- I recommend longing Shopify because the market is undervaluing their product ecosystem. Several lines of business and potential revenue sources have not been priced-in to the stock.
- For example, I predict Shopify could eventually levy an e-commerce fee on merchants, similar to what Amazon.com does. Given that Shop Pay now has 60 million users, there is tremendous upside potential that relatively few institutional and retail investors have recognized.
- Given that SHOP has just surpassed eBay in North American e-commerce market share and merchandise volume, I predict that it will continue to increase its market share to just below Amazon’s current market. There are several reasons for this outlined below.
- Long-only hedge fund activity in SHOP has increased in 2020, suggesting a potential buy-and-hold strategy for SHOP.
Industry & Competitor Overview
- Shopify is in a unique position in the e-commerce space, with most small-to-medium e-commerce retailers choosing Shopify over its competitors.
- Shopify competitors can be broken down into:
- New product lines by big tech companies: Adobe acquired e-commerce technology firm Magento in 2018. Microsoft launched Dynamics 365 in 2019. Longtime partner Facebook introduced Facebook Shops and Instagram Shops in 2020.
- Front-end website builders with e-commerce integrations: Squarespace, Wix, and Weebly are the main ones.
- Direct competitors: BigCommerce, Volusion
- Of the competitors outlined above, I believe one of the few that could tangibly challenge Shopify’s dominance is Squarespace. Squarespace expanded into the e-commerce space earlier than other competitors in this vertical, but Squarespace is currently privately held. SHOP remains the best way to increase portfolio exposure to the e-commerce market.
- Some analysts which have had strong buy recommendations on SHOP have downgraded their ratings, while a few hedge funds have reduced their position somewhat. On the whole, institution investment activity in SHOP is below average.
- This can be put down mostly to tech giants like Facebook and Microsoft entering the e-commerce space. However, Shopify’s domain-specific knowledge will enable them to outcompete most of its competitors, as they are mainly platform-specific with no back-end ecosystem (Facebook & Instagram Shops) or focus on front-end UI without advanced store analytics (Weebly). Of course, this may change in the future, but I predict that SHOP will stay ahead until at least 2023, as they have a significant first-mover advantage over these companies - which are just beginning to build out their product and understand the e-commerce vertical.
- New entrants from other industry verticals, such as the fintech space, are also looking to join the increasingly fragmented market. Payments giant Square has just made a foray into the space with Square Online.
- Most guidance for aspiring entrepreneurs in the e-commerce space is built around learning how to utilize the Shopify platform and ecosystem. There is upside potential built into widely-available knowledge of the Shopify product ecosystem, which the market does not yet understand.
- The Canadian software company helps more than 1 million merchants across 175 countries to sell, market, and manage their products. In return, it earns subscription fees. It also offers shipping, digital payments, and fulfillment. In 2019, subscriptions accounted for 41% of revenue and merchant solutions for 59%.
- Over the past three quarters, Shopify grew earnings at a 552% average, well above the average of 101%. It grew sales by 57% on average over the past three years.
- EV/EBITDA: 2375.08
- The enterprise multiple demonstrates investor confidence and high growth for Shopify in the next 2-3 years.
- The Forward P/E ratio is 326.25 versus the current P/E ratio of 725.45
- This suggests an increase in expected earnings for Q4 and beyond. However, I would take pandemic-era analyst predictions with a grain of salt.
- Hard Catalysts: For Q4 2020, earnings reports are predicted to demonstrate the resilience of Shopify throughout the COVID-19 pandemic, as it has done with previous quarters in 2020.
- Notable achievements from Q1-Q3 2020 that could reflect in Q4 earnings and the fiscal year ahead include:
- Shop Pay Installments, a product that gives customers more payment choice and flexibility at checkout, while helping merchants boost sales through increased cart size.
- The further development of Shopify Fulfillment Network, including software development for the service. Shopify could break even on this $1 billion investment by 2023, analysts say.
- Increased programs for business lending (Shopify Capital) amid the pandemic, and to help merchants mail online orders (Shopify Shipping) with less friction.
- Soft Catalysts:
- Shopify could eventually levy an e-commerce fee on over 60 million merchants.
- Shopify could eventually reach a position where it is used by most independent retailers; in fact, most medium to large independent retailers are using Shopify.
- Facebook and Squarespace outperform Shopify in the small retailer space: Shopify may fail to capture small independent retailers and maintain its level of growth, with new store creations expected to decrease by over 5% in 2021 due to the sustained pandemic. SHOP’s 2020 performance can be classed as a ‘structural win’ over brick-and-mortar retailers and the overall retail trend is almost definitely moving towards e-commerce. Despite that, small retailers may choose to default to competitors like Squarespace and Facebook Shops, which have simpler UIs and less steep learning curves.
- Potential Squarespace IPO in 2021: an IPO of Squarespace would moderate the SHOP stock price in the short-term with investors diversifying their exposure to the e-commerce market.
- Stock may be overvalued due to market price-in of key factors such as product improvements: Shopify’s EV/Sales ratio has been steadily increasing from low double digits in 2018 to 58.62 today, suggesting the stock may be overvalued due to investor overconfidence.
- Volatile business model: While the company gets around 40% of its gross profit from subscriptions and related services, the subscribers at the end of the day are SMB businesses that often sell highly discretionary merchandise and not basic necessities. The sustained pandemic may impact consumer confidence, lower disposable income, and reduce consumer ability to buy discretionary goods from Shopify-hosted retailers. This may lead to a drop in overall subscriptions. The downturn in the SMB space, with no end in sight for the pandemic, might impact the company in terms of fewer subscribers over the medium term and fewer transactions over the near term.
- Insider selling from Q2 2020: this may suggest that insiders think the stock is overpriced and expensive. However, the stock’s performance during the height of the COVID-19 pandemic suggests otherwise.