Value (and Shopify)

Investment Analysis Clubs Saul’s Investing Discussions
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In investing, it’s important to differentiate between short term expensive and long term expensive. In the short term, Shopify is extremely expensive. PS ratio is 17 and change, the non-gaap PE is off the charts…there’s nothing cheap about this stock. But long term, the picture is completely different.

SHOP’s revenue grew 72% last Q. If it can average even 45% for the next 5 years, they’ll have something like 4 or 5 billion in annual revenue. Assuming even a 20% margin, and a PE around 30 or 35 (which is pretty low for a company growing that fast), Shopify could be on the verge of looking like a $30B company. If:

  1. they grow faster
  2. the margin ends up being much higher than 20% (as I could easily imagine for any SaaS company)
  3. the PE ends up being much higher than 30 or 35

…then the estimates only go up significantly from there.

So if it’s that easy (I use that word somewhat sarcastically – the fine people at Shopify are surely working their butts off…nothing is truly easy) for Shopify to triple in 5 years, are they really expensive right now? Not in the long run.

There are two key lessons from this:

  1. We need to find companies that are likely to continue their expansion. If Shopify suddenly started growing at only 10% or even 20%, all bets are off. (not just revenue growth either – they have to be able to scale / leverage)

  2. We really might be seeing a kind of revolution – it is so hard to value companies like this (it’s impossible with traditional methods), that a lot of opportunity remains out there.

Just some Saturday meandering thoughts. Have a good weekend.

Bear

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Since I posed that We need to find companies that are likely to continue their expansion, it makes sense for me to say why this might be the case with Shopify.

Shopify is at the center of several great trends - growth in online merchants, brick and mortar business who want to create a presence online, online payments, increase in last-mile shipping as more goods are purchased online, very targeted loans with data and mechanisms for repayment, and I’m sure more stuff than I even know about.

There’s a little company out of Seattle I could compare them to for their ability to expand into new lines of business. What will be Shopify’s AWS? Who knows. And I’m not saying it will be as big or anything. But they aren’t done innovating yet.

But the #1 factor that keeps Shopify growing at an incredible rate is the virtuous cycle effect: when their customers do well, they do well. Shopify gets a tiny % of every sale on their platform. And not only is the platform growing like mad, but their customers sell more and more online. In fact, more stuff is sold online in general every year. This is a very, very powerful trend to be a part of.

Bear

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“SHOP’s revenue grew 72% last Q. If it can average even 45% for the next 5 years, they’ll have something like 4 or 5 billion in annual revenue. Assuming even a 20% margin, and a PE around 30 or 35 (which is pretty low for a company growing that fast), Shopify could be on the verge of looking like a $30B company. If:”

This just scares me. I remember during the Internet Bubble period we would discuss things like this going out 5 year growth. When the incidences of companies growing at a 5 year 45% CAGR at any scale were almost non-existent.

But I do understand your point. And frankly, for a long-term investment, you do not need the company to sustain that level of growth. What you need is for the company to sustain its CAP (market dominance), maintain a decent growth rate, and still have a very large SAM to grow into (and always growing the serviceable addressable market.

The market rewards dominant company with long-term growth runways with high multiples even if growth slows, as long as reasonable growth and market dominance remains.

Microsoft and Cisco may be two examples of very rare companies who might have done such growth when their businesses were at scale. But it is a very rare feat to pull off.

Tinker

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Microsoft and Cisco may be two examples of very rare companies who might have done such growth when their businesses were at scale. But it is a very rare feat to pull off.

Hi Tinker, that’s an interesting observation. I’m just wondering whether the modern companies we are discussing may have a better chance of continuing their growth because of the business model. They are, most of them, selling software as a service (SaaS) on a subscription basis, so they have 90% or 95% of their revenue recurrent and guaranteed for next year. When Cisco sold something they had to go out next year and sell another one. And some good SaaS companies have a Dollar-based renewal rate of 125% or so, meaning that they actually get an actual 25% growth “almost” recurring, and thus they only need another 25% of new revenue to bring them to 50% growth. Of course, as they get bigger that 25% growth gets harder to get, and that dollar-based renewal rate may recede back towards maybe 105%, but still… What do you think? (Or anyone who wants to chime in).

