🛍️ Shopify: Back to the Main Quest
Exiting logistics to focus on simplifying commerce
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Shopify (SHOP) reported its Q1 FY23 earnings last week.
Today, we’ll cover the following:
Shopify Q1 FY23.
Recent business highlights.
Key quotes from the earnings call.
What to watch looking forward.
In a surprising turn of events, Shopify is making a 'full-180' on its strategy: the company is cutting jobs for the second time in 10 months. It has announced the sale of its logistics business to Flexport Inc. This comes less than a year after Shopify's $2.1 billion acquisition of Deliverr in July 2022.
In retrospect, Shopify's successful expansion into payments and merchant solutions seems to have led the company to an overly optimistic assumption that it could reap similar benefits in the logistics sector.
This strategic pivot signals Shopify's intent to refocus on its core e-commerce platform business, marking a shift from a capital-intensive approach back to its original asset-light model.
Let’s dive in!
1. Shopify Q1 FY23
Before we begin, here is a reminder of some acronyms:
GMV = Gross Merchandise Volume (dollar value of orders facilitated).
GPV = Gross Payments Volume (GMV processed through Shopify Payments).
MRR = Monthly Recurring Revenue.
SFN = Shopify Fulfillment Network.
GMV grew +15% Y/Y to $49.6 billion (+18% in constant currency).
GPV grew +25% to $27.5 billion, making up 56% of GMV (+5pp Y/Y).
MRR grew +10% to $116 million (34% coming from Shopify Plus).
Attach rate was 3.04% (up from 2.79% in Q1 2FY22), the highest ever.
The "attach rate" refers to the percentage of GMV that becomes revenue for Shopify. An increase means Shopify is adding more value for merchants, and the moat is expanding.
Here is a bird’s-eye view of the income statement.
Revenue grew +25% Y/Y to $1.5 billion ($70 million beat), or +27% Y/Y fx neutral.
💳 Merchant solutions grew +31% to $1,126 million.
➕ Subscription revenue grew +11% to $381 million.
Merchant Solutions have significantly grown as a percentage of total revenue, increasing from 53% in Q1 FY18 to 75% in Q1 FY23. Shopify Payments largely drove this growth. It's also important to acknowledge the growth in Subscription Solutions, which have almost quadrupled in the past five years. Despite the relative decrease in their share of total revenue, they continue to play a crucial role in Shopify's business model.
Gross margin was 48% (-5pp Y/Y, +2pp Q/Q).
Operating loss margin was -13% (-5pp Y/Y, +12pp Q/Q).
Adjusted operating loss margin was -2% (-5pp Y/Y, +1pp Q/Q).
Non-GAAP EPS was $0.01 ($0.05 beat).
Operating cash flow was $100 million (7% margin, +9pp Y/Y).
Cash and cash equivalent: $4.9 billion.
Long-term debt: $0.9 billion.
Q2 FY23 Guidance:
Revenue growth is expected to be similar to Q1 (+27% Y/Y in constant currency).
Gross margin is expected to be sequentially (48%).
Operating expenses to decrease in the single digit % vs. Q1 FY23.
Stock-based compensation to decrease to $110 million.
Capex ~$100M million in FY23.
So what to make of all this?
Revenue exceeded expectations, reaching +25% Y/Y versus the expected +19%. Shopify shows signs of a clear rebound after a massive growth acceleration caused by COVID in 2020 and 2021, followed by a hangover in 2022. Let’s look at the revenue growth since 2019:
FY19: +47% Y/Y (AKA “pre-COVID”).
FY20: +86% Y/Y.
FY21: +57% Y/Y.
FY22: +21% Y/Y.
FY23 (first half): +25% Y/Y (or 27% in constant currency).
The post-COVID hangover may be behind us. Overall, seeing the company re-accelerate toward its pre-pandemic growth is great.
Shopify grew faster than Amazon 3rd party seller services (+18% Y/Y in Q1 FY23), illustrating market share gains.
Shopify Payments penetration rate hit an all-time high of 56% (+5pp Y/Y). The strong performance of merchants using Payments was a factor.
Shopify Plus represented 34% of MRR (+4pp Y/Y), showing that Shopify merchants are growing alongside the platform.
The losses were not as bad as feared by Wall Street. But make no mistake; the company has a lot of work ahead. Management is re-investing aggressively in the business, from POS to marketing services.
MRR growth is expected to benefit from pricing changes to the standard subscription plans that took effect in late April.
