Among a sea of awesome cheap opportunities now available, Shopify remains unjustifiably highly overvalued, with a business model that is about to start unraveling. Shopify has pulled its full-year guidance and is best avoided for now. Here’s why:
Global Downturn Is Bearing Huge Risks for Shopify
While the economy was growing, investors were delighted with Shopify’s share price steadily rising week after week, and unwilling to ask difficult questions about their investment.
Presently, a very different situation has presented itself and Shopify’s share price is rapidly declining. Investors are now asking whether Shopify is as rewarding an investment as they believed. Does Shopify make for a safe investment in this turbulent market? On both counts, I argue that it does not.
Dissecting Shopify's Business Model
Shopify’s GAAP unprofitable business has two revenue streams: Subscription solutions and Merchant solutions.
Its Subscription solutions, as the name entails, is a recurring revenue stream and the aspect investors crave. Shopify mostly focuses on selling to small and medium-sized businesses (SMBs), and startups. Furthermore, Shopify’s subscription plans typically have a one-month term and cost less than $50 per month.
This revenue stream is highly attractive - with steady and predictable revenue. Also, it has gross profit margins of close to 80%. Essentially, this revenue stream is the crown jewel of Shopify and wherein the bullish thesis is built. However, this revenue stream only accounts for a third of Shopify's total revenue.
The bulk of Shopify’s revenue, at approximately 65% of total revenue, is made up from its Merchant solutions. This is a value-added service for merchants and includes accepting payments, shipping and fulfillment.
The problem for Shopify is two-fold. Merchant solutionshas much lower gross profit margins of just 63%, but critically its growth is proportional to the overall volume on the platform.
Furthermore, Shopify’s sales volume increases predominantly with the addition of new merchants signing up to the platform, rather than from existing merchants, which are mostly small businesses.
Consequently, for the business model to succeed, Shopify needs new merchants to sign onto the platform continuously. But this will ultimately increase the competition among the small-sized merchants, with merchants having to substantially discount their prices to gain sales.
However, if the economy contracts meaningfully, the number of new merchants signing up to sell on Shopify likely would substantially be reduced..
Valuation - No Margin of Safety, Guidance Pulled
Investors had been content to pay more than 25 times trailing sales for Shopify under the premise that its business model had tremendous operating leverage and was able to continuously rise with the addition of new merchants.
Specifically, investors were paying a huge multiple for Shopify’s ability to rapidly grow and have strong visible and predictable revenue growth. But now that economy will contract, Shopify has pulled its guidance as it believes that its ability to reach its guidance set out at the start of the year is too uncertain.
Indeed, it now appears that its steady and growing revenue is not as predictable as many were led to believe. In a time of market meltdowns, Shopify remains vastly overpriced and doesn’t offer investors the predictability they were pricing in.
The Bottom Line
Investors were willing to pay a large multiple for Shopify under the assumption that Shopify’s recurring revenue stream implied that its merchants were locked-in, but upon further analysis this doesn't appear to be the case.
As the economy will hit hard times, many merchants that would have adopted Shopify's platform will seek out less risky ventures, which will significantly impact Shopify’s rapid revenue growth.
Avoid this stock.