Shopify

Moat: 4/5

Understandability: 3/5

Balance Sheet Health: 5/5

Shopify is a leading e-commerce platform, empowering merchants worldwide with tools to establish and manage their online businesses.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: Shopify provides a comprehensive suite of e-commerce solutions for businesses of all sizes, enabling them to set up, manage, and scale their online operations. The company’s platform includes tools for building websites, managing inventory, processing payments, marketing, and customer engagement. Shopify operates on a subscription-based revenue model, where merchants pay recurring fees to use its services, as well as transaction-based revenue via Shop Pay. In essence, it is a software provider for merchants across the globe.

Revenue Distribution:

  • Subscription Solutions: This includes recurring fees paid by merchants for access to Shopify’s platform and features. As of Q3 2023, subscription revenues accounted for 30% of total revenue.
  • Merchant Solutions: This revenue stream is derived from transaction-based services, such as payment processing fees, shipping label sales, and other auxiliary offerings. Merchant Solutions has become a bigger part of overall revenue making up 70% in Q3 2023.
  • Geographically: Shopify has a diverse global base, with its largest revenues coming from North America, and a strong presence in Europe and Asia.
  • By business size: Shopify focuses mainly on small to mid sized merchants.

Industry Trends:

  • E-commerce Growth: The e-commerce market is still showing strong growth, expected to reach a value of around $7.3 trillion by 2025. A good and healthy tailwind for Shopify.
  • Omnichannel Retail: More businesses are adopting an omnichannel approach, trying to get all their customers engaged through a variety of different channels, rather than just one, so that they dont leave them behind if their preferred shopping method fails.
  • Direct-to-Consumer: The popularity of direct-to-consumer sales has increased a lot over the last 10 years. D2C is a direct-to-consumer business where a company is able to sell its own goods and services directly to the consumer, without the use of an external distribution system. Shopify is uniquely positioned to benefit from this.
  • Growth of Social Commerce: Platforms such as TikTok, Instagram, and Pinterest are emerging as an increasingly important sales channel. This can also benefit Shopify.
  • Increased Competition: A lot of players are seeking a piece of the booming e-commerce industry which can put additional pressure on Shopify.

Competitive Landscape: The e-commerce landscape is diverse, with established players and emerging competitors:

  • Big Tech: Amazon is a competitor to Shopify on both ends. They offer sellers to sell through their marketplaces and also offer companies ways to create their own websites through Amazon Web Services. Amazon is much bigger than Shopify and can rely on their enormous infrastructure and capital to put up competition.

  • E-commerce platforms: Companies like Big Commerce, Wix, and Adobe also offer competitive solutions that will draw in new customers, and take existing ones away. Some are more focused on larger companies while others on smaller ones.

  • Brick and Mortar Retailers: Retailers such as Walmart and Target offer online marketplaces which give sellers the possibility of putting their product online. They have a massive customer-base, and are capable of pushing hard to achieve gains in this space.
  • Other niche players such as Etsy offer some competition, but mainly exist in their own space.

What Makes Shopify Different?

  • Focus on Merchants: Shopify is laser-focused on helping small-to-medium sized businesses. Most of its business is made up of companies which are selling through Shopify’s offerings, and not primarily on its own business.

  • Platform Flexibility: Shopify offers a high degree of customization, making it a flexible option for new and expanding businesses. It has lots of plugins and customizations available.

  • Strong Brand: Shopify is often recommended as a leading solution, and has a lot of mind-share amongst sellers. Its brand attracts new customers.

  • Integrated Ecosystem: The various services that Shopify provides are deeply integrated, reducing friction for merchants and creating a lock-in effect. Shop Pay, in particular, keeps users in the ecosystem as they can make checkouts a breeze.

Financial Overview (Q3 2023):

  • Revenue Growth: In the most recent earnings call, for Q3 2023, revenue grew 25% year-over-year, driven by both subscription and merchant solutions. In 2022 they had 21% revenue growth compared to 2021. Overall growth is very strong.
  • Gross Profit: Gross profit increased 31% in the third quarter of 2023, compared to the same quarter last year. Gross profit was 53.3% in 2022.
  • Operating Income: Their operating loss was significantly lower in Q3 2023 versus Q3 2022, meaning that the company is gaining more efficiency in its operations. They were unprofitable in 2022.
  • Free Cash Flow: Shopify is rapidly improving its cashflow. They had positive free cash flow in 2023, a big improvement over negative free cashflow in 2022.

