#shoppablepics.com

In Shopify’s Q3 2015 earnings report, the Company told us that 56.1% ($29.6M/$52.8M) of its revenue comes from ‘Subscription Solutions’ (a.k.a. Software-as-a-Service or SaaS) and the balance 43.9% ($29.6M/$52.8M) from ‘Merchant Solutions’.  Why is this important? 

Having recently represented a seller of an Inc. 500 Fastest Growing in the sale of its SaaS business, I know from negotiating valuation with sophisticated strategic and financial buyers (e.g. private equity groups) that investors won’t pay a premium SaaS valuation for any revenue that: (1) Isn’t SaaS or (2) Has a low customer retention rate. In the case of Shopify 43.9% of the Company’s revenue isn’t SaaS, and its customer retention rate (reported at over 100.0%) was calculated in a non-traditional manner that in my opinion significantly overstates retention.

Why I think Shopify stock could drop 40%

In Buy or Sell Shopify? What You Need To Know About Amazon’s Favorite Ecommerce Firm I stated that over a sample of 38 public Software-as-a-Service (SaaS) companies, enterprise value / revenue valuation multiples ranged between 2.0x and 28.9x, with a median of 6.8x and mean of 8.0x. If we counted all of Shopify’s revenue as SaaS (what I believe the market is doing right now) the Company shares currently trade at 15.1xrevenue. However only $81.23M ($144.8M * 56.1%) is SaaS.

Dividing Shopify’s $2.18B enterprise valuation by $81.23M of SaaS revenue implies a 26.8x enterprise value / revenue valuation multiple. That’s ridiculously high to me in light of the fact that merchant retention is ’consistent with what we would associate with early stage businesses’ (page 55 of Form F-1). Of course there is value in the low margin Merchant Solutions (Merchant Payment) business, but overall Shopify loses money and the merchant payment business is wildly competitive so I’m not inclined to assign a nose bleed valuation to that segment of the business.

101.0% customer retention rate ‘may be calculated in a manner different than (that) used by other companies’

(Financial table presented in F-1 Filing)

(As described in Form 6-K)

Key performance indicators that we use to evaluate our business, measure our performance, identify trends affecting our business, formulate financial projections and make strategic decisions include Monthly Recurring Revenue and Gross Merchandise Volume. Our key performance indicators may be calculated in a manner different than similar key performance indicators used by other companies. We calculate Monthly Recurring Revenue, or MRR, at the end of each period by multiplying the number of merchants who have subscription plans with us at the period end date by the average monthly subscription plan fee revenue in effect on the last day of that period, assuming they maintain their subscription plans the following month. MRR allows us to average our various pricing plans and billing periods into a single, consistent number that we can track over time. We also analyze the factors that make up MRR, specifically the number of paying merchants using our platform and changes in our average revenue earned from subscription plan fees per paying merchant. In addition, we use MRR to forecast and predict monthly, quarterly and annual subscription solutions revenue. We had $ 9.8 million of MRR as at September 30, 2015 .

The Big Picture

Although I’m critical of the company’s valuation, you may be surprised to hear that I am one of the 200,000+ merchants using its product (See ShoppablePics.com). In my experience a key point of differentiation that I’ve found is that merchants are able to sell products through Facebook, Twitter and Pinterest. Given the market for social commerce is so massive (FB has 1.5 billion monthly active, Instagram and Twitter are in the 300 million monthly active range) it’s likely that Shopify will continue to grow at a healthy clip, and ultimately become profitable. Until that happens though I would be a seller and not buyer of the stock.

Follow me on Twitter @AbeGarver

Summary

Shopify's stock is up 113% since it's May 21, 2015 IPO, due in part to recenlty announced partnerships with Facebook, Amazon and Twitter.

Shopify is growing revenues quickly (average 89.7% quarterly year-over-year growth), however its SaaS (Software as a Service) revenue is growing slower than its Merchant Payment (MP) revenue.

Mix of revenue is approximately 60% SaaS and 40% MP. According to its financial disclosures, MP revenue is much lower margin, than SaaS.

Shopify stated in its offering documents that merchant retention is 'consistent with what we would associate with early stage businesses'

From a valuation perspective, there are a number of red flags for us to keep out eyes on.

