Shopify Profile (NYSE: SHOP): making commerce better for everyone

Shopify might not be a “true” Fintech company, yet in 2021 alone the company processed $85 billion in payments via Shopify Payments and originated $1.4 billion in merchant cash advances via Shopify Capital. The company also offers a wide range of financial services and products, including Shopify POS software and hardware, checkout solution Shopify Pay, Buy-Now-Pay-Later loans Shop Pay Installments, merchant banking accounts Shop Balance….I hope you get the point.

Shopify might have started as a software company offering an e-commerce platform for small merchants; however, over the years it became a force in consumer and business financial services, and I believe the company is just getting started! Let's break down the company’s financials and its efforts in financial services.

Business Overview

In their own words, “Shopify is a leading provider of essential internet infrastructure for commerce, offering trusted tools to start, grow, market, and manage a retail business of any size.” Founded in 2006, the company is mostly known for its e-commerce platform which allowed millions of merchants to launch and operate their online stores. The company’s value proposition became especially relevant at the onset of the pandemic when many offline businesses had to shut their stores and move online.

Nevertheless, over the years, Shopify became a more complex organization offering numerous products and services across many geographical locations. The three core “pillars” of the business are 1) the commerce platform, including its enterprise tier Shopify Plus and the ecosystem of third-party applications, 2) financial services, including Shopify Payments and Shopify Capital, and 3) delivery and logistics offering, including Shopify Shipping and Shopify Fulfillment Network.

Image source: Q4 2021 Financial Results Presentation

Shopify’s commerce platform is powering millions of online stores and is catering to both, small and medium-sized businesses, as well as large enterprises (the company uses three customer segments in its materials: “entrepreneurs”, “SMBs” and “Larger Brands”). The company offers multiple pricing tiers (“Basic”, “Shopify” and “Advanced”) for SMBs, and in 2014, launched Shopify Plus, an enterprise offering, to pursue larger brands. FIGS, a healthcare apparel brand, which launched on Shopify in 2013 and went public in 2021, is a great testimonial to the power of Shopify.

From its early days, Shopify has been actively investing in growing an ecosystem of third-party developers, which were building extensions and custom designs. As of 2022, Shopify App Store features over 8,000 applications and themes. In addition to powering online stores, Shopify helps merchants with reaching prospective clients across multiple social media platforms and marketplaces, such as Facebook and Instagram, YouTube, TikTok, and eBay (this set of products is often referred to as “Social Commerce”).

Image source: Shopify Plus

During the pandemic, the company also launched Shop App (2020), a mobile consumer shopping and discovery application, and Shopify Markets (2021), a localization solution allowing merchants to sell internationally. While still early in their respective life cycles, the Shop App was the third most downloaded shopping app in the United States in 2021 with estimated 30 million downloads, and the Shopify Markets solution is already used by more than 100,000 merchants.

At the end of 2021, 55% of Shopify merchants were based in North America, 25% in Europe, the Middle East, and Asia (EMEA), 15% in the Asia-Pacific region (APAC), and 5% in Latin America. In terms of revenue, 71% of the company’s income comes from its customers in North America, followed by EMEA (17%), APAC (10%), and Latin America (1%).

Image source: Shop App on Google Play

In 2013 Shopify ventured into the financial services world by launching Shopify Payments, a fully-integrated payment processing solution, and introducing Shopify POS, a point-of-sale solution aimed to support merchants with a brick-and-mortar presence. Building on the success of its financial products, in early 2016 the company announced the launch of Shopify Capital, a merchant cash advance solution, and, Shop Pay, a checkout solution that later would expand beyond the Shopify ecosystem.

Financial services, and Shopify Payments, in particular, are major drivers of the company’s revenue growth, so the company continuously launches new products and services. There is also Shopify Balance, a free business account for merchants, and Shopify Installments, a Buy-Now-Pay-Later product that the company offers in partnership with Affirm, and I would expect more products to come in the future. At the end of Q2 2022, Shopify Payments offering was available in 18 countries, while Shopify POS was available in 13 countries.

