There's no doubt that Shopify (NYSE:SHOP) has been an incredible success story over the past few years, both as a business and as a stock. The Canadian tech company has grown from humble beginnings into the leading back-end software company for e-commerce companies. Though the company began by helping small and medium-sized businesses manage their e-commerce sites, Shopify has more recently been able to lure larger consumer companies such as Johnson & Johnson, Unilever, and Procter & Gamble to its Shopify Plus offering.
The move to higher-end offerings along with the announcement of Shopify's new fulfillment initiative have caused the stock to more than triple this year, before a recent sell-off. Yet even after the September swoon in high-growth software names, Shopify is still up almost 150% in 2019.
But if you're thinking of buying into this growth story today, Shopify's more recent move to raise capital should raise some red (or at least yellow) flags. Here's why.
Management sells shares
On Monday, Sept. 16, Shopify announced that it will be selling 1.9 million shares, with the potential for the company's underwriters to purchase another 15% of that figure for up to 30 days. The pricing of the offering was at $317.50 per share and was expected to raise just over $600 million after discounts and fees.
When a company offers stock in a secondary offering, it usually generates a hit to the stock price because of concerns about diluting future profits across more shares. However, if the new money is invested by management at a high rate of return, it could become a long-term positive.
Many times, companies realize they need cash only when they're in trouble and have to sell equity at low prices. However, Shopify's capital raise is being done after an impressive run in the stock. For current holders, that could be interpreted either positively or negatively.
Glass half empty
What's interesting about Shopify's capital raise is that the company doesn't appear to need more money. Shopify had roughly $2 billion in cash and securities at the end of last quarter, with no debt. Yes, the company just agreed to acquire 6 River Systems for $450 million, but Shopify is paying 40% of that total in stock. That means Shopify had already essentially "sold" shares, even prior to the current equity raise, and the cash needed for the deal is only $270 million.
That acquisition, of course, was designed to help Shopify build out and manage its fulfillment network, which will also take investment. Still, Shopify announced that the fulfillment investment would only be $1 billion spread over five years.
Thus, the acquisition and extra fulfillment network investment should only be around $500 million this year, and Shopify has actually been free cash flow positive for the first six months of the year.
So why did the company raise more money? It could be that Shopify now sees higher investment needs for its fulfillment expansion than previously announced, or it could merely mean Shopify wants to retain a base $2 billion level of cash.
Of course, none of these were pressing needs, which leads to the potentially ominous conclusion for investors -- that management thought this was the best stock price they were going to get for a while.
Given the precipitous rise in the stock price over the past few years and with the stock still trading at a whopping 28 times sales, I can't help but wonder if management saw an opportunity to raise money at a great price while they could. And while that may be commendable, investors may not want to buy at a time when management thinks it's a great time to sell.
Building a roof when it's sunny out
On the other hand, there are a few silver linings for Shopify investors. If the stock happens to have gotten ahead of itself and management is smart enough to raise capital, that's a good sign regarding its capital allocation skills. Compare this with Tesla (NASDAQ:TSLA), which has raised lots of capital through the debt markets in recent years. That's caused some to worry about Tesla's solvency over the long term. While Tesla eventually raised equity this past spring, the lingering debt load is an extra risk you never like to have as a tech investor.
In addition, Shopify's management has actually raised money in the open markets before, both in February 2018 at $137 and December 2018 at $154 per share. Those raises haven't seemed to dent the company's performance or investor confidence, so it's not clear that this raise will automatically lead to stock declines, either.
Keep a cautious eye
While Shopify's recent money raise isn't necessarily a harbinger of disaster, investors should be wary anytime management thinks that it may be a good time to sell stock. At a very expensive valuation of 28 times sales, a lot of good news is priced in. Thus, I would be very wary of buying more Shopify shares at the current moment.