Saul

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Just to throw in a bit of different perspective from someone who is an ISV for a company which was one of the early leaders to enabling software providers to move to SaaS …

Transitioning from initial licensing to SaaS tends to imply a short term revenue hit because the initial license sale is now spread over future years. Ultimately, the total revenue return may be greater because the SaaS revenue will exceed the combination of initial license plus maintenance, but there is nothing magical about SaaS in insuring that will happen. Instead, the likelihood is more based on a happier customer who can grow easily by small increments to added capacity, which can be hard to monitor or enforce on an initial license basis.

SaaS is considered a win-win proposition for supplier and consumer in much the same way that PaaS offerings like Amazon AWS are, i.e., turning a large initial purchase price into an on-going expense with easy growth (or reduction, especially seasonally). A SaaS company is likely to have a more even income stream than one doing traditional initial licensing, but they need to keep the customer happy even more since the consequences of switching to another provider are that much less.

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Saul,
You can count me as one of the fortunate Cisco shareholders who got out prior to its crash. Made 14X my money in 3 years, barely.

Anyway, I would ask does CSCO have subscription revenue? Does CSCO have increasing GMV that it gets a cut of? Did any of CSCO’s one time competitors throw in the towel and recommend their clients go to CSCO? But to answer the question: “Can SHOP grow for 5 years at better than 45%?” Revenue growth extrapolates at least that fast. The question in my mind is when and if they can convert revenue into meaningful profit. SHOP is my largest holding so I HOPE this will be the case.

Microsoft had more recurring revenue due to upgrade cycles back in the day, but Microsoft didn’t necessarily benefit when their customer’s business improved.

I am happy to stay the course until I see data otherwise.

Best,

bulwnkl

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I am happy to stay the course until I see data otherwise.

That’s pretty much it in a nutshell. Keep your eye on the ball. There is no company that is destined to be around and continue to grow indefinitely.

100 years is long time in human affairs. Shopify has had a remarkable run so far. They look as if they’re postured to continue to grow rapidly for the foreseeable future. How long is that? For me, after a couple or three years the crystal ball gets awfully cloudy. If I could identify all the potential threats, that would add some clarity, but the uncertainty associated with predicting the future remains irrespective of how much due diligence and mental exercise I apply.

Tom Gardner has a service where everything he buys he holds for a minimum of five years. There was a time, not all that long ago when I would have found that concept appealing. Now, I can’t fathom the idea of buying a company and just going away for five years. Due diligence does not end with the buy decision, that’s just the beginning.

Saul (and I, and I imagine quite a few others who follow here) never looks back at stock he’s sold. Why not? Lack of curiosity about what might have happened if he had kept the stock? Well, I can’t speak for Saul, but I imagine that’s part of it. But probably more significantly, it’s a matter of time. Keeping up to date on one’s holdings is time consuming. Keeping up to date on everything one may have held at one time is time wasting. As one ages, one becomes increasingly aware that there is less time available and what’s left, moves on more quickly. When you’re ten years old, a year is a long time, a tenth of your total life. When your 70, that years has dwindled to a seventieth of your total life. It rushes by pretty quickly.

I buy and hold stock as long as I think the company will continue to prosper. When I see signs that the prosperity is on the wane, I get out. Is that a year? Five years? The answer is maybe. Have I made mistakes in selling “too soon?” I’m sure I have. So what? I’ve made buying mistakes as well. I’ve held some companies for only a few months - new information (to me, it may have been there all along) came to light and as a result I choose to head for the exit.

I think that’s “modified buy and hold” as Saul puts it, kind of. I never buy a company (anymore) with the foregone conclusion that I will hold it for given amount of time. I sell for four reasons: 1) I made a mistake when I bought, 2) The story changed, 3) I see a better opportunity elsewhere, or 4) I need some money. I hold stock in each company I’ve chosen to invest in until I sell it.

