I know, I know. Shopify Inc (NYSE:SHOP) looks absurdly expensive. The SHOP stock price sits at roughly 11 times 2018 revenue expectations. And Shopify stock trades at a crazy 240 multiple to 2019 consensus earnings per share (EPS).
There’s a reason why short sellers like Citron Research have taken aim at SHOP. From a valuation standpoint alone, I can see why some investors might want to step aside, if not join the shorts.
But Citron’s case actually falls flat upon closer inspection, as I wrote last year. And while SHOP is expensive, it also has one of the best growth stories in the market. The company is disrupting the B2C (business-to-consumer) market — and the more lucrative B2B (business-to-business) market could be next. There’s a reason the SHOP stock price climbed so high before the recent pullback — and plenty of reason to believe Shopify stock can again reach those levels.
After the SHOP stock price shook off Citron’s first report in October, Citron added a new angle last month. The firm argued that the data scandals surrounding Facebook, Inc. (NASDAQ:FB) would bleed over to Shopify.
It’s essentially a different version of the same song. Citron’s broad contention is that Shopify is benefiting from merchants using shady tactics and from overpromising at-home users about the potential of opening online stores. That’s why, the firm argues, Shopify doesn’t disclose churn (how many customers leave the platform). It’s an unsustainable strategy — one that, eventually, will run out of potential customers. At that point, Shopify’s growth will decelerate, and its stock will plunge.
In some ways, it’s similar to the short case made by Bill Ackman and others surrounding Herbalife Ltd. (NYSE:HLF). Ackman lost literally billions of dollars on his HLF short — and the case against Shopify isn’t nearly as strong.
Even the article Citron cites that discusses the “fake news of e-commerce” only mentions a handful of Shopify customers. It also notes that the platform cut off customers upon being told they were selling what were knock-off goods. Citron is arguing that there is this massive Shopify-related underworld of affiliate marketers and shady resellers. But it doesn’t have the data to back up that contention.
Admittedly, that’s because Shopify hasn’t disclosed some of that data, including churn. But that doesn’t prove Citron’s point alone. And what data Shopify does disclose paints a very different picture.
The Growth Opportunity
Shopify ended 2017 with 609,000 merchants worldwide, 56% of whom were in the U.S., according to its year-end 40-F. Unless there’s a material number of those merchants using questionable strategies, Citron is ignoring a hugely successful business while focusing on a few bad apples.
And those merchants are driving incredible growth. Revenue grew 71% in 2017. It’s likely to grow close to 50% in 2018. Profitability is minuscule – but margins will expand as Shopify builds scale, improves operations, and can pull back on marketing. Acquired customers are extremely high-margin; there’s a reason the SaaS model Shopify uses drives such high valuations elsewhere in the industry.
Indeed, Shopify plans to get non-GAAP operating margins from roughly zero in 2018 to 20-30% over the next 5-10 years. So profitability should come at some point. In the meantime, Shopify is benefiting from the same trends that are helping stocks like Square Inc (NYSE:SQ). Small businesses finally have the ability to use the Internet in the same way as their bigger rivals. And with millennial attitudes, in particular, favoring those smaller, unique, offerings, that creates a huge playing field in B2C for Shopify going forward.
Add to that the B2B opportunity. Shopify Plus has been rolled out, with the company already picking up Ford Motor Company (NYSE:F) as a customer. That adds another multi-billion-dollar opportunity — and an even longer runway for growth.
If Citron is wrong — and I believe that it is — there’s an enormous opportunity ahead of Shopify, and years of revenue growth and margin expansion. The question, even after the pullback, is what that opportunity is worth.
What’s Shopify Stock Worth?
Again, at 11 times revenue, Shopify stock isn’t cheap, or even close. But SaaS stocks generally aren’t. High margins and sticky revenue mean investors will pay a premium for the business model.
I argued after the Q4 report, with the SHOP stock price at $137, that there was still more room for upside. That continues to be the case. Margin and revenue targets suggest a path to at least $5 in EPS over the next few years. With salesforce.com, inc. (NYSE:CRM) at 65x EPS and Workday Inc (NASDAQ:WDAY) at 105x, that suggests a multi-year trek for SHOP to over $200 and likely a double — at least.
Even discounted back, that suggests a current valuation in the range of $150-$175 per share. Analyst targets are more conservative, at $145. Even that figure still represents almost 20% upside from current levels.
Again, SHOP isn’t cheap. But growth stocks rarely, if ever, are. It’s going to come down to execution, and the story. And while Citron has raised some doubts in the minds of some investors, I believe the long-term story here will win out.
And if that comes to pass, Shopify stock should rebound nicely — and provide attractive returns both near-term and long-term.
As of this writing, Vince Martin has no positions in any securities mentioned.
