Bear's Shopify SepQ Review

Great points re: leverage Tinker.

Points regarding merchants:

In the CC they made a point to mention that the partner/affiliate program was in 3rd place behind advertising (2nd) and organic (1st) in bringing in new merchants.

GMV grew 69% yoy. 6.4 billion dollars flowing through Shopify’s merchants. Doesn’t look like fake online stores does it Mr.left?

The fact that such big names such as Budweiser, Tesla, Redbull, are still using SHOPIFY is a big green flag for me. This means that the off-the-shelf solution that shopify is supplying is still providing good value for money for the big corporations, not just allowing the little guys in onto a level playing field. This makes it highly unlikely for the small/medium businesses to jump ship once they become successful or scale up.

Now I agree, if Tobi releases some sort of information telling us the exact merchant churn and its make up that would be fantastic. For example, if he said retention rate of all merchants making a profit is 100%, then amazing. He recognises that a lot will fail and drop out and SHOPIFY will lose $26 a month from them (whoopee). He’s laser-focused on making shops succeed, and then they succeed, GMV goes up. When GMV goes up, SHOP succeeds.

Don’t you think drop-shipping business will increase with the rise in v-bloggers and other social media platforms? I’m not basing my investment in SHOP in this, but I think it’s true. The amount of people using youtube, twitch, Instagram to show-off their lives or products they use to their hundred of thousands or millions of followers is rising. With a click of a button their fans can buy something.

Anyways, they mentioned they probably won’t get back into profit again soon and are fully concentrated on growth. Whether or not they show a profit in adjusted EPS, I don’t know, but with SBC causing the positive EPS this quarter, I don’t think it actually meant anything.

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I have not even finished reading through the earnings call, so I am to going to comment on the substance of this question, but this is to me the largest question for me. Just how valuable are all these new merchants coming in vs. cost of retaining them, and what is the reason that leverage does not appear to be showing up? Is it just hidden in the numbers, or is it just not there?

Tinker,

I look at it like this: SHOP’s top two channels for acquiring new customers are self-onboarding (customers just show up) and SEO. The third highest channel is referrals through their partner network. SEO costs marketing dollars but the other two are free or close to free.

I’m not worried about their marketing spend because they are and will continue get leverage. Here are the gross margins for their subscription and merchant businesses:


	Subscription Revenue in $000							
	        2012	2013	2014	2015	2016	Q1 2017	Q2 2017	Q3 2017
Revenue	        19200	38339	66668	111979	188606	62080	71598	82435
Cost of Rev	 4291	8504	16790	24531	39478	12254	13688	15458
Gross Profit	14909	29835	49878	87448	149128	49826	57910	66977
GM	        78%	78%	75%	78%	79%	80%	81%	81%

	Merchant Revenue in $000							
	        2012	2013	2014	2015	2016	Q1 2017	Q2 2017	Q3 2017
Revenue	        4513	11913	38350	93254	200724	65299	80057	89021
Cost of Rev	 485	5009	26433	69631	140357	42884	51127	55971
Gross Profit	4028	6904	11917	23623	60367	22415	28930	33050
GM	        89%	58%	31%	25%	30%	34%	36%	37%

Here is their 50% of their GMV is now from Shopify Plus merchants; these are merchants who are larger and less likely to churn or go out of business. For revenue GMV to keep growing SHOP needs the success of their customers who don’t leave plus their newly acquired customers to contribute more to revenue than those who are leaving. We already know that their NET new customers has been rising by a lot because they have provided total merchants as opposed to new merchants. Here are the numbers that they reported for previous quarters:


       Total merchants greater than:
Q116   275000
Q216   300000
Q316   325000
Q416   377500
Q117   400000
Q217   500000

SHOP stopped reporting total merchants in Q3 2017, but they did say the following on the conference call:

We grew revenue 72% year-over-year to $171.5 million both revenue lines contributing to this rapid expansion. Subscription solutions revenue grew 65% to $82.4 million; the underlying monthly recurring revenue also grew 65% and ended the quarter at $26.8 million. The slight acceleration over last quarter is due primarily to another record number of merchants paying to run their business on the Shopify platform.

