Shopify (NYSE:SHOP) has performed stunningly since its IPO in 2015 -- its share price has grown a whopping 175% in just the past 12 months alone.
On this episode of Industry Focus: Tech, Motley Fool analysts Dylan Lewis and Michael Douglass are joined by summer intern Ryan Reeves to make the case for why Shopify is still a solid buy for long-term investors today. Find out how Shopify works and how it makes its money; how its business strategy is symbiotic with customers -- and why that's so good; a few of the most important risks investors need to be aware of; how Shopify still has room to grow after such huge success; and more.
A full transcript follows the video.
This video was recorded on July 21, 2017.
Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, July 21, and we're talking Shopify. I'm your host, Dylan Lewis, and I'm joined in the studio by Ryan Reeves, one of The Motley Fool's summer interns, and my good friend, Fool.com's Michael Douglass. What's going on, guys?
Ryan Reeves: Thanks for having me.
Michael Douglass: Happy Friday!
Lewis: Yeah. This is not your podcast debut, right, Ryan?
Reeves: Yeah, I was actually on Market Foolery at the beginning of this week. That was a great introduction.
Lewis: I think that's the right order of operations, if you were to be debuting on a show and having to do subsequent ones.
Douglass: Start with the big leagues.
Lewis: Yeah, start with Chris Hill and get the A-team experience, and then work your way down to Industry Focus once you have a show under your belt.
Douglass: Yeah, there's a reason this show was on Friday, end of the week.
Lewis: I'm not sure what that means.
Douglass: Heading into that slump.
Lewis: Yeah, just kind of ease your way into the weekend.
Reeves: No, you guys are being humble.
Douglass: [laughs] With the cool tones of smooth jazz, Industry Focus edition.
Lewis: Yeah, mellow, smooth jazz. Ryan, before we get into our stock talk today, do you want to give listeners a little flavor for what's it's been like being a summer intern here at the Fool, what you've been working on this summer?
Reeves: Yeah, this summer has been amazing. I've been on the Rule Breakers team, so I got to pitch a couple of stocks to David Gardner. That was amazing. And I've been doing three stock pitches, and next Wednesday is the final stock pitch in front of the whole investing team. So just gearing up for that.
Douglass: No pressure.
Reeves: Some nice, difficult questions, hopefully. But yeah, it's been an awesome learning experience. My mentor is Aaron Bush. It's been great.
Lewis: And you kind of have a little bit of Aaron Bush, David Kretzmann in you, right? You're someone who started investing at a very early age. You're young, but you've been investing for quite some time.
Reeves: That's true. About 13 I got interested in the stock market, and ever since then I've been reading a bunch about it. It's kind of a dream come true to be here at The Motley Fool for the summer.
Lewis: How does that feel, Michael, being seven, eight years older than Ryan, that you guys have been investing for the same amount of time?
Douglass: Well, so, technically speaking, I have to point out, I started in mutual funds when I was 12.
Lewis: Oh, good for you.
Douglass: Well, but they're mutual funds, so I underperformed. I didn't know anything about stocks. I didn't learn individual stock-picking until I was in my 20s.
Reeves: Still had the foresight.
Douglass: Well, I timed the market at basically the worst possible time. It was mid-2001, shortly before a lot of things.
Lewis: There's a lesson there.
Douglass: Yeah, don't try to time the market. [laughs]
Lewis: [laughs] Exactly. Well, speaking of individual stock picking ...
Douglass: [laughs] Oh, I see.
Reeves: What a pivot. Look at that.
Lewis: Today, we're going to be talking about Shopify. This is a stock that has been on an absolute tear for the last year. In the last 12 months alone, it's up 175%. It's been a favorite of the investing team for quite some time, and I know it's actually a company that Ryan's been following for quite some time, so I wanted to bring him in to talk about it. To kick us off, how would you describe this company to someone who's never heard of it? What do they do, and how do they make money?
Reeves: Shopify is an e-commerce solutions company. They help you build your website; they help with inventory management; they integrate payments. They basically have two segments for how they make money -- subscriptions and merchant solutions. When you're trying to build an e-commerce platform, you can subscribe to Shopify and then you get access, and there's Basic Shopify and Advanced, and there's even Plus for enterprises. There's basically these four levels, and it varies by the number of features that you get. The merchant solutions is mainly Shopify payments. Based on the amount of merchandise that flows through your online business, you pay a percent of that to Shopify, so that you get the payments capabilities. Then, Shopify Merchant Solutions also has Shopify Shipping, Capital, and they even have a point-of-sale system that they rolled out pretty recently. So it's mainly these subscriptions and the merchant solutions, how they make money.