Image source: Shopify POS

Finally, in 2015, Shopify embraced the ambition of helping merchants with shipping and delivery, launching Shopify Shipping, a service offering merchants discounted shipping with local postal services, such as USPS, UPS, and DHL in the United States. In 2019, the company made an even bolder bet on the logistics business by launching the Shopify Fulfillment Network (or SFN), a network of partner-operated and fully-owned fulfillment centers across the United States. SFN enables merchants to store and ship merchandise directly from SFN fulfillment centers with the ambition to enable a two-day delivery.

During Q4 2021 earnings call, the company’s management announced the intention to redirect all gross profit and invest approximately $1 billion into the development of the Shopify Fulfillment Network over the 2022-2024 period. The company further doubled down on its intentions by acquiring Deliverr, an e-commerce fulfillment company, for $2.1 billion, with $1.7 billion paid in cash and $0.4 billion paid in company stock. The acquisition of Deliverr closed in July 2022.

Image source: Shopify Fulfillment Network

Before moving to the financials, I would like to mention the four investment “themes” that Shopify is pursuing: a) Building buyer relationships (“extending ways for merchants to connect with more buyers” by investing in Shop App, Shopify POS, Shop Pay, and Social Commerce), b) Going global (“helping merchants reach buyers globally” by investing in Shopify Markets), c) Growing from first sale to full scale (“make it easier for merchants to be successful at any stage” by investing in Shopify Balance, Shopify Capital and app ecosystem), and d) Simplifying fulfillment (“continue building simple and fast fulfillment”, including consolidation of the network into larger facilities).

Gross Merchandise Volume

Two key performance indicators for the company are Gross Merchandise Volume (or GMV) and Gross Payment Volume (or GPV). Shopify defines GMV as “the total dollar value of orders facilitated through our platform including certain apps and channels for which a revenue-sharing arrangement is in place in the period, net of refunds, and inclusive of shipping and handling, duty and value-added taxes.” GPV is the amount of Gross Merchandise Volume processed through Shopify Payments.

Gross Merchandise Volume grew at a Compound Annual Growth Rate (or CAGR) of 61% during the 2017 - 2021 period, reaching $175.4 billion in 2021. GPV grew at a CAGR of 71% during the 2017 - 2021 period, reaching $85.8 billion, or 49% of GMV, in 2021. GMV and GPV are the key drivers of “Merchant solutions revenue”, the core element of the company’s income (more on that below).

The chart below illustrates the impact that the COVID-19 pandemic had on Shopify's business. Thus, GMV more than doubled during 2020, as the businesses faced lockdowns and moved online. However, the YoY growth of GMV has been cooling down since Q2 2021, reaching just 11% in Q2 2021. Please note that Shopify’s GMV has seasonality with Q1 being the least active quarter, and Q4 being the most active quarter.

To offset the slowdown in e-commerce sales, Shopify started investing aggressively into its POS offering aimed at bring-and-mortar merchants, as well as merchants having an omnichannel presence. Thus, in 2022, the company expanded the offering to Belgium, Spain, Denmark, Italy, and Singapore bringing the total number of markets to 13. For now, the company does not disclose offline GMV, or GPV processed via Shopify POS, but this is definitely an initiative to follow closely.

Shopify Payments is a fully-integrated payment processing service, allowing merchants to accept payments online and offline without a need for a third-party gateway or processor (meaning Shopify gets to keep the full merchant discount rate). Consequently, although Shopify earns referral fees from third-party processors for the portion of GMV that is not processed via Shopify Payments, it is financially beneficial for the company to handle the whole process end-to-end. The share of GMV processed via Shopify Payments continued to increase into 2022.

Revenue

Shopify disaggregates its revenue into two categories: “Subscription solutions revenue” (sale of subscriptions to the platform, including the variable component from Shopify Plus subscriptions) and “Merchant solutions revenue” (payment processing fees, currency conversion, sales of POS hardware, interest on merchant cash advances, BNPL income, shipping and fulfillment fees, advertising revenue, etc).

The company does not provide a further breakdown of merchant solutions revenue, but the 2021 annual report states that Shopify “principally generate[s] merchant solutions revenues from payment processing fees and currency conversion fees from Shopify Payments.” For instance, Merchant solutions revenue increased from $936 million in 2019 to $3,270 million in 2021 (an increase of $2,334 million over two years), and $1,714 million of this increase (or 73%) came from Shopify Payments.

