward.

  5. Shopify’s founder-led growth story brings significant upside as it expands its already enormous total addressable market.

The Basics

Shopify is becoming the centerpiece of building e-commerce all around the world. Its broad business model allows it to provide services to any kind of business — local shops, mid-sized regional players, and even large corporations.

The company’s revenue profile is broken down into two main segments:

  • Subscription Solutions

  • Merchant Solutions

Subscription solutions revenues are made up of fees related to Shopify’s online store plans. Business owners have the option to choose from four plans, varying in features and price, to suit their specific needs. Each plan has a monthly fee attached to it, contrary to other "freemium" offerings in the market.

Merchant solution revenues stem from three main sources:

  • transaction fees from sites

  • shipping and financing services

  • point-of-sale ("POS") hardware

For every purchase on a Shopify-hosted site, the company takes a small percentage.

For shipping and financing services, Shopify provides services for business owners to ship their products to customers.

Along with supporting businesses online, Shopify also provides hardware-based solutions with POS devices to conduct business in person.

Shopify Revenue by Segment (Q3 2021)

Source: Shopify Investor Relations

Payments

Shopify boasts a robust payments network within its ecosystem.

For online stores, owners have the option to use Shopify Payments as a payment network. Using the company’s software gives businesses the ability to pay no extra charges; they are only required to pay the transaction fee attached with their subscription plan.

Shopify Payments Infographic

If a business decides to use another payment network, such as PayPal, users are required to pay anywhere from 0.5%-2% depending on their subscription plan. As a bonus, users have an interactive dashboard through Shopify Payments to track their transactions along with total sales.

Stripe powers Shopify's in-house payments processing service.

Perhaps it speaks to how great Stripe is. Perhaps there is an opportunity to expand margins if Shopify builds the solution in-house.

Shopify's Payment DashboardSource: Shopify Investor Relations

To expand on its online payment network even further, Shopify introduced an ad-on called Shop Pay. This software is intended to make checkout fast and secure for the consumer, only using an email address.

Shopify recently partnered with Facebook to create Facebook Shops. It is a tool that users can use on Facebook and Instagram to open online shops through social media, while checking out through Shop Pay. This partnership was intended to help the company to expand its outreach even further and allow any business to access commerce, regardless of platform.

Shopify Pay systemSource: Shopify.com
Shopify x Facebook GraphicSource: Shopify.com

This strategy of encouraging the use of Shopify Payments and Shop Pay allows Shopify to expand its reach and explore optionality as it introduces new services and onboards new customers with many different needs. The logic is: if business owners are more familiar with the brand, they are more inclined to use Shopify products in the future through its ecosystem.

Shopify Revenue ($M) (Q3 2021)

Starting with Snowboards

Before Shopify began its reign as the e-commerce king, the company started by first selling snowboards.

In 2006, two Canadians, Tobias Lütke and Scott Lake, wanted to sell snowboarding equipment online, so they opened an online store called Snowdevil. However, Lütke did not like the functionality of the existing e-commerce platform the store was built on at the time. He wanted more versatility. With his programming knowledge, he re-created his own e-commerce platform and re-built Snowdevil’s online store. A few months later, the duo launched the e-commerce platform under the name Jaded Pixel in June 2006. This site went on to become the now-known multi-billion-dollar company, Shopify.

Over some time, Shopify introduced more and more features to its online stores, while gaining more traction in the e-commerce industry.

2010: Store owners could now use an iOS application to track and manage their store

2013: Introduction to Shopify Payments, allowing merchants to accept credit cards on their online store. In addition, POS hardware was introduced to in-person stores to allow businesses to accept both debit and credit cards.

2014: Reached a milestone of 120,000 online retailers

2015: Went public on both the New York Stock Exchange and Toronto Stock Exchange, under ticker SHOP and SHOP.TO, respectively

2017: Partnership with Amazon to allow merchants to sell products on Amazon through Shopify Stores

2019: Opened a Fulfilment Network to sort out logistics and shipping services for online merchants to use

Competitive Advantages

Product Stickiness

Shopify is widely considered the holy grail of do-it-yourself ("DIY") e-commerce services for businesses of any size. No coding or website-building experience is required to put together a highly aesthetic and functional website.

