Why We Cut Shopify's Fair Value

After missing on results for a few quarters now, these concerns at the Canadian e-commerce giant have us wondering if the company is cursed.

Ruth Saldanha 6 July, 2022 | 4:39AM
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Ruth Saldanha: Earlier this year, we asked if Shopify is cursed. To remind you, in May 2020, Shopify (SHOP) briefly became the largest company in Canada by market cap, dethroning the Royal Bank of Canada to gain that top spot. Now, there's this idea that if any non-bank becomes the biggest Canadian company, it immediately tanks, and that kind of seems to have happened with Shopify. The stock is down over 70% since last year. So, what should we make of this? And is this a buying opportunity? Or is it going to go the way of previous recipients of the curse with names like Nortel or Valeant Pharma or BlackBerry being cursed in the past? Morningstar analyst, Dan Romanoff, is here today to tell us what he thinks about this.

Dan, thank you so much for being here today.

Dan Romanoff: Thanks for having me.

Saldanha: The last time we met, you said you didn't believe in the curse. So, what do you think now?

Romanoff: Yeah, I definitely do not believe in the curse here, and I think some of those examples are pretty extreme there. With Nortel and BlackBerry, you're talking about companies that either went fully bankrupt or sort of dwindled away to nothing. But at the same time, Shopify is not – it's not equivalent at all. It does about a billion dollars of recurring revenue from enterprise customers annually. So, that is a pretty profitable and attractive revenue base that's not going to evaporate. And of course, there's the rest of the software business from the SMB, and then all of the merchant solutions on top of it. So, this is a big business. Software tends to be recurring in nature, and it generates a lot of free cash. Although that's not really the case with Shopify just yet, but they are investing a lot for their big plans. So, no, I don't really believe in the curse. But I certainly acknowledge that the stock has, let's say, retreated a little bit from its highs six or eight months ago.

Saldanha: Well, recently you also reduced your fair value estimate. So, what were some of the reasons for that? And just last week the stock did split. Has that impacted your analysis in any way?

Romanoff: Okay. So, two questions there. I'll try and take them one at a time. So, the first one, yes, we definitely reduced our fair value estimate pretty substantially. We cut it loosely in half. And I would say that in the runup the stock was trading loosely $1,600 or $1,700 at its peak in U.S. dollars. At that time, our fair value estimate was a little over US$800 as I recall. And our point during all of that runup is this is unsustainable, times are great now, but in order to believe like a valuation of where it's trading now, you have to make some pretty extreme assumptions, like 10 and 20 years out, to support that kind of valuation, and I just didn't believe it.

So, now, we're several quarters sort of post-COVID lockdown, the easing period, and Shopify has sort of missed on results a few quarters in a row already. So, like, they don't give explicit guidance. They give you some qualitative guidance. And sort of based on the results and some of the commentary they make we're trying to adjust our models in real time. And so, it's very challenging in the case of the extreme runup and sort of the extreme rundown, if you will. So, we struggle with that a little bit. And now, they're talking about a substantial increase in expense levels as they are building out the Shopify fulfillment network. And we had – I mean, we definitely had increase in expenses to account for that, but not nearly to the level they seem to be guiding to. So, for that reason, took a little bit out of our growth, took a lot more out of our profitability estimates though over the next 10 years and hence sort of this second big fair value estimate cut.

Oh yeah, and then – I'm sorry – on the stock split, yeah, I don't really think that that impacts our valuation at all. Obviously, we just took our fair value estimate and sort of divided it by 10 to account for the new share count. But in reality, – so, sure, I think that a stock split is good for retail investors, as like an individual investor who maybe couldn't even afford a US$450 share price for Shopify just a few months ago, now, all of a sudden, yes, they can afford a $30 stock or potentially they could afford that. So, I think that is good for individual investors overall. But in reality, it doesn't change the underlying fundamentals. It doesn't change the growth trajectory of the company or the margin profile that they might exhibit over the next few years.

Saldanha: Great. The last thing I wanted to talk about was governance. Now, one of the things that worried a few shareholders was the fact that the CEO would have special voting rights. Are you worried about that at all?

Romanoff: So, I'm going to give you a nuanced answer here, and it's kind of a little bit of yes and no. So, from a high-level perspective, I generally do not like to see – from an ESG perspective, I don't like to see my companies sort of moving power back to management. I don't think that is generally a good path for investors. They should be able to have their voting rights sort of retained. So, having said that, Tobi is the CEO, his voting rights were around 40% recently and over the last couple of years, it's sort of been diminished from some acquisitions and some share issuance. So, I think, he got down to 34% of the vote. And so, Shopify is moving to restore that to 40%. That's at a high level. Like, is that the end of the world to me? No, it's not. And on top of that, I think that Tobi has made some really great decisions, and he has executed well on his strategy. Shopify is obviously, notwithstanding the runup and rundown, it's been very successful. And the vision for the fulfillment network and the Deliverr acquisition like to be a viable alternative to Amazon, like the third-party merchant solution from Amazon. I think these are all pretty obvious strategies to pursue, and they are doing it with gusto, and they're doing it properly. So, I think that Tobi should get a little bit of a leash. And so, to restore his voting rights back to around 40%, I don't think that's the end of the world. Of course, I would prefer that this generally doesn't happen. And then, there are some other nuances within the governance structure that made the restoration of his voting power a little unique. And I would say the same thing about those. I generally don't think that companies should sort of bend over backwards to concentrate or reconcentrate, in this case, voting power back in the hands of management teams. So, sorry, a little bit of a yes and a little bit of a no there.

Saldanha: Great. Thank you so much for being here today, Dan.

Romanoff: Sure. No problem. Thanks for having me.

Saldanha: For Morningstar, I'm Ruth Saldanha.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Shopify Inc Registered Shs -A- Subord Vtg80.41 CAD3.29Rating

About Author

Ruth Saldanha

Ruth Saldanha  is Editorial Manager at Morningstar.ca. Follow her on Twitter @KarishmaRuth.


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