On May 5, 2022, e-commerce platform Shopify (SHOP 1.61%) announced that it was acquiring logistics company Deliverr in a $2.1 billion transaction, which was completed in July. On May 4, 2023, Shopify announced it was getting rid of its logistics business in an abrupt about-face.
Logistics was consequential to a Shopify investment thesis due to the amount of money it had invested. In light of today's announcements, investors should revisit Shopify's investment thesis yet again.
Here's what Shopify just did
Shopify reported financial results for the first quarter of 2023 today, showing year-over-year revenue growth of 25%. That growth was far better than what management had guided for and more than analysts expected.
Revenue growth isn't today's big story, however; Shopify's major changes are. Management said it is selling its logistics business to Flexport in exchange for a 13% stake in the company.
Moreover, Shopify also announced that it's laying off 23% of its workforce. This partly relates to divesting its logistics business, but appears to extend beyond it as well.
These moves will be expensive for Shopify in the near term. Selling its logistics business to Flexport will trigger an estimated $170 million in stock-based compensation expenses. And layoffs will come with charges of $140 million to $150 million.
What should investors do now?
Changes to investment theses are usually gradual but Shopify's thesis is suddenly getting major alterations. For better or worse, logistics was part of Shopify's reality. Now investors need to consider whether the exit will make Shopify's business more valuable over the long term or not.
First, I've acknowledged the near-term expense of shifting gears so suddenly. Those expenses will likely be recognized within the next couple of quarters. The silver lining is Shopify's growth rate reaccelerated and it's free-cash-flow positive again. Moreover, it expects to generate positive free cash flow in each quarter of 2023, despite one-time expense headwinds.
SHOP Revenue (Quarterly YoY Growth) data by YCharts
It's possible the aforementioned list of expenses is nonexhaustive. Shopify currently has $1.8 billion in goodwill on the balance sheet. And divesting the majority of its logistics business could cause a future reduction. Moreover, investors can't forget that the cash portion of its acquisition of Deliverr just last year was $1.7 billion. That cash is gone.
It's also worth noting that analysts didn't like Shopify's acquisition of Deliverr in the first place. Logistics is known to be a low-margin opportunity whereas Shopify's core business model had a high gross profit margin. However, as recently as March, Shopify's management defended its emphasis on logistics nonetheless.
Shopify is competing with Amazon. With Amazon, customers expect fast shipping and the company has the logistics to make it happen. That's what Shopify was trying to build for itself.
In the fourth quarter of 2022, Shopify started offering its Shop Promise badge to select merchants. This badge guaranteed consumers shipping services comparable to those of Amazon. And management said that the Shop Promise badge boosted sales conversions by up to 25%.
Shopify didn't have the logistics to provide this promise to all merchants. But the notion was compelling: If the company could build logistics and offer the Shop Promise to 100% of merchants, it would theoretically boost sales volume. And that would be a more profitable venture for Shopify than logistics in isolation. Therefore, the investment in logistics made sense after hearing management's explanation.
As a Shopify shareholder myself, I'm concerned with today's announcement. On one hand, the company is cutting expenses. And exiting logistics should boost profit margins. But I don't like how much was invested, how recently these investments were defended, and how abruptly the change happened today.
That said, Shopify is at least exiting logistics smartly, in my opinion, which gives me hope. In a manner of speaking, Shopify is transferring its investments to Flexport and outsourcing the day-to-day operations. And by naming Flexport its partner, the company can still eventually offer the Shop Promise badge to more merchants.
Moreover, Shopify gets to participate in Flexport's upside. It received a 13% stake in the company today. But Shopify was already an investor in Flexport, notably last year when the company raised funds at an $8 billion valuation. Therefore, Shopify's investments in logistics to date may not be a total loss.
To summarize the investment thesis today, Shopify is doubling down on its e-commerce platform -- a platform with reaccelerating growth -- which is good. The company is mostly exiting logistics and outsourcing that to its new partner, Flexport. The move could boost Shopify's profit margins back to more historical levels. Hopefully Flexport can continue building what Shopify started so that it can better compete with Amazon.
In conclusion, Shopify could create shareholder value from here in light of today's changes. Admitting mistakes and moving on is a good thing. But the abruptness of the changes make it important to watch management all the more closely, to make sure it's not haphazardly running toward other costly strategic errors.