Shopify’s total revenue grew at a CAGR of 62% over the 2017-2021 period, reaching $4.61 billion in 2021. Subscription revenue grew at a CAGR of 44% and Merchant solutions revenue grew at a CAGR of 73% over the same period. As can be seen from the table below, the share of Merchant solutions revenue has been consistently increasing, reaching 71% of the total revenue in 2021.

As illustrated by the chart below, revenue growth decelerated in the first half of 2022. The company’s management does not provide guidance on revenue growth, just noting that “Merchant solutions revenue growth YoY to be more than double that of subscription solutions revenue growth for FY22”, and that “GMV growth to outpace overall retail growth in 2H22.”

Although the company does not report its Take Rates, we can calculate Merchant Solutions Take Rate (by dividing Merchant solutions revenue by GMV), and Total Gross Take Rate (by dividing Total revenues by GMV). Merchant solutions revenue is driven by the GMV, while Subscription solutions revenue is primarily driven by the number of customers. You can think of the take rates as follows: Shopify earns 2% of GMV in Merchant solution revenue, and an additional 0.8% of GMV in Subscription solutions revenue (using Q2 2022 data from the chart below).

Gross Profit

Shopify calculates gross profit by deducting direct costs associated with providing the service (“Cost of revenue”) from the total revenue. The company reports the cost of revenue for each revenue category. Thus, “Subscription solutions cost of revenue” includes “infrastructure, hosting costs and other direct costs, allocated cost of the operations and support functions, credit card fees related to billing merchants, amortization of acquired intangible assets and internally developed software.”

“Merchant solutions cost of revenue” includes “payment processing and interchange fees related to Shopify Payments, credit card fees related to billing its merchants, amortization of acquired intangible assets and internally developed software, POS hardware costs, infrastructure and hosting costs, and an allocated costs the operations and support functions.” In addition, “Merchant solutions cost of revenues” includes costs “of warehouse storage, outbound shipping, picking, packaging, and the preparation of orders for shipment as part of the Shopify Fulfillment Network offering.”

Shopify’s gross profit grew at a CAGR of 60% during the 2017-2021 period, reaching $2.48 billion in 2021. The compound growth of gross profit was closely aligned with the growth of the revenue (60% vs. 62%), indicating that the company managed to sustain its gross profit margin over the period. Thus, as the table below illustrates, the gross profit margin experienced only a minor compression, declining from 56% in 2017 to 54% in 2021.

It should be noted that gross profit margin compression is the result of a higher share of Merchant solutions revenue, which has a lower margin than Subscription solutions revenue. As can be seen from the chart below, Shopify consistently generates ~80% gross profit margin on its Subscription solutions revenue, and ~40% gross profit margin on Merchant subscriptions revenue. The gross profit margin on Subscription solutions revenue was stable over the last 5 years, and even slightly improved in the case of Merchant solutions revenue.

The company’s management expects “gross profit dollar growth to trail revenue growth due to a larger mix of Merchant Solutions”; however, as the chart below illustrates, there is only minor margin compression taking place in 2022. As an oversimplification, one can calculate Shopify’s expected gross profit as GMV * 2.8% (total gross take rate) * 50% (total gross profit margin). You can think of gross profit as the money left to cover operating expenses, as well as pay interest and taxes.

Operating Expenses

Shopify groups its operating expenses into four categories: “Sales and marketing” (41% of total operating expenses in 2021), “Research and development” (39%), “General and administrative” (17%), and “Transaction and loan losses” (4%). The first three categories are self-explanatory, while “Transaction and loan losses” is the increase/release in the provisions for losses related to Shopify Payments, Shopify Capital (Merchant Cash Advances), Shop Pay Installments, and Shopify Balance.

Operating expenses grew at a CAGR of 51% during the 2017-2021 period, reaching $2.2 billion in 2021. The growth in operating expenses considerably lagged behind the growth of both revenue (62% CAGR) and gross profit (60% CAGR) during the same period. Nevertheless, Shopify reported Operating income only during the two pandemic years of 2020 and 2021 (see table below), and the company is on track to return to an operating loss in 2022.