Basic: $29 ➡ $39.
Shopify: $79 ➡ $105.
Advanced: $299 ➡ $399.
The logistics exit is expected before the end of Q2, so management factored it into the outlook.
Is the business sustainable?
Shopify generated positive operating cash flow for most of its life as a public company. Management expects positive free cash flow for each quarter of 2023.
However, the company's aggressive hiring strategy in response to the pandemic-driven demand surge in FY20, coupled with heavy investment in logistics through its acquisition of Deliverr, led to negative cash flow margins in FY22. As a result, the company now needs to adjust its strategy to restore balance.
Shopify has a robust balance sheet with a net cash position close to $4 billion, which gives ample room for the company to fuel its growth path forward, even assuming a global recession in 2023.
After cost-control efforts and a potential growth re-acceleration for e-commerce, the cash flow margin should improve. So the business continuity doesn’t appear at risk in the near term.
2. Recent business highlights
Let’s get to the meat and potatoes of this quarter: the end of logistics.
Founder-CEO Tobi Lutke wrote a letter on important changes.
As a former executive in the gaming industry, I love a good video game analogy:
“Shopify finds it useful to talk about the difference between main quests and side quests internally. The main quest of the company is its mission, the reason for the company to exist. Side quests are everything else. Side quests are always distracting because the company has to split focus. Sometimes this can be worth it, especially when engaging the side quest creates the conditions by which the main quest can become more successful. […]
Shopify’s main quest is to make commerce simpler, easier, more democratized, more participatory, and more common. I think that we have built the best commerce platform in the world for that. […]
Logistics was clearly a worthwhile side quest for us, and started to create the conditions for our main quest to succeed. From the beginning, we worked with lots of partners on all aspects of this same problem: warehouses, robotics, transportation, crossdock, freight. We iteratively built a solution, step by step, through software, leases, and M&A deals, that could be an independent company one day. Shopify was the perfect place to bootstrap this effort from 0 to 1 and we have done this. The next step is to take what we have and take it from 1 to N as a main quest.“
Shopify will sell most of its logistics business to Flexport by the end of Q2.
Flexport will become the official logistics partner for Shopify.
Shopify will receive a 13% equity interest in Flexport.
Harish Abbott, CEO of recently acquired Deliverr, will lead the transition.
Flexport CEO Dave Clark will serve as a guide.
Shopify will name a director to Flexport's board.
The transaction is expected to close in Q2 2023, subject to conditions and regulatory approval.
More context from Shopify President Harley Finkelstein:
“We are changing the shape of Shopify significantly today. The decade we're in shows the speed of change accelerating beyond what anyone has ever experienced. The pace of change can never outpace our ability to adapt. […]
So we are making changes and refocusing the priorities that we believe will get Shopify to the size and the shape necessary to unlock the next era of growth and innovation. […] This planned sale will enable Flexport to leverage their DNA in logistics and allow Shopify to focus on what we do best, designing and scaling a breadth of solutions and essential infrastructure that our merchants need to compete in an increasing digital world.”
So what are the immediate impacts on Shopify we should be aware of?
Shopify will maintain the merchant-facing SFN app, now powered by Flexport.
Shopify’s percentage ownership of Flexport will be in the high teens.
For context, Flexport raised $935 million in 2022 at an $8 billion valuation.
Workforce reduction of approximately 20%.
Some employees that are part of the reduction will move to Flexport.
The logistics sale will impact financials in the second half of FY23.
Q2 will include $140-$150 million in severance and $1-$1.5 billion in impairment related to logistics businesses. But the margins should improve after that.
Product and merchants developments
Harley Finkelstein touched on three core focus areas:
Expand from “first sale to full scale:”
The company launched Commerce Components by Shopify (CCS), a modern composable stack that provides enterprise customers with a flexible and customizable e-commerce platform.
Shopify aims to attract enterprise brands and system integrator partnerships through companies like IBM and Cognizant.
The massive volume handled during the holiday season demonstrated the platform's capacity to handle high throughput flash sales.
Cross-border sales accounted for 15% of total GMV in Q1 FY23, showcasing Shopify's growing international reach.
To further support global sales, Shopify has enhanced functionalities in Markets and Markets Pro, enabling localization of the buyer’s experience with local currencies and payment options.
Markets Pro is set to roll out in the US and the UK later this year.
