In this second part of our Shopify series, we investigate the e-commerce solutions provider’s rise to being the largest Canadian company by market cap and its current valuation. We compare Shopify to both other large Canadian companies and its e-commerce peers to justify its current valuation.

Shopify began 2020 with a market cap of $60.3 billion. COVID-19 resulted in the global economy shutting down in mid-March, with global stock markets taking a hit due to the widespread economic impact. Like other e-commerce companies, Shopify experienced a surge in demand for its services as both customers and retailers focused more on e-commerce during the pandemic. On May 5th, 2020, Shopify overtook the Royal Bank of Canada (RBC) as the largest Canadian company by market cap. As of August 26, 2020, Shopify had a market cap of $171.9 billion, $27.6 billion more than RBC. Shopify’s substantial 185% increase outperformed RBC’s -3% return year-to-date.

We now compare the top five Canadian companies by market cap.

Despite leading all Canadian companies in market cap, the other metrics tell a different story about Shopify.

Shopify ranked sixth in terms of enterprise value. The company’s enterprise value lagged TD, RBC, Brookfield Asset Management ($355 billion), Bank of Nova Scotia ($244 billion) and just nosed out Enbridge. The enterprise value of these major Canadian companies indicate that their operations are funded with a larger portion of debt, as compared to Shopify which is predominantly equity funded.

From a trailing twelve-month (TTM) revenue perspective, Shopify ranked 89th out of all Canadian public companies with $3 billion in revenue (113th based on 2019 revenue). This is significantly smaller than the top five TTM revenue Canadian companies: Brookfield Asset Management ($88 billion), Alimentation Couche-Tard ($74 billion), Great-West Lifeco ($52 billion), George Weston ($52 billion) and Loblaw Companies ($50 billion).

Shopify reported $5 billion in total assets in its most recent quarter. Based on this metric, the company ranked 138th out of all Canadian public companies. The five companies at the top of the rankings: RBC, TD, Bank of Nova Scotia ($1,086 billion), Bank of Montreal ($852 billion) and Manulife Financial ($509 billion) reported total assets that dwarfs Shopify’s.

Looking at employment statistics, Shopify reported 5,000 full time employees in its most recent quarter, ranking 92nd out of all Canadian public companies. The largest public Canadian employer was George Weston, with 194,000 full-time employees reported. When compared to the top five market cap companies above, TD is the largest employer with just under 90,000 employees or nearly 18 times more employees than Shopify.

Valuation

We use three market valuation methods to compare Shopify to its peers: EV to revenue (EV/Revenue), EV to EBITDA (EV/EBITDA), and Price to Earnings (P/E). We first compare Shopify’s valuation to the top five market cap companies in Canada. In addition, we compare Shopify to other publicly traded e-commerce companies.

A.      EV/Revenue

Shopify’s Canadian peers are currently trading within a 3x and 10x EV/Revenue range. These blue-chip comparable companies are matured and have demonstrated a track record of consistent profitability. On the other hand, Shopify is a growth-oriented company. Since its 2015 IPO, the Company has experienced a compound annual growth rate (CAGR) of 63.9% on revenue. Growth companies tend to trade at a premium compared to matured companies.

To justify its trading multiple premium, we compare Shopify’s to leading e-commerce companies. We incorporate the forecasted revenue growth of each company to support our EV/Revenue analysis. Despite Shopify’s forecasted 2020 revenue growth to double both Amazon’s and Alibaba’s, Shopify’s 2020 EV/Revenue is 11 times Amazon’s and 5 times Alibaba’s respectively. When compared to ETSY’s 88.5% forecasted 2020 revenue growth which outpaces Shopify’s, ETSY is currently trading at 9.8x 2020F Revenue, 5 times less than Shopify’s.

Based on our findings, we fail to justify Shopify’s current EV/Revenue multiple. We believe the current valuation is not sustainable. The stock is clearly overbought, likely due to the continued increase in e-commerce adaptation, which has been further fueled by COVID-19. In addition, the software and technology sector has been on a historic tear in the public markets over the past six months, likely due to the perceived business resiliency as compared to other sectors which are more vulnerable to the prolonged economic impacts of the pandemic. This momentum investing in Shopify will likely decline going forward, which will cause a decline in demand for its shares. With the forecasted revenue growth rate declining over the next three years as well, we expect Shopify to trade at a lower EV/Revenue multiple as compared to its current level.

B.      EV/EBITDA

For the TTM period, Shopify reported negative EBITDA. Therefore, our EV/EBITDA comparison factors in fiscal 2020-2022’s forecasted EBITDA as per analysts’ consensus.