I assume that Russ Jones meant that total merchants increase to a record level, although he could have also meant that Q3 2017 had the largest increase in total merchants ever. I’d like them to clarify, but at minimum the total merchant count is increasing so those joining outpaces those leaving. Also, those merchants who remain are successful enough to remain so we can assume that their business are growing their revenue which means SHOP makes more money from them also. Also, SHOP is putting in a substantial effort in getting Shopify Plus merchants signed up; Shopify Plus merchants will be companies that have larger revenue and are much, much less subject to going out of business.

With all that said, we can just look at the overall performance to get a pretty good picture of what is happening. Revenue growth is hardly slowing at all; it was 75.2% in Q2 (y/y) and 72.1% in Q3 (y/y). And in spite of this continued growth margins are continuing to expand. All seems good to me.

Chris

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Bear:

How will Shopify become (highly) profitable? You mentioned that the expense is a smaller % of the total revenue but the expenses are higher than the TTM quarter.

How do you interpret that? they need to spend more to capture more customers but at one point this expenditure should level off but they still would capture more customers or continue to increase their revenue from them.
What other expenditures are they spending on? and will these increase as they grow? what is the model here?
how are they investing for future growth?

tj

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What matters to me is the cash flow a company produces, not necessarily earnings. One only has to look at Amazon as an example.

Amazon has a TTM cash flow from operations of 17 billion. Who cares if they show earnings or not. They are taking all of their profit and putting it back into the business to grow and expand. That is what I want them to do, it is their best use of cash, and no taxes.

The same with Shop. I want management to deploy its capital for the best return possible. They are taking all of their resources and putting it into growing the business, which is exactly what they should do. I would like to see them start improving cash flow though so they can fuel their business from cash flow and not new shares.

Jimbo

GauchoChris:

“I look at it like this: SHOP’s top two channels for acquiring new customers are self-onboarding (customers just show up) and SEO. The third highest channel is referrals through their partner network. SEO costs marketing dollars but the other two are free or close to free.”

isn’t SEO a ‘development cost’?

aren’t they paying for referrals?

so only self boarding is really ‘free’?

tj

What matters to me is the cash flow a company produces, not necessarily earnings. One only has to look at Amazon as an example. - Jimbo

You won’t get an argument from me on that point. I’ve used the term “unencumbered cash flow” to describe the cash generated by a business that can then be used as management chooses (I’ve been accused of not using proper “GAAP Speak”). Regardless, it may be held as cash on the balance sheet, distributed as dividends, used to buy back shares or used to invest in the business itself. I pay attention to how free cash is deployed, and while I prefer stock buybacks, dividends and wise capex, there’s lotsa room for debate. Amazon has been used as the poster child for cash flow being plowed into a business to fuel further growth. What gets lost sometimes in the discussion/comparisons is the fact that Jeff Bezos focused on capex. That is, he purchased/built tangible assets: fulfillment centers, data centers, trucks, planes, food store chain, etc., etc. He did not spend all that cash as opex (operating expenses such as marketing). It’s an important distinction. Please note: Amazon sports a price to cash flow of 28.36. Amazon’s net operating cash flow is $16.74 B.

Salesforce.com (CRM) is another company that showed little/no profit for many years running as it worked its way into the very structure of the world’s largest corporations. CRM’s price/cash flow is $27.35, and its net operating cash flow is $2.42 B.

Now, here’s SHOP: It sports a price/cash flow of a whopping 3,044.34! It’s net operating cash flow is a NEGATIVE $5.10 M. Yeppers, cash flow is important and it’s important to note when cash flow is negative.

(Note: the data came from Seeking Alpha)

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The slight acceleration over last quarter is due primarily to another record number of merchants paying to run their business on the Shopify platform. I assume that Russ Jones meant that total merchants increase to a record level, although he could have also meant that Q3 2017 had the largest increase in total merchants ever. I’d like them to clarify…

Chris, Perhaps you missed this in the press release. It was the best interpretation possible:

another record number of merchants joined the platform in the period

Saul

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