Build consumer relationships (unified commerce):
Shopify's Point-of-Sale (POS) solution is gaining traction, with offline GMV increasing by +31% Y/Y. A significant development is that Intuit has decided to sunset its QuickBooks desktop POS product and chose Shopify as the preferred partner for retailers needing a new POS solution.
The Shop App, with its Shop Pay integration (the best-converting checkout on the Internet, according to management), offers a plug-and-play mobile experience that now includes an AI shopping assistant.
Shopify Audiences, a special feature for Plus merchants, drives better ad performance across Meta, Google, and Pinterest. Recent algorithm improvements have nearly doubled the return on ad spend compared to the original release.
Shopify operates outside the 'walled gardens' of Google, Meta, and Amazon - ecosystems where the platforms control the user experience and data. This approach presents challenges but offers merchants more flexibility and the opportunity to evaluate return on investments from a wider perspective.
3. Key quotes from the earnings call
During the Q&A, Harley Finkelstein added some color to the logistics exit and how Shopify has a long history of partnerships:
“Look, I think Shopify, unlike a lot of technology companies, we actually do partnerships really, really well. If you sort of go back, I don't know, 8 or 9 years ago, so when we first decided to go into the payments business, we deeply partnered with Stripe and was able to go to market much faster with an incredible product. And that partnership obviously continues. We've done the same thing with companies like Affirm when we felt that they were doing buy now, pay later better than anyone else globally on the cross-border commerce side of things. So I mean, Shopify, going back to what you heard today and Tobi's letter, but our main mission, our main quest versus side quest, we do something in the world better than anybody else, which is building commerce software. And that's what we want to be able to do. We want to focus on that. […] As we began to build out the logistics business, which started about 4 or 5 years ago, remember at the time, there was no one else that was helping small businesses, medium-sized businesses with logistics and shipping. And so even though we knew it was going to be an incubation period for us, we felt there was no one else doing it and better for us to do it than for our merchants to do it.
As things progress and we began to further and more deeply integrate with Flexport with Dave and Ryan and the team, it became clear that, that is their main quest. They are so focused on creating logistics and shipping infrastructure for small and medium-sized businesses. And this way, we get product acceleration, and we can focus on what we do best, they can focus what they do best. But again, I think we're a company that has proven that when we can build something better than anyone else, we do it, and we've done that across a whole bunch of different areas of our business. But when there's a partner that we can deeply integrate with that can get us further faster and more efficiently, we will do that, too. And that was the case here.”
On Flexport being a preferred partner but not exclusive:
“Part of our role is being the centralized operating system for these millions of businesses and brands, is to enable them to bring the best products, the best infrastructure that they need to run their business. So Flexport is going to be the preferred partner.”
4. What to watch looking forward
The evolving relationship between Shopify and Amazon will be fascinating to monitor, particularly the potential partnership involving Amazon's "Buy with Prime" feature.
Amazon's "Buy with Prime" has posed a notable threat to Shopify, primarily because it exclusively works with Amazon payments, potentially undercutting Shopify's own payment integration. With a massive user base of over 200 million Prime members worldwide (approximately 150 million in the US alone), this is a significant factor that cannot be overlooked.
Possible cooperation with Amazon: Shopify President Harley Finkelstein has expressed openness to partnering with Amazon if it serves their merchants' best interests, reinforcing Shopify's reputation as a “partnership company. It's noteworthy that Shopify's competitor, BigCommerce, has already hailed Amazon's "Buy with Prime" as “a compelling value-add for merchants aiming to increase their sales and optimize the omnichannel experience for their customers.”
Amazon's new strategic direction remains a threat to Shopify: By moving Prime out of its walled garden, Amazon is transitioning from an aggregator to a logistics-as-a-service provider, a model similar to Amazon Web Services (AWS). This change could potentially encroach on Shopify’s market.
Potential win-win situation: Industry analyst Ben Thompson suggested an agreement could be reached where Shopify merchants utilize Amazon's "Buy with Prime" while Amazon gains some of Shopify's payment margins and additional volume. This arrangement would allow Shopify to concentrate on its core business, alleviating concerns about logistics and creating mutual benefits.
That’s it for today!
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Disclosure: I am long SHOP and AMZN in the App Economy Portfolio. I share my ratings (BUY, SELL, or HOLD) with App Economy Portfolio members here.
Author's Note (Bertrand here 👋🏼): The views and opinions expressed in this newsletter are solely my own and should not be considered financial advice or any other organization's views.