Lewis: This is kind of a one-stop shop, that's the idea, for people who want to get an e-commerce presence off the ground. And it's not limited to just your small Podunk yarn business or something like that. This is something that a lot of major brands actually use.
Reeves: Exactly. The Los Angeles Lakers, Tesla, Nestle, GE, Red Bull, all of them use Shopify Plus for the enterprise subscription. As of 2016, 378,000 total merchants, so Shopify is definitely gaining some traction there.
Douglass: And it's so attractive in so many ways. Essentially, on the bottom end, when you're trying to start a business, you've got a lot of different things you have to think through, particularly hiring. On people, you have payroll, you have HR. Whatever you're actually doing to make money -- someone to essentially take all the e-commerce side of it and just make it a push of a button. Maybe not quite that simple, but pretty close. That's a really powerful value proposition to new entrepreneurs who are, frankly, often working 80 or 90 hours a week to get something off the ground. This basically takes a whole channel off your plate in terms of the work you have to do.
Lewis: And it's tech literacy that you don't necessarily need to have. It makes it easy and plug-and-play for a lot of people who might not have that expertise and really just want to be able to sell something that they might be selling on Etsy instead, but it allows them to control the experience a little bit more. I think one of the coolest things about this company is the back story, and how Tobias Lutke, the CEO, wound up deciding to actually found it. He did not get into this to start an e-commerce company; it was something that was born out of necessity for him.
Reeves: Yeah, exactly. The story kind of goes, Tobi got a computer when he was really young, and at about 11 or 12 he started programming, and he actually dropped out of school in the 10th grade in order to attend a coding school. Then, in 2004, he and a couple buddies wanted to sell snowboards online, and he found that there wasn't a good e-commerce software. So he was like, this is interesting, and he basically built out his own platform, i.e., Shopify. It was actually a funny story -- before 2011, the company was called Jaded Pixel Technologies.
Douglass: Not the best name there.
Reeves: [laughs] Yeah, thankfully they changed it to Shopify.
Lewis: Yeah, that name is both long and disillusioned. [laughs] Like, why are they jaded? Why are the pixels jaded?
Reeves: Yeah. But it's definitely had some serious success in the last couple years as the stock price has almost tripled. Yeah, Tobias Lutke.
Lewis: And something that we love to see as Foolish investors that's the case here with Shopify is, Tobias Lutke owns a sizable chunk of the business. I think he has about 8% of shares outstanding, if I remember correctly. So you like having a founder that's leading this company and has a substantial amount of skin in the game. Looking at their financial statements, not surprisingly, they paint the picture of growth. We've seen this incredible stock price rise over the last couple years. Looking at the most recent quarter, revenue was $127 million, and that was up 76% year over year. The company is currently losing money -- not really a huge surprise, though, given it's a fairly young and high-growth business. I know it's tempting to just look at these top-line numbers and also check in on the bottom line, but my feeling is, with a company like this, there are a lot of numbers that aren't on the financial statements that's probably worth checking in on. Do you want to walk through the important ones?
Reeves: Sure. One important one is GMV, or gross merchandise volume. That's basically the total amount of merchandise flowing through their customers' platforms. In 2016, that ended at $15.4 billion, growth of over 99%, actually. So they're looking to grow that. It will probably decelerate a little bit. But GMV, over $20 billion, for sure, which, that's crazy. Another metric to look at is average revenue per user. Last quarter, it grew 81%. Now it stands at over $1,200. As of 2016, they had almost 400,000 merchants at an average revenue per user of $1,200, so you can do some of the math, but that ends up at quite a bit of revenue. And you've seen the top line grow rapidly.
Lewis: And when we say "user" here, we're talking about the actual business owner that is running a site with them as an e-commerce solution, not the end user like you and I buying something, right?
Lewis: It's worth clarifying, because very often that RPU number that we site --
Douglass: It's like $0.75.
Lewis: -- for social media companies like Facebook or Twitter, it's a little bit different.
Bringing it back around to Shopify, I think the exciting thing is, for as much as they've grown, and as much as their share price has appreciated in the last couple years, it feels like they're really just starting to scratch the surface of the market they're in. Do you want to talk a little bit about what that total addressable market, that TAM, looks like for them, and what that market opportunity is?
Reeves: Yeah. They target mainly small to medium-size businesses, and they estimate there's about 46 million of those worldwide, meaning under 500 employees. As I said, the average revenue per user is about $1,200. So if you multiply $1,200 by 46 million, you end up with around $55 billion. So they're on track for doing around $570 million in revenue, so we're just getting started. If they capture 10% of that, that's 10 times the amount of revenue.