Detailed Financials

The following sections have been rewritten to make the financial section easier to understand. Let’s analyze Shopify’s financials in more detail:

  • Revenue: Shopify’s revenue is split between two main categories: subscription solutions and merchant solutions. Subscription solutions, which account for about 30% of revenues, includes monthly recurring fees from subscriptions. Revenue growth in this category is usually stable. Merchant solutions accounts for about 70% of revenue and is comprised of transaction-based revenue which is directly correlated to sales on the platform. Overall revenues has grown 25% year-over-year in Q3 2023, and 21% over the whole of 2022.
  • Cost of Revenue: Shopify’s cost of revenue includes cost of goods sold (COGS) related to payment processing, cloud infrastructure costs, and the cost of merchant services. Costs related to the merchant service fees are largely variable with sales on the platform, while costs related to cloud infrastructure is fixed.
  • Gross Profit: The difference between revenue and cost of revenue gives the gross profit. This is a good metric of profitability of its products before adding operating expenses. Gross margins improved from 53.3% to over 56% in the latest quarterly filing of 2023. This shows that they have a significant pricing power over their customers.
  • Operating Expenses: Operating expenses include marketing, research and development (R&D) and general and administrative expenses. These are the expenses incurred to continue to operate the business. Marketing expenses were 20.1% of revenues in Q3, R&D expenses at 20.5% of revenues, and G&A expenses at 13.6% of revenues. G&A and Sales and Marketing are declining as a percentage of revenues while Research and Development has remained fairly constant over the past 2 years.
  • Operating Income/Loss: This is defined as gross profit less operating expenses. It shows what profitability of the underlying business before interest and taxes. Shopify has been improving this metric lately, with a huge jump into positive territory in Q3 2023.
  • Net Income: To get net income, we have to account for financing costs and taxes which Shopify has. After this we see that Shopify is finally showing positive profit numbers, after having made a loss in the year of 2022.
  • Cash Flow:

    • Free Cash Flow: It was significantly negative in 2022, but in 2023 it has had multiple quarters with positive free cash flow. Improving. This is measured as Operating cashflow - Capital expenditure.

    • Operating Cash Flow: A more nuanced metric. Shopify is beginning to show signs of generating a sustainable cash flow from operations.

  • Balance Sheet:
    • Cash & Short-term investments: Shopify has a massive cash pile worth more than 5 billion dollars at the end of Q3 2023. This means they have enough reserves to withstand almost anything and gives them flexibility to be able to invest for the future.
    • Total debt: Is approximately 1.2 billion dollars. They have a very healthy capital structure.
    • Equity: Is more than 15 billion. In total a very healthy balance sheet.

Moat Analysis:

Based on the analysis of Shopify, the company has a solid and a sustainable moat.

  • Network Effects: Shopify benefits from a network effect, as its ecosystem becomes more attractive as more merchants and consumers join. In recent years the company has increased its focus on connecting its users by the introduction of Shop Pay, a service that allows for very seamless checkouts across its platform, further solidifying its network.
  • Switching Costs: Integrating its service deeply into the business of its users, it becomes difficult and costly to change providers, as Shopify’s tools manage a business’s daily operations and it is very disruptive for businesses to change these systems.
  • Intangible Assets: Although Shopify is not a company with a physical presence, it still has a very strong brand name that generates customer loyalty, as well as an ever-improving platform that attracts new businesses.

Moat Rating: 4 / 5

The rating is not a perfect 5, because there are still some competitive threats to Shopify from companies like Amazon that are trying to also compete in the D2C and seller space, as well as emerging new technologies that might allow others to replicate their network. It is still very hard for others to fully replicate Shopify, so it has a relatively strong and enduring moat.

Risks to the Moat and Business Resilience:

  • Intensifying Competition: Increasing competition from tech giants and other e-commerce platforms could erode Shopify’s market share and pricing power. Amazon is the biggest threat here, by far.
  • Technological Obsolescence: Rapid technological changes could render Shopify’s platform outdated, and require expensive investments in R&D.
  • Regulatory Changes: Increased regulations affecting e-commerce and payment processing can introduce significant compliance costs and create new hurdles to operating a business.
  • Global Economic Downturn: As an e-commerce service, a lot of business depends on consumer spending. A global economic downturn or other factors that negatively affect demand can cause major problems for the company’s financials.
  • Pricing Sensitivity: If customers become unwilling to pay the premium they currently do, it could cause the profits to decline.
  • Management missteps: While management is great, certain strategic missteps could erode the company’s competitive advantage if it were to fail to capitalize on its current and future strengths.

Business Resilience:

  • A company with high margins and great cash flow has more flexibility in a bad scenario. A downturn would have less of an impact than it would for other companies.
  • Shopify has a proven business model and loyal customer base. In the past, the company has shown its ability to recover from large negative events and continue to grow profitably, which is a sign of a resilient business.
  • The company’s large pile of cash can protect it against negative scenarios and gives flexibility to expand operations.

Understandability Rating: 3/5 The business model itself is simple and easy to understand but the market they operate in and the intricacies of their operations can be complex, this is why it is not rated as a 1.

Balance Sheet Health Rating: 5 / 5 Shopify’s balance sheet is very strong. They have a large pile of cash and very low debt. Their assets also exceed their liabilities, resulting in healthy equity. There is no reason to suspect that they are in a financially precarious position.