Shopify's Valuation is Challenging, Yet Misunderstood

Updated: Jan 7, 2021

2 Peter Chapter 1, verses 5-7 state, "But also for this very reason, giving all diligence, add to your faith virtue, to your virtue knowledge, to knowledge self-control, to self-control perseverance, to perseverance, godliness, to godliness brotherly kindness, and to brotherly kindness love." As I look to maintain and grow my faith in God, these verses offer very practical and important steps to succeeding in this effort. Without continually seeking wisdom from God's word and looking to apply it in my life, actionable steps will likely not materialize. Without actions supporting my faith, how can it then truly be faith? And without faith, how then can I show love for all God's people on earth?

At the same time, I find these words from the Bible inspiring to take steps in deconstructing investment opportunities and applying things like diligence, knowledge, self-control and perseverance towards defining strategies and managing investments.

This brings me to today's investment focus, Shopify, Inc. (SHOP). Shopify is a company that gives split reactions. On the one hand, the business is growing very strongly with a direct correlation to Stock Price, SP, performance making sense; and on the other hand, the valuation can seem like an insurmountable barrier. The term, "that's what makes it a market" is never a helpful response, so I think it's prudent to dive further into the review.

I am long Shopify and it reflects the second largest holding in the portfolio that I manage, created in January 2020. I have purchased Shopify four times this year and have a 27% return to date.

I value all investment holdings under management on two core metrics - Revenue growth and Cash Flow, CF, performance. CF performance is always broken down by Operating Cash Flow, OCF, and Free Cash Flow, FCF. Additionally, I consider a company's Net Cash Position, Gross Margin, GM, OCF/FCF Margin, and other key business metrics, that may differ depending on sector, and/or industry.

Shopify's key metrics as of their latest filing and on a Trailing Twelve-Month, TTM period are as follows:

  • Net Cash Position: $5.4 billion

  • Revenues: $2.5 billion

  • GM: 53%

  • OCF / Percent: $233 million / 9.5%

  • FCF / Percent: $244 million / 10%

  • Shares Outstanding 123 million

  • Monthly Recurring Revenue, MRR: $74 million

  • Shopify Plus MRR Contribution: $19 million

  • Gross Merchandise Volume, GMV: $99 billion

  • Gross Payment Volume, GPV: $43.5 billion

Shopify has a current SP at $1,034 per share which affords the company an Enterprise Value, EV of $122 billion. At this valuation, the company trades 50 times EV/Revenues and almost 550 and 520 times OCF/FCF per share.

While Shopify's valuation today is steep, I am most interested where the company is going and comparing how the strength of the business model is fairing. Based on my projections and estimates through 2022, here is what I am modeling for Shopify:

  • Net Cash Position: $6.2 billion

  • Revenues: $5.3 billion

  • GM: 55%

  • OCF / Percent: $800 million / 15%

  • FCF / Percent: $850 million / 16%

  • Shares Outstanding: 137 million

  • MRR: $110 million

  • Shopify Plus MRR Contribution: $27 million

  • GMV: $201 billion

  • GPV: $92 billion

Based on these estimates, I am modeling Shopify with an EV/Revenues multiple of 45 and OCF/FCF per share multiple at 300 times for my Price Target, PT, through 2022. This affords a PT at around $1,750 per share, representing 69% upside from today's SP. I suspect that this PT would be achievable at some point over the next 18-month period.

This is why I initially purchased Shopify in late-March, and have accumulated more with the SP dropping below $1,000 multiple times.

The most important factor for any company's investment consideration is its ability to sustain strong Revenue growth, while maintaining and/or improving OCF/FCF results. OCF/FCF are how I as an investor measure my equity stake in the business - a company's CF margin is paramount to the value of the business and corresponding return that I will get on my investment. This is why Revenues are so important as well, as it is the core driving force for CF performance.

As such, Shopify's performance since 2016 has been nothing short of spectacular. Revenues were just below $400 million and OCF was at $14 million. For 2020, these results are estimated to improve to $2.9 billion and $290 million respectively - that's 70% and 215% annualized growth for Revenues and OCF respectively.

Take it out further towards 2025 with analysts and myself included targeting Shopify's Revenues to increase towards $11 billion, with OCF approaching $2 billion. This would reflect 30% and 45% annualized growth for Revenues and OCF respectively, a substantial decline in growth rates from the prior mentioned four years. At this point, Shopify will be approaching $450 billion in GMV, and $230 billion in GPV. I still believe that Shopify will command an EV/Revenues north of 35 times, and be within a 150-250 times CF range with a PT towards $2,500.

From an investment perspective, watching Shopify grow its business from peak multiples for EV/Revenues and OCF per share of 50 and 1,600 times respectively through 2020, towards 35 and 175 times over a five-year period thereafter is tremendous growth into its valuation. From 2016 through 2025 estimates, Shopify's Revenues will have potentially averaged an annualized rate of 45%, while OCF will have witnessed an annualized growth rate of over 70%.

Shopify is the second largest e-commerce generating business in the U.S., second only to Amazon (AMZN), and is poised to be the biggest threat towards Amazon's market leadership. Other's like Wal-Mart (WMT), and other retailers shifting towards e-commerce will not keep the same pace as Shopify. Smaller and new entrants including ContextLogic, Inc. (WISH), BigCommerce Holdings, Inc. (BIGC), even DoorDash, Inc. (DASH) are all focusing on this opportunity as well, and face numerous challenges based on their scale, and business models.

As an investor, if I am looking for Shopify to trade with an EV/Revenues multiple closer to 20 times, and an OCF per share near 50 or lower, I may end up waiting for another decade. By then, I risk missing out on some of the best business growth and corresponding stock performance during this phase of the business.

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