Lewis: That's gaudy growth. Something else that's kind of interesting to me with this business is, even after the rise that it's gone on, it's still just under a $10 billion company, which is a lesson in why investing in small- and mid-cap companies can be very good for your profile you if you pick good ones.
Douglass: I think that also highlights, one of the other things to keep in mind is, sure, Shopify's main thing is small and medium business. But as Ryan already pointed out very ably earlier, there are a lot of big businesses that are getting involved with Shopify, too. So if you think about the opportunity there, that could expand, perhaps, that total addressable market, to make it even bigger.
Lewis: And beyond what they're doing right now, they also have some other growth initiatives in the works. My understanding is, you talked a little bit about shipping and capital -- do you want to touch on some of the stuff they're doing there?
Reeves: Yeah. Shopify Capital gives a little bit of seed money to business owners that will be interested in using Shopify and expanding their platform. Shopify Capital is growing pretty quickly. Something that they've rolled out pretty recently is the point-of-sale system. So they're kind of competing with Square now in this space. If you go to a farmer's market or any small business, you see that iconic Square. It's white, little --
Lewis: Credit card reader.
Reeves: Exactly, the card reader, you see that. Shopify is trying to take some market share there. And if you already have your e-commerce platform set up, it seems kind of natural to use Shopify's point-of-sale system as well. And, actually, another development, just last week, they made a partnership with eBay, actually. It seems like a symbiotic relationship, taking out one of their competitors and bringing them into the Shopify ecosystem.
Douglass: And just that integration across the board, enabling Shopify to do more and more things, I think is such a powerful opportunity for them, sort of like a sticky relationship, network effect kind of thing, because so often you have WordPress for your website, or something for something else, and Square for a third thing. But if someone can offer all of that, particularly because they're integrating it all and doing it cheaply, they're able to do it at a lesser cost than each of those things individually, why wouldn't you go there?
Lewis: And all of Shopify's incentives align with people that are using the platform. It's a symbiotic relationship. They grow as all of the smaller merchants grow. So as you're processing more orders, you have more transaction volume come through. That's going to benefit you; it's also going to benefit Shopify. So they want to see everyone succeed on their platform.
Douglass: Yeah, they want to help you grow your business if they can find a way to.
Reeves: Exactly. Tobi Lutke has a quote: "Shopify is exactly this: the only platform you need to build your empire. Shopify is the first thing clients log into in the morning, and the last thing they log out of at night."
Douglass: I could see Shopify Empire being a Netflix special.
Douglass: Right? [laughs]
Lewis: What did you bill Tobi Lutke as before? The ski bum?
Douglass: Yeah, something like that.
Lewis: The ski bum that made billions. [laughs] For all that Shopify does have going for it, I think there are some risks that investors need to be aware of, particularly because it's a high-growth company, and it has just been running away with its valuation lately. Right now, it's currently trading around 20 times trailing sales, which is not cheap by any means, and I think that sets the company up for some hiccups if they're unable to deliver on any Wall Street's expectations.
Douglass: Yeah, I came to the Fool in biotech, and even in biotech, 20 times sales is really expensive. You just don't see that kind of valuation often. But on the flip side, it's like, sure, that could cause some volatility, if they fail to deliver, God forbid the economy enters a recession, something like that. But at the same time, when you are addressing such a small percentage of your potential total addressable market, how much does valuation really matter when you're that small? You have this opportunity to grow to 10 times or far more your size. Twenty times sales doesn't sound so crazy, if you're able to actually execute.
Lewis: Yeah. I think the tough thing for investors with these types of businesses is, it's easy to fixate on valuation numbers, but the reality is, a $7 billion business versus a $9 billion business when the total addressable market is in tens of billions in revenue, it's kind of making a point out of nothing. It's almost silly to try and draw anything from it, because it's so inconsequential and the growth runway is so big. But it's worth noting.
Douglass: Yes. Investors beware. High-growth companies are incredibly volatile, and frankly, execution risk is a bigger concern. Procter & Gamble can afford to have some mess-ups before things get rough. Shopify is much smaller and has a much lower margin of safety.
Lewis: Yeah, and when you're working off a quarterly revenue base of just over $100 million, you're not Procter & Gamble. [laughs]
Douglass: Right. [laughs] Hint: you're not Procter & Gamble.
Lewis: I think some other things you need to keep in mind with this company are, there are other players in this space, maybe slightly less inclusive full systems, but there are other people trying to get at that addressable market that we talked about before.
