Given Shopify's (NYSE:SHOP) large cash position and positive adjusted earnings, the share offering management announced a couple of weeks ago seems surprising. The cloud-based commerce platform has been growing rapidly for many years. But even if management expects revenue growth to continue, the offering may signal a less rosy story.

A surprising share offering

During last year's second-quarter earnings call, Shopify CFO Amy Shapero said: "We have no current intention to undertake an offering". Yet the company launched a share offering four months later, on December 2018, to raise $400.4 million.

With this context, and given Shopify's results, management's announcement about another share offering one week ago surprised me. Management indicated that it would use the $693.7 million proceeds to strengthen the company's balance sheet and provide flexibility to fund its growth.

But at the end of the previous quarter, Shopify's balance sheet was already strong, with $2 billion of cash and no debt. The company has been generating GAAP losses as it funds its growth, but when you exclude the non-cash expense of share-based compensation, the company's results look more favorable. For instance, during the first half of the year, the company reported a GAAP loss of $52.8 million. But excluding $78.8 million of share-based compensation and associated taxes, the company reported a positive adjusted net income of $26 million. Thus, besides management's justification for this new share offering, I see two additional reasons for it.

First, management may think that the market's overvaluing Shopify. Even in the context of the company's strong expected 42% revenue growth in 2019, its TTM price-to-sales ratio of 27.7 remains high. Besides, the company still has to show it can generate a GAAP profit. Shopify's high valuation might give management an opportunity to raise capital cheaply. The higher the share price, the more cash the company gets, the fewer shares it needs to issue to get that cash, and the less it dilutes existing shareholders. New shares from the offering represent only 1.95% of the diluted weighted average number of shares during the previous quarter.

The second reason looks less positive for the company: Given its growth initiatives, Shopify's business is changing, and management may well expect the company to generate losses for a long time.

Online shopping

Image source: Getty Images.

No profit anytime soon

Shopify has been sacrificing short-term profits to gain market share and scale. Revenue increased from $50.3 million in 2013 to $1.07 billion in 2018, and the midpoint of the forecasted revenue in 2019 is $1.52 billion. After years of losses, Shopify posted yet another GAAP net loss of $52.8 million during the first half of this year.

There's no guarantee this strategy will lead to GAAP profits in the long term, though. And I expect Shopify will still report GAAP losses over the medium term.

The evolution of Shopify's product mix makes it harder for the company to improve its gross margin. Its merchant segment is its fastest-growing business, with revenue growing 55.6% year over year in the most recent quarter. In contrast, revenue from its subscriptions segment rose by only 38.2%. But the merchant segment is less profitable, posting a considerably smaller gross margin of 64.7% to subscriptions' 91.8%.

Furthermore, without giving extra details, management announced increased spending during the recent conference call. And the development of the fulfillment network management recently announced is a shift toward a capital-intensive business. This growth initiative will require $1 billion of additional investments over the next five years.

Beyond revenue growth

The lower gross margin in Shopify's fastest-growing segment drags on the company's operating leverage, while the development of its fulfillment network is a capital-intensive growth initiative that will require extra spending over the next five years. In addition, Shopify's surprising offering of shares could simply be management's strategy to take advantage of the company's rich valuation and raise capital in preparation for many years of further losses. 

Investors must look beyond Shopify's impressive revenue growth to understand the evolution of the business and properly value the company. Despite Shopify's valuation at a lofty price-to-sales ratio, that growth may not translate into profits anytime soon.