While Shopify is not the easiest to use nor does it offer a free version (besides the 14-day free trial), it ranks as #1 according to users. Shopify's main competitors, Wix and Squarespace, provide easy-to-use services and perform exceptionally well.

Shopify's pricing tiersSource: shopify.com

However, they are not quite as powerful as Shopify. Shopify is an e-commerce-first website host with plenty of shopping experience enhancing apps, third-party connections, and solid customer support. The platform is harder to learn and use, but once learned, it performs better for businesses looking to scale or already scaling. As many businesses look to scale in size, Shopify is an intuitive platform to scale with.

Wix and Squarespace can be considered "introductory" products for these types of scaling businesses. But, they work great for their specific niches — micro- to small-sized businesses and freelancers like Wix, and artists, creatives, and photographers generally go with Squarespace.

Shopify wins in the market for its powerful resources, connectivity, and support. The three price tiers presented above provide access to the foundational aspects of a website — the website, blog, support, shipping and payments capabilities, and basic POS services, among others. Above this, additional features and apps to enhance a website and tailor it to a business's specific needs are added costs.

Business owners can generate invoices and refund policies, ship through Shopify’s shipping service, and even create company logos, all from one place. Having a platform to access all your needs as a business owner is crucial. Shopify’s ability to capture mind share from new entrepreneurs trying open up a business is what allows them to perform so well.

At first glance, this may seem somewhat "predatory". However, these apps and features increase stickiness. For an affordable price, businesses can design their websites exactly how they want them to improve the customer experience and increase sales.

The company’s monthly recurring revenue ("MRR") growth in the subscription solution segment is driven by increasing numbers of active merchants on the platform. As more businesses use Shopify, total recurring revenue increases. It has been evident Shopify is executing extremely well.

Since no other website host performs to this standard, and Shopify takes time to learn, we believe the Shopify business boasts high barriers to entry by focusing all investment dollars on being an e-commerce-first platform that customers love, and customers face high switching costs in terms of time and cost. It is no surprise that Shopify is the leading platform for e-commerce.

Shopify's Monthly Recurring Revenue Growth in a chartSource: Shopify Investor Relations
Shopify's Subscription Revenue Growth in a graphSource: Shopify Investor Relations

E-Commerce Usage Distribution on the Entire Internet

Source: trends.builtwith.com

Financial Scalability

Shopify's platform and exceptional e-commerce capabilities cost large sums of money that translate into low profits, for now. However, the company has shown tremendous operating leverage with its three main expense line items:

  • sales & marketing ("S&M")

  • research & development ("R&D")

  • general & administrative ("G&A")

As the company grows, matures, and secures its place in the market, expenses in these discretionary areas decline as a percentage of revenue. Shopify has built a highly scalable product that can be iterated over and over again, regardless of how many customers sign up.

Additionally, Shopify has minimal capital expenditure requirements. The company is still in growth and spending mode to make sure it stays on top. However, its declining spending requirements as the company grows its top line is impressive and seemingly a sure path to massive profitability down the line.

Shopify Main Operating Expenses % Revenue (Q3 2021)

The Rise of E-Commerce

Tobias Lütke and Scott Lake revolutionized the way entrepreneurs approached online business. Before Shopify, e-commerce was not as popular, and selections were limited. With this software and technology, it is easier than ever to open an online store, gain traction through social media, and make sales.

A large portion of this success was the massive growth in the e-commerce industry over the last decade. In 2021, the total addressable market ("TAM") had reached nearly $153 billion. It will continue to gain more popularity as COVID-19 spurred greater e-commerce penetration as a percentage of total sales, changing the way we view retail and shopping. Consumers can sit in the comfort of their own home and shop for all their needs, with the click of a button.