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Tinker: Microsoft and Cisco may be two examples of very rare companies who might have done such growth when their businesses were at scale. But it is a very rare feat to pull off.

Saul: Hi Tinker, that’s an interesting observation. I’m just wondering whether the modern companies we are discussing may have a better chance of continuing their growth because of the business model. They are, most of them, selling software as a service (SaaS) on a subscription basis, so they have 90% or 95% of their revenue recurrent and guaranteed for next year. When Cisco sold something they had to go out next year and sell another one. And some good SaaS companies have a Dollar-based renewal rate of 125% or so, meaning that they actually get an actual 25% growth “almost” recurring, and thus they only need another 25% of new revenue to bring them to 50% growth. Of course, as they get bigger that 25% growth gets harder to get, and that dollar-based renewal rate may recede back towards maybe 105%, but still… What do you think? (Or anyone who wants to chime in).

Saul,

As you might imagine, I very much agree with this. It’s a great summary of the advantages of a subscription business and I will refer back to it often.

Another way to put it is that the money they spend on Opex (S&M especially) is a one time expense for an indefinite amount of revenue not the same quarter, but for an indefinite amount of quarters into the future. Where as a non-subscription company has to spend more each quarter in hopes to have more revenue than the last quarter, a subscription company’s S&M spend is totally in pursuit of additional revenue. Basically they are starting at 100% of the previous quarter’s revenue (or possibly more if they have deferred revenue!) before they begin.

Here’s how I visualize what this does to the Income Statement. The gross margin is the mathematical limit of profitability. As in mathematics, you never reach the limit, you only approach it. The gross margin in these companies is usually anywhere from 60 - 80%, so we’re really talking huge potential. Because eventually OpEx eventually becomes a smaller and smaller percentage of revenue, operating profits grow toward the gross margin limit. Again, they never actually reach 60% or 80% operating margin, but they should continually increase toward that over time. That’s why I’m so excited about the business model.

Adobe is a good current example for a much larger company, and they’re “only” growing revenue about 25%. Check out the operating income growth, though!

2013: 413M (10% of revenue)
2014: 903M
2015: 1494M
2016: 2168M (30% of revenue)

Now that’s just incredible improvement in 3 years. And that kind of blast of profit potential should be in the future for companies like Shopify. My case in the first post of this thread was intentionally understated, because I do think their operating margin might very easily be more like 30%+ in 5 years. So even if they average less that 45% revenue growth (even though I see that as achievable as well), they just have so many ways to win.

The interesting thing is that other companies have even higher gross margin than Shopify (Wix and Hubspot have gross margins over 80%). Think about the potential there!

Bear

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Saul (and I, and I imagine quite a few others who follow here) never looks back at stock he’s sold. Why not? Lack of curiosity about what might have happened if he had kept the stock? Well, I can’t speak for Saul, but I imagine that’s part of it. But probably more significantly, it’s a matter of time. Keeping up to date on one’s holdings is time consuming. Keeping up to date on everything one may have held at one time is time wasting. As one ages, one becomes increasingly aware that there is less time available and what’s left, moves on more quickly. When you’re ten years old, a year is a long time, a tenth of your total life. When your 70, that years has dwindled to a seventieth of your total life. It rushes by pretty quickly.. --Brittlerock

Well said. The Fool advocates the study of sold stocks as a way to learn from one’s mistakes (if there were any). Of course the catch is if the lesson is actually worth the time spent, which is likely to be immense.

Many of us have decided that it is not.

Jeb
Long SHOP
Explorer Supernaut
You can see all my holdings here: http://my.fool.com/profile/TMFJebbo/info.aspx

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This just scares me. I remember during the Internet Bubble period we would discuss things like this going out 5 year growth. When the incidences of companies growing at a 5 year 45% CAGR at any scale were almost non-existent.

To be fair though during the dot com bubble companies were valued at a P/S of 200 (and more!) based on the expectation of a 50% growth 5 years in a row. SHOPs P/S of 17 seems pretty cautios compared to that.

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