Shopify offers a cloud-based all-in-one commerce platform that's used by more than 175,000 small business merchants. On it's first day of trading in May, shares skyrocketed 51% (from $17 to $25.68). In less than five months the stock is up another 41% (to $36.21). The company's market capitalization (# of shares outstanding multiplied by stock price) is $3.0 billion dollars. In the latest twelve months Shopify lost $16.9 million dollars, on $144.8 million of revenue. What is driving the meteoric rise in the stock, and should you be a buyer or seller of Shopify stock (NYSE: SHOP)?

Recent Partnership Announcements with Facebook, Amazon Twitter and Pinterest

The market for social commerce is a massive. And new sites like ShoppablePics.com are springing up help facilitate it. Facebook (NASDAQ:FB) has 1.5 billion monthly active, Instagram and Twitter (NYSE:TWTR) are in the 300 million monthly active range). On September 16, Facebook said Shopify merchants will soon be able to sell their wares through a new Shop section on small business Facebook pages. When a user clicks on a product, merchants can either direct shoppers from Facebook to their online store or let them checkout directly on the Facebook site or mobile app. Shopify will handle payment processing and transaction tracking. On September 17, Amazon (NASDAQ:AMZN) selected Shopify to be its preferred platform for helping small and midsize retailers build and manage online stores. Then on October 6, Shopify launched a partnership with Twitter to allow Shopify merchants to sell products directly on Twitter. Twitter's "Buy Now" buttons will be available to U.S.-based Shopify merchants. The Canadian company has also inked a partnership with Pinterest that allow its merchants to sell products via buyable Pins.

Financial considerations

Shopify is growing revenues quickly (average 89.7% quarterly year-over-year growth), however its SaaS (Software as a Service) revenue is growing slower than its Merchant Payment (MP) revenue

Mix of revenue is approximately 60% SaaS and 40% MP

According to its financial disclosures, MP revenue is much lower margin, than SaaS

To be successful, SaaS companies count on very high user retention (e.g. 90% of new merchants are still customers at the end of the year)

Shopify stated in its offering documents that merchant retention is 'consistent with what we would associate with early stage businesses'

8 out of 10 SMBs fail in the first 18 months (Forbes)

Shopify merchant perspective

About a month ago I decided to experiment with the Shopify platform to see how much time and effort it would really take to launch a business on the platform. Here is what I found:

In general the platform is robust there is a growing community of 3rd-party app developers (who have created about 1,000 apps)

There is a steep learning curve to get up and running (I'm still not 100% ready to launch ShoppablePics.com)

When I needed phone support to customize my site, the experience was akin to Apple's (NASDAQ:AAPL) genius bar (no availability today)

The 20 minute support call I scheduled, didn't resolve all my issues, so it was recommended that I hire a 3rd-party "expert"

"Liquid", the backbone of Shopify themes (and also used to load dynamic content on storefronts) is not a common programming language

I tend to complete things that I start, so expect the store to be live soon

The jury is out on whether I'll still be a Shopify merchant 12 months from now

Should you sell Shopify Stock?

In order to avoid any conflict of interest I don't trade individual stocks. I also don't give price targets. However I will tell you that I believe Shopify's stock is currently overvalued and here is why.

In an article I wrote last year I reported that enterprise value / revenue multiples ranged between 2.0x and 28.9x over a sample of 38 public SaaS companies. After having dug into Shopify's financial statements, my sense is that about 60% of Shopify's $144.8 million dollars of revenue is SaaS. In other words there is about $86.9 million in the latest twelve months.

Of course there is value in the low margin MP business, but if we stripped that out, today's $3 billion dollar valuation implies a 34.5x multiple to SaaS revenue. That's ridiculously high to me in light of the fact that merchant retention is 'consistent with what we would associate with early stage businesses'. My own experience on the platform also confirms this.

Yes, Shopify's potential to become an integral part of the selling process on Facebook is exciting. Personally I'll wait until the company begins to 'show me the money' before recommending that anyone buy shares.

If you found the article to be informative and are interested in the state-of-the-art for ‘social commerce’ follow me on Twitter @abegarver