This influx in traction has given Shopify the edge as many users have shifted to online stores to keep their businesses running amid the pandemic. The company continues to gain e-commerce market share with more merchants constantly joining the most powerful e-commerce platform in the world.

We think Shopify will continue to execute well within this ever-growing TAM with its integrated solutions and customer-centric approach. It is meant to grow with businesses as they scale, and therefore, it will grow with the overall market and gain meaningful share over time.

Share of U.S. Retail E-Commerce Sales 2020 (%)

Source: eMarketer

Seamless POS Technology

Aside from the software that Shopify has built, it also offers POS solutions for physical stores. These devices include iPads and chip readers to help customers with ordering and item checkout.

The POS system is well-integrated within the Shopify ecosystem. All transactions go through Shopify Payments and business owners get the same perks as those with online stores, with transaction history and sales tracking.

This option allows for the ability for businesses to run omni-channel operations. From online stores and warehouses to pop-up shops and standard physical locations, a business on the Shopify network can seamlessly pivot between channels that customers love most on a regional basis.

Think of it this way — not everyone is willing to shop online all the time for all items. Different stores, industries, and regions demand different solutions. Shopify provides the flexibility businesses need to make sure they capture every type of customer.

Risks

Limited Themes

Many Shopify shop owners have brought up the concern that there is very limited creativity when it comes to building online stores. There are a set number of themes users can access to build their site, but after a while, many businesses will start to have similar-looking online stores. For many, brand recognition is vital for a successful online business, and a one-size-fits-all solution may not be the way to go. 

Despite having the ability to add Shopify Plus, the most premier Shopify service, not all business owners can afford the service. With a $153 billion total addressable market in small- to mid-sized businesses, Shopify should be looking for new ways to allow businesses to keep their brands unique and creative.

Competition

Despite Shopify being a leader in this market and dominating market share, there are other competitors that may pose a threat to the company, such as Wix, SquareSpace, and BigCommerce.

With Shopify having a very broad business model, serving all kinds of customers, some competitors cater their services to specific target markets such as small businesses (Wix) or fast-growing businesses (BigCommerce).

This lack of focus could pose a threat to Shopify if they are not able to provide the best services to all segments of their target market accordingly. Shopify should strive to distinguish themselves as the best e-commerce store builder, in order to be appealing to more consumers.

Stripe Payments

Perhaps more opportunity than risk, but with every transaction made, Stripe takes a small portion of the total for allowing Shopify to run on its payment network. As Shopify’s total payment volume continues to grow, that small percentage will make up a larger portion of revenues, which may be troublesome in the future. Shopify should look to creating its own payment network to capitalize on the entire transaction instead of just a portion. Over time, we think this would improve margins and top-line figures.

Pulled-Forward Growth

Investors should be wary of Shopify’s share price growth trajectory thus far. The stock has been on a tear, far outpacing its growth in income. The market is implying that Shopify will continue to grow at such rates, despite having limited insight into what its margins and growth will look like when it reaches a mature, steady state.

The business undoubtedly trades at extremely expensive valuation multiples and multiple compression is a risk to investment returns moving forward.

Bottom Line

Shopify has taken a significant market share in the e-commerce industry by providing small- to mid-sized businesses the tools to create a powerful online presence.

Its two segments — subscription and merchant solutions — allow for strong recurring revenue, diversified revenue streams, and the ability to explore optionality. The entire business model is built around a commerce ecosystem in which its product and service offerings are highly complementary to each other.

This strategy is what keeps attracting business owners to Shopify while keeping churn low.

Shopify's Growth CycleSource: Shopify Investor Relations

The combination of secular growth in e-commerce and Shopify’s execution by a founder-led management team has driven substantial growth. As it focuses on expanding its business, Shopify will continue own a large mindshare in e-commerce. To sustain growth, the company should continue to grow their TAM, flex optionality, and win key partnerships as it continues to reign king as the e-commerce platform of choice.

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