As seen in the EV/EBITDA comparisons above, Shopify is currently trading at a materially steep premium compared to its peers. While the EV/EBITDA multiple falls as forecasted EBITDA increases over the forecasted period, Shopify is not trading within a reasonable range as seen in both its Canadian and e-commerce peers. Even if 2022’s forecasted EBITDA is expected to double 2021’s, the 215x EV/EBITDA is still an outlier. Therefore, we deem Shopify’s current trading EBITDA multiples to be meaningless. As much of its enterprise value consist of its market cap, we believe this further supports our claim that Shopify’s stock is currently overvalued by momentum focused investors with little regard for fundamental valuation measures.

C.      P/E

Shopify reported negative earnings per share (EPS) in the TTM period. Therefore, our P/E comparison is forward looking, based on fiscal 2020-2022’s forecasted EPS as per analysts’ consensus.

Shopify is forecasted to report positive EPS for the first time since inception at the end of fiscal 2020. Based on the current P/E multiple, investors are willing to pay $449 for each dollar of its 2020 forecasted earnings. We believe this current valuation is inflated and meaningless to compare to its Canadian peers.

As expected, Shopify’s e-commerce peers are currently trading at higher P/E ratios, a common theme among the e-commerce industry especially during COVID-19. Amazon with a 2.3 trillion market cap has experienced a 90% market cap increase year-to-date. Amazon’s growth prospects are diverse as well, with its evident success in its non-e-commerce segments such as Amazon Web Services (cloud services), Amazon Go (convenience stores), Amazon Prime Video (video production and streaming) etc. Shopify is expected to grow earnings by 50% in 2022, compared to Amazon’s forecasted 43%. Despite that, Amazon is currently only trading at 109 times its forecasted 2020 EPS. Despite Shopify’s near-term growth prospects, we find it hard to justify that the company is worth four times as much as Amazon’s 2020 forecasted P/E. Even with the earnings growth in 2022, Shopify would still be trading at 312 times compared to Amazon’s forecasted P/E of 54 times. This further proves that Shopify is currently materially overvalued from a comparable standpoint.

Equity Raising

Our opinion that Shopify is overvalued is further supported by Shopify’s recent actions in the capital markets:

• May 12, 2020: Raised $1.5 billion in equity by selling 2.1 million class A shares, with the net proceeds used to strengthen its balance sheet and to fund future growth strategies.

• July 28, 2020: Filed a US$7.5 billion mixed shelf registration, giving Shopify the right to sell a variety of securities including its Class A shares, preferred shares, debt securities and warrants.

Public companies’ equity issuance can be perceived to be a negative signal where management believes the company’s shares are overvalued. In Shopify’s case, it can be argued that its recent capital raises are hot on the heels of its significant share price appreciation over the past eight months, and management has indicated the funds will be geared towards further growth initiatives which includes: potential acquisitions; continued investment into its warehouse fulfillment network; its Shop app intended to further connect end customers and merchants; Shopify Studios, its media production subsidiary.

What Should Shopify’s Share Price Be?

We seek to determine what Shopify’s shares are worth based on public comparables. In our analysis, we use the e-commerce peer group’s average as a benchmark to determine the implied share price of Shopify. We use the forward looking 2022 forecasts for our analysis, the fiscal year where Shopify is expected to experience higher growth. Our analysis is provided below:

We begin by calculating a revenue and EBITDA multiplier based on Shopify’s growth, which exceeds the peer group average:

Based on Shopify’s above average revenue and EBITDA growth, we apply the growth multiplier to 2022’s peer group average trading multiples to obtain Shopify’s implied trading multiples:

Based on the implied multiples calculated, we predict Shopify’s enterprise value and market cap as follow:

Our analysis indicates Shopify’s share price within a range of $580 - $685, which would represent a 52-59% decline compared to its $1,431 closing price on August 26, 2020.

Overvalued

Based on our analysis, we believe Shopify is currently overvalued from a fundamental perspective. We predict its share price to fall by more than half to our forecasted $580 - $685 range. We believe that as an IT services company, Shopify would command a higher valuation than the average Canadian public company. However, our analysis indicates that Shopify’s current valuation is dramatically higher than even its e-commerce peers to a point that we deem its current trading multiples as irrelevant for comparison purposes. Despite its near-term growth prospects, we were not able to find adequate support to justify its inflated valuation today. We predict that Shopify’s share price will fall from its current levels once momentum investors stop seeing weekly stock price appreciation. We see a decline in its market cap and enterprise value from current levels when the hype surrounding its stock wanes and when its growth slows below current expectations.

The last three companies to overtake RBC as the largest Canadian company by market cap are Valeant Pharmaceuticals (2015), BlackBerry (2007) and Nortel Networks (2000). All three companies were not able to sustain the number one ranking for long, with a steep decline in market cap following shortly after as momentum investors lost interest in these respective companies, as well as other company specific issues. We’re adding Shopify to this list and are predicting a steep share price correction in the next 12 months. Short-sellers, we smell blood…