Shopify potential stock dilution

Employee/exec compensation is one key criterion I use to evaluate potential investments. (For example, LinkedIn grants about 17% of their revenue in stock-based compensation, which increases the risk in investing in them.)

Shopify’s Compensation:
As a new, fast-growing public company, this won’t yield clear metrics right now, but will give a prelim baseline to start evaluating how shareholder-friendly the leaders are going forward.

One ratio I use is the value of stock/option grants in a year over revenue and possibly over net income. If I’m reading their annual report right (http://goo.gl/jxuxwz), SHOP actually didn’t grant options in 2015: “Given the existing equity holdings of our executive team, and taking into consideration the unvested portion and value of outstanding equity awards, no equity award grants were made to our named executive officers in 2015.” So, that’s a plus. A ratio of 0 options over any REV and NI is nice.

SHOP currently has ~$80M of unexercised in-the-money options. That’s a high percentage of their current REV (nearly 40%), but ~3.2% of their current market cap of $2.5B.

Another ratio to consider is executive salaries over revenue and net income. SHOP’s 5 execs currently make $1.25M per year. With REV over $200M, their salaries are about .6% of REV. With negative NI, we can’t calculate a ratio for that yet, but with gross profits of $111M, their salaries are just over 1% of gross profits, which is shareholder-friendly and doesn’t add to the risk of SHOP as an investment.

SHOP has 11M outstanding options, or ~14% of the current 80M public shares. For 2016, SHOP did not limit it’s 5% increase cap to the number of Class A subordinate voting shares available for issuance, so 6.8M more shares are available for stock option issuance in 2016 (8.5% of current outstanding shares). Issuing these shares would have some diluting effect and would give a very high Options/REV ratio, that would suggest some risk worth monitoring. But, SHOP is also growing REV fast, so the REV and NI denominators are increasing significantly, so we don’t have really reliable baselines yet. (Btw, INFN has consistently had very high share dilution due to stock options, which is one risk with them that leads me to limit my investment in INFN).

Other Stock Dilution Risk:
SHOP has authority to issue an “unlimited number” of shares and they anticipate issuing Class A shares “from time to time” “in the future.”

CONCLUSION
It’s too early to tell how shareholder friendly (or unfriendly) SHOP’s execs and directors are, and this is just a starting point, but share dilution for SHOP is not currently a show-stopper for me. 2015, SHOP’s first year as a public company, was a “friendly” year for shareholders from an employee stock option and salary perspective. There is real risk that option grants and additional stock issuances could be used to dilute shares, so this is something to keep an eye on going forward (as with all public companies’ unproven management teams).

I welcome any other thoughts and feedback.

dstw


Glassdoore: Shopify has excellent glassdoor ratings so far: https://www.glassdoor.com/Reviews/Shopify-Reviews-E675933.ht…. (But so does LinkedIn–positive employee reviews don’t always equate to positive shareholder treatment. :/)

Fools coverage page on Shopify: http://www.fool.com/quote/nyse/shopify/shop (select “news” to see recent articles).

Details from SHOP’s annual report:
"Our constating documents permit us to issue an unlimited number of Class A subordinate voting shares and Class B multiple voting shares.
“Our restated articles of incorporation permit us to issue an unlimited number of Class A subordinate voting shares and Class B multiple voting shares. We anticipate that we will, from time to time, issue additional Class A subordinate voting shares in the future. Subject to the requirements of the NYSE and the TSX, we will not be required to obtain the approval of shareholders for the issuance of additional Class A subordinate voting shares. Although the rules of the TSX generally prohibit us from issuing additional Class B multiple voting shares, there may be certain circumstances where additional Class B multiple voting shares may be issued, including upon receiving shareholder approval and pursuant to the exercise of stock options under the Legacy Option Plan that were granted prior to our initial public offering. Any further issuances of Class A subordinate voting shares or Class B multiple voting shares will result in immediate dilution to existing shareholders and may have an adverse effect on the value of their shareholdings. Additionally, any further issuances of Class B multiple voting shares may significantly lessen the combined voting power of our Class A subordinate voting shares due to the 10-to-1 voting ratio between our Class B multiple voting shares and Class A subordinate voting shares.” (Page 36)

"Equity Compensation. As a privately held company for most of our history, we had historically used stock options as the principal component of our executive compensation program. Consistent with our compensation objectives, we believe this approach has allowed us to attract and retain key talent in our industry and aligned our executive team’s focus and contributions with the long-term interests of the company and our shareholders. Typically, stock options granted to our executive officers are subject to time-based vesting at a rate of 25% on the first anniversary of the vesting start date with the remainder vesting in equal installments over the next three years, allowing them to serve as an effective retention tool and to focus the executives on achieving long-term value. We anticipate that future equity grants to
executive officers may include restricted stock units (RSUs) in addition to stock options.
“In determining the size and frequency of executive option awards, our board has customarily considered, among other things, individual negotiations with the executive officers at their time of hire, the executive officer’s total compensation opportunity, the need to create a meaningful opportunity for reward predicated on the creation of long-term shareholder value, the need to attract and retain employees in the absence of a cash bonus program, the Chief Executive Officer’s recommendations, individual accomplishments, adjustments to duties, the executive officer’s existing equity award holdings (including the unvested portion of such awards), and the retention implications of existing grants and our incentive goals.” (Page 54)

Summary Compensation and Options Tables (pp 55-56)
Unexercised in-the-money options: ~$80M

“We did not grant any share-based awards to our named executive officers in 2015.” (pp 55)

Incentive and Stock Option Plans (pp 58-59):
For 2016, our board of directors has not limited the 5% increase to the number of Class A subordinate voting shares available for issuance, in the aggregate, under the Stock Option Plan and the LTIP, so that as of January 1, 2016 there were 6,786,124 Class A subordinate voting shares reserved for issuance, in the aggregate, under the Stock Option Plan and the LTIP.

Table of options outstanding (Page F23)

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Thank you, dstwhit, for a Kevin-level analysis. :wink:

Foolishly,
Jackson

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