To The Moon

Introduction

My thesis is that Shopify (NYSE:SHOP) is helping merchants take some of the complexity out of freight, distribution, fulfillment and delivery.

Simplifying Logistics

Using their merchant-centric focus, Shopify is implementing an asset-light approach to help simplify logistics - especially forsmall and medium sized merchants. Freight, distribution and fulfillment/delivery are key steps and Shopify is making progress across the board. In the 1Q22call, President Harley Finkelstein noted that supply chain management and fulfillment are challenging for merchants. He said Shopify is creating an end-to-end logistics platform that will simplify the process:

To actually get an order to a buyer, they have to fumble through a maze of freight providers, 3PLs and middle and last-mile carriers. We know merchants trust Shopify to offer simple, reliable, cost-effective solutions to their biggest problems. That's why we're creating the world's most merchant-obsessed, end-to-end software and logistics platform, fully integrated into the Shopify ecosystem. We are simplifying logistics across every stage of a merchant supply chain, from inventory inbounding to inventory distribution across all merchant channels, to fast and affordable D2C order fulfillment and returns.

President Finkelstein went on in the 1Q22 call to announce the acquisition of Deliverr which is accelerating Shopify’s path to an end-to-end merchant supply solution. The 2Q22presentationexplains the ways Shopify is simplifying logistics:

simplifying logistics(2Q22 presentation)

Freight

On the freight side, Shopify has invested in Flexport, a company that helps merchants with inventory inbounding. Dave Clark left a senior management position at Amazon (AMZN) and he’ll soon be the CEO of Flexport starting September 1st. Shopify President Finkelstein breaks down freight in the 2Q22call, saying merchants need to work with upwards of 10 vendors in a system that is often set up at the container level. Shopify and Flexport have a pilot program together where merchants can ship at the pallet level instead of the container level. Speeds can be up to 50% faster with a lower than average cost per pallet. Flexport is shown as a key part of inventory inbounding in Shopify’s 2Q22 presentation:

flexport(2Q22 presentation)

Distribution

President Finkelstein covers distribution in the 2Q22 call. As inventory arrives in port, independent merchants can have a hard time preparing and routing it for distribution across multiple channels. Shopify closed their acquisition of Deliverr in July in order to accelerate the simplification of the distribution process, starting in Atlanta:

The first example of this will be at our Atlanta Hub warehouse. Using software and machine learning, these SFN hubs, leveraging Deliverr's capabilities, will unpack, scan and inspect all inventory, then compare against metadata in Shopify's back office to route the goods to a merchants' various distribution channels as well as forward-position inventory into SFN-spoke direct-to-consumer fulfillment centers based on expected buyer demand. With this software-based approach, Deliverr is helping us expand 2-day delivery across SFN.

At the August Canaccord GrowthConference, Senior Manager Ana Raman explains that Deliverr is acting as an accelerant in various channels such as wholesale and brick-and-mortar:

So Deliverr is really helping to accelerate a roadmap that we already had planned. Now they're just helping us get there faster. So things like distributing product through channels, so multiple channels. So whether that is B2B wholesale, whether that is brick-and-mortar, whether that is any online channel from marketplaces to social media or the merchant's online store. With their smart inventory placement, we're going to be able to really effectively allocate inventory through the channels

The 2Q22 presentation shows how Deliverr helps with distribution:

Deliverr(2Q22 presentation)

Fulfillment and Delivery

In the 2Q22 call, Shopify President Finkelstein explains that the last step in logistics is 2-day fulfillment and delivery. It is the most critical step and in the past it has been hard for merchants to get this right on their own. The numbers show that conversions increase when merchants can promise a delivery window - even if it is up to 3 or 4 days:

By leveraging Deliverr software in SFN hubs and SFN Spoke partner warehouses all equipped with 6 River Systems technology, we can forward position merchants inventory to support timely fulfillment with a minimal inventory commitment for merchants. We've also continued our early access to Shop Promise, which lets merchants offer 2-day delivery promises across online storefronts and channels like Google, Facebook and Instagram. Deliverr data suggests that as Shop Promise reaches scale, many merchants will be able to increase average conversion rates by more than 30%.

The 2Q22 presentation shows that the “Shop Promise” badge helps merchants give customers peace of mind with respect to delivery timelines:

fulfillment(2Q22 presentation)

Valuation

Shopify’s 202140-Fshows 64.5% of revenue coming from the U.S. and eMarketershowsthat in 2021, only 15% of total retail in the U.S. was done online. Shopify will benefit in the coming years as the U.S. increases this percentage to be more like the UK where 28.5% or total retail was online per eMarketer. Commerce keeps moving online in the U.S. and around the world but this doesn’t benefit all companies equally. In the 3Q21 BigCommerce (BIGC)call, CEO Brent Bellm answered a question about the companies they’re displacing. BigCommerce, Shopify and Salesforce (CRM) are all taking customers from on-premise Magento (ADBE) and around 500 other platforms:

And the easy thing to say is Magento is by far the biggest donor platform to us. But in aggregate, they're probably - I mean, I don't have the specific figure, they're probably no more than 20% of the mid-market and above migration, an awful lot of custom sites and then a very long tail. I mean we get sites migrating from every other platform that you can imagine, big, small, old, really old. It's really all of them. The point is that as you look forward, SaaS is clearly the future for most merchants. There are 3 leading SaaS platforms. You know those 3:it's us, Shopify and at the high end of the market, Salesforce. And all 3 of us are taking share from the rest of themin addition to competing for net new builds.

Back in 2016, Shopify’s annual GMV was just $15.4 billion and it grew explosively over the next 5 years to reach $175.4 billion in 2021:

GMV growth(Author’s spreadsheet)

GMV growth has slowed down substantially since the fourth quarter of 2021. 1Q22 GMV was $43.2 billion which was only 16% above what we saw in 1Q21 and 2Q22 GMV was $46.9 billion which was only 11% above what we saw in 2Q21. Much of this slowdown is because of the pull-forward we saw from covid in 2020 and 2021. The 2022 GMV growth rate might end up being single digits but I am optimistic that it will go back to healthy double digits in 2023 - maybe between 20 and 30%.

I am optimistic that half or more of merchant solutions gross profit dollars could make their way down to operating income if growth investments were paused. One of the reasons for this optimism is due to the fact that much of the merchant solutions gross profit is payment related and BigCommerce CEO Brent Bellm said the following at the December 2020 Raymond James Technology Investors Conference:

Remember, net margin is really important to focus on because credit card interchange is such a big part of cost of goods sold for any payment processing fees. So we're getting, let's call it, very 100% profit margin to us. Rev share from these strategic partners and that -- and the rev share we get constitutes a very meaningful percentage of the net margin on transactions.

Half of TTM gross profit for merchant solutions comes to $751 million. It is difficult to say what type of multiple this segment deserves in an environment where its gross profit growth has been slowing and interest rates have been going up. We won’t see year-over-year growth of 175% again anytime soon but I also think we can do quite a bit better than the 7% y/y growth we saw in the most recent quarter. Based on tremendous growth possibilities, I think a multiple of 40x to 50x is not out of the question such that this segment alone could be worth $30 to $38 billion.

Today’s market cap is a little about $41 billion based on the August 26th share price of $32.42 and the 1,262,011,665 shares in the 2Q22 release. The enterprise value is less than the market cap seeing as cash and marketable securities outweigh other balance sheet considerations. I think the stock is undervalued, seeing as the market cap is less than my valuation range for the sum of the merchant solutions and subscription solutions businesses.