The chart below illustrates perfectly the positive impact that the COVID-19 pandemic had on Shopify’s financial performance. The company turned from an operating loss of $73.2 million in Q1 2020 to an operating income of $139.4 at its peak in Q2 2021. Shopify returned to an operating loss in 2022, which resulted in the company freezing hiring and laying off 10% of its workforce in July 2022.

Before the pandemic (2017-2019), the company has been consistently operating with operating expenses representing ~64% of the total revenue (see table above). As the revenue skyrocketed during the pandemic, this ratio decreased to 40%+; however, is returning to the pre-pandemic level reaching 65% in Q2 2022 (see the chart below). The company’s management expects the growth of operating expenses to “decelerate in Q3 and again in Q4”; however, did not provide more specific guidance.

Gross profit is the money left to cover operating expenses, as well as pay interest and taxes; thus, if the operating expenses, relative to revenue, stabilize at the pre-pandemic level of 64-65%, the company will be reporting an operating loss given the gross profit margin of 50-52% (resulting in a negative operating margin of 12-15%).

Net Income (Loss)

Shopify reported a Net income of $2.9 billion, and an Adjusted Net income of $814.4 million in 2021. The company calculates Adjusted Net Income by deducting from GAAP Net Income, the share-based compensation, and related income taxes, amortization of acquired intangible assets, and gain (loss) on equity investments.

Thus, in 2021, Shopify booked a gain on its equity investments of $2.86 billion. In particular, these are investments in Affirm and Global-E, which Shopify received as incentives for partnerships (i.e. Shopify partners with Affirm on Shop Pay Installments). Both, Affirm and Global-E, went public in 2021, which resulted in a gain on equity investment for Shopify.

As the stock market started correcting in Q4 2021, Shopify had to start booking losses on these investments. Thus, it booked a $0.51 billion loss on equity investments in Q4 2021, and a $2.57 billion loss in the first six months of 2022. As the chart below illustrates, the company’s Net income evaporated and turned to Net loss. Moreover, in Q2 2022 Shopify reported a net loss even on an adjusted basis.

The company’s management did not provide Net Income or Adjusted Net Income guidance for the full year 2022, but guided for $750 million in stock-based compensation and $62 million in amortized intangible assets. Some back-of-the-envelope calculations: $190-200 billion in GMV * 2.8% take rate = $5.3-5.6 billion in revenue for the year. A negative 15% operating margin would result in an $800-840 operating loss, or approximately break-even Adjusted Net income given $812 million in adjustments for stock-based compensation and amortization.

At end of Q2, 2022 Shopify had $6.95 billion in cash, cash equivalents, and marketable securities. However, it closed the Deliverr acquisition in early July 2022, so the cash balance should have decreased by $1.7 billion.

Things to Watch

• Gross Merchandise Volume. As I illustrated in the text above, Shopify has managed to maintain (and even slightly improve) its gross take rates, which means that the company’s revenue is purely a function of Gross Merchandise Volume. GMV growth decelerated to 11% YoY in Q2 2022, so let’s see how it evolves over the rest of 2022 and into 2023.

• Shopify Payments / Shopify POS. In a longer-term perspective, I believe the transition from the “online” to the “offline” world is critical for the company. The pandemic did not result in a sustained acceleration of e-commerce, and offline commerce share is back to 85% of the total retail sales. This is a huge opportunity for the company, and its POS offering.

• Shopify Fulfillment Network. The company’s bet on Shopify Fulfillment Network (SFN) seems like an expensive and risky bet. The company plans to invest $1 billion in its fulfillment network during 2022-2024, and has just spent $2.1 billion to acquire Deliverr ($1.7 billion in cash, and $0.4 billion in stock) and double down on its ambition. Tobi Lütke, the founder of the company, explained on one of the calls that tech companies grow by making bets, and SFN is Shopify’s current bet.

• Tech Partnerships. Shopify is actively pursuing partnerships with other tech companies, such as Flexport, Affirm, and Global-E, and I expect more great things to come out of such partnerships. Tobi Lütke also sits on Coinbase Board, so perhaps, it’s time to strike a partnership with the crypto giant?

Source of the data used above: Investor Relations

Disclosure & Disclaimer: despite rocky performance in 2021 and 2022, I own shares in most of the companies covered in this newsletter, as I am extremely bullish on the long-term transformation in the financial services industry. However, none of the above is or should be considered financial advice, and you should do your own research.