Shopify (SHOP) is a high-flying SaaS e-commerce company focusing on the SMB segment which floated in May 2015 at $17 and currently trades at $153 as of June 25. It hence boasts a $16.27 billion market cap and an Enterprise Value of $14.77 billion (it has $1.5 billion in cash). Shopify has become a Wall Street darling due to its hypergrowth, showing 65% revenue growth as recently as its last quarterly earnings on May 1. 2018. The company is guiding to revenues of $1 billion this year and is trading at a sky-high EV/2018 rev multiple of 14.77x. The majority of Shopify’s revenue is not subscription license revenue but merchant solutions revenue with a much lower gross margin. It isn’t profitable and spends 61% of its gross margin just on sales and marketing. Wall Street expects SHOP to eventually become highly profitable by cutting S&M spend and spreading its R&D and General & Administrative costs across a much larger revenue base with revenue nicely stable and predictable due to its SaaS subscription nature. SHOP management has been very skillful in supporting this picture.
In this report we will attempt to prove that Wall Street has gotten Shopify completely wrong. We think that Andrew Left of Citron Research was right about many of the allegations he made against Shopify. He just really didn’t have the data to back them up to be undisputable (but hats off to his intuition). We think we do and we will also show much more. We will prove our investment thesis with myriad pieces of data nobody has ever published before and show that SHOP’s true value is nowhere near its current market cap. At this point in time we are quite in the contrarian camp on SHOP. Out of the 28 analysts covering Shopify, 27 have a BUY or HOLD rating on the stock and only 1 has a SELL. We believe Wall Street will take note of our findings and the stock should start re-rating very soon. Please note we are set to profit from a fall in Shopify stock, so our view may be biased. But in contrast to Wall Street analysts who have no skin in the game, we actually put our money where our mouth is.
- Shopify customer churn is monstrous and hence SHOP has no way to deserve an EV/REV multiple like other SaaS companies. Spoiler: 85% of newly signed up paying clients are likely dead within 1 year.
- Shopify is buying its massive revenue growth through acquiring very large quantities of low quality customers (basically your average Joe type that happens to fall for various make money online schemes). In the case of Shopify, they are sold the dream that they can make substantial amounts of income from drop shipping items from AliExpress with a 5x markup. Only a minority of newly signed up clients are businesses that are already actually selling something. We believe a surprisingly high proportion of SHOP’s revenue comes from clients that are less than one year old. Spoiler: Through an analysis of the .com zone file we have found that 753,000 .com are hosted by Shopify. 405,000 of these domains are less than 1 year old! That’s 53.7% of all their domains.
- Shopify will not be able to improve its operating leverage by cutting its massive sales & marketing spend, currently running at 61% of its gross margin, because its revenue growth would massively decelerate. This is Shopify’s deal with the devil. As opposed to standard SaaS businesses which spend a lot of S&M money to acquire a client and then the client brings a constant stream of cash for a very long time and has a low likelihood of churning, Shopify, on the other hand, spends a lot on S&M on clients that have a very short average lifetime. Our analysis shows the average lifetime of a new Shopify client is about 14 months! The Shopify growth model is heavily dependent on a constant inflow of large amounts of new clients. What happens when this inflow eventually starts drying out?
- The number of Shopify paying customers is plateauing. Our research shows that the number of net adds of domains hosted is already very low based on our analysis of the .com zone file. Shopify’s problem is that it needs to bring in large quantities of new paying clients just to replace the clients that churn off. Eventually there will be more customers churning off than being added. Spoiler: Through an analysis of the .com zone file we have analyzed the number of domains that stop being hosted by Shopify. This means either the domain expires or the domain is redirected elsewhere, in either case it is obvious that the owner of the domain is no longer a Shopify client. Out of a total of 765,000 (please not this report has been in the works for a long time, so total number of hosted domains may vary in different parts of the report) domains hosted by Shopify, 2,309 domains churn off from Shopify every single day on average!
- We believe a significant majority of Shopify customers are not doing very well and are hence very likely to churn. We have run the entire list of domains hosted by Shopify through SimilarWeb.com and found that only 123,000 of the 765,000 domains are showing ANY traffic at all.
- On June 12. The WSJ reported that Facebook is offering a new feature that will let users rate shopping that stems from Facebook ads. Facebook will then start banning low quality stores. This will have a very significant impact on Shopify’s GMV and Merchant solutions revenue because a huge slice of GMV is tied to Facebook and Instagram ads. We believe that there is a massive clean-up in Facebook ad space coming and Facebook will make a move on low quality drop shipping stores on Shopify. Spoiler: We have analyzed the top 250 most visited Shopify stores representing 162 million visits in May and found that possibly up to 50% of this traffic could be at risk in a true Facebook cleansing scenario.
- Looking at Shopify’s 250 most visited stores we have found that 29 have very suspect traffic patterns. Historically they have been showing 0 traffic and then suddenly in April and May they shoot up from 0 traffic to several hundreds of thousands or even millions of visits per month. We use these stores to illustrate how fickle some Shopify revenue might be. Here’s a concrete example:
- Shopify has been focused a lot on its Shopify Plus offering, which is a solution priced at $2000+ per month. Shopify management has been spinning this as new revenue from blue-chippy clients with enterprise grade qualities. Our research has found that a significant chunk of these Shopify Plus clients are not those A-class businesses. For example, Fleshlight.com (Shopify’s #4 visited website according to our SimilarWeb data) or SiliconWives.com are peddlers of “sexual hardware”, but worse, a significant chunk of Shopify Plus clients are showing terrible Trust Pilot ratings (2* and less) such as ColourPop.com, KylieCosmetics.com or MVMTwatches.com (all 3 are top20 Shopify Stores according to SimilarWeb) with the majority of reviews saying they have not been delivered product at all or they have impossible return policies. These stores could massively be affected by changes in Facebook policies towards low quality advertisers. Since pricing for Shopify Plus is variable, this could hurt Subscription solutions revenue.
- We believe Shopify Capital is behind the significant improvement of Merchant solutions gross margin. We however believe that the cash advance portfolio (origination tripled y-o-y) could end up being quite toxic. Our hypothesis is that these cash advances are taken up predominantly by drop shipping customers whose destiny is tied to their ability to promote their stores on Facebook and Instagram. When Facebook goes after low quality store advertisers Shopify will have a problem to collect these cash advances since it does the collecting through taking a percentage of their daily revenues.