EUR 850.00 For Business Accounts Only

Morningstar | Shopify Reports Solid 2Q, but Tepid Guidance; Maintaining $150 FVE

Shopify reported a solid second quarter of fiscal 2018, with numbers coming near our expectations. We are maintaining our $150 per share fair value estimate and narrow moat rating. The prevailing news of the quarter was that Shopify would be offering $5 billion in mixed securities over the next 25 months, with management iterating that this is for the ordinary course of business given the pending expiry of the current shelf. We hypothesize that the offering, coupled with the firm’s equity raise last quarter, could result in a large acquisition. On a negative note, the firm failed to raise third-quarter guidance above consensus, and gross merchandise volume growth was muted, but our long-term view remains the same. We posit that what we view as a broader sell-off in various software firms we cover over the past few days affected Shopify. We see shares as modestly undervalued but note that due to our uncertainty rating, shares continue to trade in 3-star territory.

Looking at the quarter, Shopify had notable Shopify Plus (the firm’s enterprise-oriented product) wins, bringing on Reckitt Benckiser, De Beers, and SodaStream. From a product standpoint, Shopify added multilocation inventory tracking, Payments fraud protection, and a partnership with Google and Nest. Of the announcements, however, the area we are focused on is international expansion, with Shopify unveiling native languages and payment methods for additional geographies this quarter. At the end of fiscal 2017, 78% of revenue came from the U.S. and Canada, leaving ample room for expansion overseas.

Financially, Shopify Shipping and Capital, which has higher gross margin relative to the larger Shopify Payments, doubled year over year, and we continue modeling incremental increases in merchant solutions gross margins over our explicit forecast period as these two products expand. In addition, Shopify announced that one third of eligible merchants in the U.S. and Canada are using Shopify Shipping.

On Shopify’s call, questions addressed the impact of Adobe’s acquisition of Magento and the impact of Facebook advertising changes on Shopify’s end merchants. Tobias Lutke, Shopify’s CEO, largely asserted that they don’t foresee much of a change with Adobe owning Magento, but noted that Adobe is a voracious competitor. We see advantages for Adobe emanating from coupling Magento’s e-commerce solutions with its marketing cloud products, which could impede Shopify’s growth prospects. In terms of Facebook, the most interesting part in our view, was management’s response, in which they said that they have considered making a proprietary, centralized marketplace for sellers, but it isn’t one of their near-term goals. A centralized Shopify marketplace could further take advantage of the platform’s scale and hedge against the risk of any of Shopify’s major partnerships eroding. We iterate, however, that any changes to Facebook that affect the effectiveness of ads or make it more difficult to target customers could have a negative impact on Shopify.

Shopify’s cash, cash equivalents, and marketable securities for the quarter sit at $1.57 billion, near an all-time high for the business. Management is increasingly asked about the acquisition strategy, and we posit that the firm may be gearing up for a major purchase as it has tapped the equity market to raise funds in the first quarter. Previous acquisitions, such as Oberlo, Boltmade, and Kit CRM have all been on the smaller side, serving as tack-on offerings to augment products. We would not be surprised if Shopify sought to acquire BigCommerce, WooCommerce, or even Wix, to add scale and gain share.

We theorize that Shopify is falling today because of possibly more muted guidance for the third quarter than what the market was expecting. Shopify has developed a reputation for aggressive guidance raises over time, but third-quarter guidance remained near consensus. We think these factors, coupled with the SMB focus, where Shopify’s end merchants are more susceptible to churn than an enterprise-oriented peer, support our very high uncertainty rating for the firm. We assert that this is likely compounded by a slowdown in gross merchandise volume year over year compared with the past several quarters. We have maintained our fair value estimate at $150 per share as we believe our long-term thesis is intact.