Reeves: Exactly. You have BigCommerce. Similar to Shopify. You have Wix and Squarespace; they're more just building out websites. So Shopify, exactly how you said, they integrate everything, which is a huge advantage if you're a business owner. Just like you said, Michael, you just have the e-commerce portion completely taken off your plate, simple to set up. Squarespace and Wix and Weebly, other companies like this, they'll set up your website, but then you have to use other companies for inventory management or payments or something like that. But yeah, the barriers to entry aren't necessarily super high, with it being a software company. But yeah, there's some competition for sure.
Lewis: I think, to walk back some of those concerns, the switching costs are kind of high. There's going to be resistance to switching from your existing customer base. Those types of companies might impact future customer acquisition, but the people that use Shopify and love it, they're probably not going to switch just because there's another competitor out there.
Douglass: So long as the value proposition remains.
Lewis: Right, that's huge.
Douglass: If Shopify gets greedy and hikes prices too much, that's going to be a big problem. At certain point, it's like, yeah, this will be a pain in the butt, but it'll save us $50,000 a year; we're going to make the switch. But I think the fact that they're integrating all this together means that they should be able to bundle things for cheaper and get some economies of scale out of it. That's the hope. That would be my thesis around the company.
Lewis: Yeah, makes sense. This is something that a lot of entrepreneurs want to have work. They don't really care how it works; they just want it to be easy and simple for them.
Reeves: Yeah, exactly. One thing that I think really shows the value of Shopify is -- in 2015, Amazon was actually competing in the space, and they bowed out basically and referred all their customers to Shopify and said, they're basically doing a better job than we are. If that's not a testament to how much value Shopify gives their customers, I don't know what is, really.
Douglass: Yeah. Jeff Bezos does not usually walk away from a fight.
Lewis: [laughs] Just ask the grocery business.
Douglass: And pretty much everybody else.
Reeves: Pretty much everything.
Lewis: Yeah. That's insane to me, because this is something that's well within their core competency.
Douglass: Right, theoretically, at least.
Lewis: And they just seem to be swallowing up everything that is tangentially related.
Douglass: The Washington Post. [laughs]
Lewis: Even for them to be like,"No, we respect what you guys are doing." That's a big vote of confidence.
Lewis: Well, thanks for hopping on the show, Ryan!
Reeves: Thank you so much for having me!
Lewis: I know you've written a little bit for Fool.com in your time here. Any pieces you want to highlight or give a shout-out to?
Reeves: Sure. I wrote one the other day telling the back story about MercadoLibre. Their CEO is pretty cool, Marcos Galperin, and how he was a student at Stanford Business School, and a private-equity guy came and talked to them, and he offered to give the man a ride back to his private plane, and he made a couple of wrong turns in order to buy some time, and he actually pitched him the idea of MercadoLibre, and that was his first investor. I thought that was a pretty interesting story.
Lewis: Wow. Do either of you guys watch Silicon Valley? The HBO show?
Reeves: I've heard of it.
Douglass: Yeah, ditto.
Lewis: The first episode of this most recent season, the founder of this company in the fictional show, Richard Hendricks, is pretending to be an Uber driver and picking up people from the private-equity event, and doing sales pitches in the fake Uber ride to try to get some money for his business, because they are desperately in need of money.
Douglass: That's amazing.
Reeves: Wow, they must have heard.
Lewis: Art imitating life, I guess, right there.
Douglass: Wow. Listeners, if you're interested in reading Ryan's pieces, just drop us a note, firstname.lastname@example.org, and Dylan will be sure to get back to you. [laughs]
Lewis: Yeah, those go to my personal inbox, so I will be sure to respond if it's related to the Tech show. If not, I'll let one of the other hosts handle us. And of course, you can always tweet us, @MFIndustryFocus. That's always an option, too. Thanks for hopping on, guys. Appreciate it.
Reeves: Thanks so much! It was fun.
Lewis: Folks, if you're looking for more of our stuff, you can subscribe on iTunes or check out the Fool's family of shows over at Fool.com/podcasts. As always, people on the program may own companies discussed on the show. For example, Michael owns Amazon, as do I. I own Mercado. I don't know about you.
Douglass: I don't, but I have some options on Shopify.
Lewis: So, listeners, The Motley Fool may have formal recommendations for or against stocks mentioned, and we clearly have our own interests, so don't buy or sell stocks based solely on what you hear. Thanks to Austin Morgan for all his work behind the glass. Today was an episode that required a decent amount of editing. For Ryan Reeves and Michael Douglass, I'm Dylan Lewis. Thanks for listening, and Fool on!