Shopify: 3rd Quarter Update, Raising 12-Month Target To $55

| About: Shopify (SHOP)
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Shopify reported third quarter results that were substantially higher than expectations, continuing its streak of outperformance and validating its best-in-breed e-commerce platform.

Management revised guidance upward for the third time in 2016, and now expects full year total revenue to grow between ~84-86% from FY 2015.

Shares remain undervalued given the substantial amount of headroom available in the SMB space. My updated target of $55 represents a base case of around 28% upside from present levels.

In early November Shopify (NYSE:SHOP) reported yet another stellar quarter of results with total y/y revenue growth of 89%, primarily driven by a 114% jump in revenue from the company's merchant solutions segment. Of note, the continued adoption of Shopify Capital for merchants looking for seed capital and the new integration of Canada Post with Shopify Shipping continues to drive the merchant solutions segment as merchants gradually look to condense their resources into one e-commerce platform. Further, a beat and raise for the third consecutive quarter this year adds to the already solid credibility that management has built for itself. That said, I am raising my 12-month price target to $55, representing further upside of ~28%.

Highlights from the Quarter

  • Subscription/merchant solutions revenue mix comes in evenly split 50/50 for the second straight quarter. Albeit being overshadowed by the growth in the merchant solutions segment, revenue from subscription solutions continued its consistent rise with growth of 69% y/y and 14% on a sequential q/q basis. That said, the mix between the two segments as percentage of total revenue has now stayed consistent at 50% from the past two quarters. Recall, subscription solutions revenue accounted for ~63% of total revenue back in FY 2014, so the company has achieved significant progress in terms of diversifying the revenue mix over the past 18 months. The benefit of this shift is two-pronged: 1) concerns regarding a deceleration in revenue growth should fade as the issue of customer/merchant churn diminishes as the revenue basket becomes increasingly diversified and 2) gross margins should continue to improve as existing users sign up for add-on services such as Capital, Payments, and Shipping. In fact, an analyst on the earnings call actually referenced the latter, and management stated that the continued push towards Shopify Plus has actually required a significant amount of marketing expenditures, causing a suppression in gross margin for the time being. For reference, Non-GAAP gross margin for Q3 was 53%. Regarding churn, CFO Russ Jones made an encouraging comment on the earnings call stating that many customers utilize the Shopify platform as their only web presence, thereby increasing the value and "stickiness" of the platform for many merchants, especially those who operate on a smaller scale.
  • Average revenue per merchant (ARPM) continues to trend higher with 6% q/q growth on a sequential basis. Notably, the company announced that its merchant base has now exceeded over 325,000 merchants, thus based off what the company has publicly disclosed, ARPM came in at around $306 (for Q3) or ~$102/merchant per month. Moreover, ARPM actually grew 16% on a y/y basis, primarily due to the +60% growth in merchant base and the movement towards higher priced plans by existing customers, which I highlighted in my last update.
  • Market for SMB e-commerce solutions remains large leaving significant headroom for the company to capture. Assuming the midpoint of management's revised FY 2016 guidance of $380 million in revenue and the outlined TAM (total addressable market) of $10 billion in the markets the company currently operates in, Shopify has only captured a mere ~4% at the present time. Assuming the company continues to focus on merchant success and execution, I believe peak market share could potentially reach 10% by 2019 resulting in around $1 billion in full year sales. Expansion into additional markets would serve as a free call option, but it seems that the focus will be on North America in the near-term.
  • Operating margin improved by two-hundred basis points in Q3; Expecting further declines in OpEx moving into 2017. Recall, management has continuously guided (and reaffirmed) for profitability on an adjusted basis in Q4 2017. To date, I shared the same view however I am now modeling for adjusted EPS of $0.02/share in Q3 2017. Granted, this can and will shift in the event that the contraction in operating expenses slows down. Adjusted loss was $0.03/share for the third quarter as the company remains aggressive in its push towards transitioning existing and signing up new merchants for Shopify Plus. Specifically, management stated that nearly 50% of Plus merchants were new to the platform, which was a key driver for the 67% growth y/y in monthly recurring revenue (MRR). Regarding the balance sheet, the company has around $400 million in cash and equivalents with the completion of the secondary offering announced in August.

Model Update

The company is now guiding for fourth quarter revenue to come in between $120 - $122 million and also updated full year 2016 guidance to $379 - $381 million. For Q4, I am now modeling for ~$121 million in total revenue, representing y/y and sequential q/q growth of 72% and ~22%, respectively. That said, my FY 2016 total revenue projection is at the midpoint of company's guidance, which would represent ~85% growth from FY 2015.

Moving on to 2017, I expect Q1 to be seasonally softer compared to the rest of the year, yet still am projecting above consensus for Q1 - Q3. Management will provide an outlook for 2017 on the Q4 2016 call. I am projecting FY 2017 revenue to come in around $565 million, representing growth of around 49% from FY 2016. Below, I have charted a comparison between my personal estimates against consensus for the next five quarters.

Figure 1: Personal vs. Consensus Revenue Estimates

(Source: Bloomberg, personal estimates)

Figure 2: Shopify Updated Income Statement Projections

(Source: Company filings, personal estimates)

Valuation Summary

I am switching over from utilizing the NTM EV/Revenue multiple to a 2017 EV/Revenue multiple for my valuation. That said, by applying the 7.5x multiple I've used in the past, I arrive at an updated target of ~$55/share.

Figure 3: Shopify Updated Valuation Summary

(Source: Company filings, personal estimates)

Note: Data as of market close, November 28th, 2016.

Disclosure: I am/we are long SHOP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.