SHOPIFY ON THE DEFENSIVE

Shares slide despite record revenue

Shopify’s share price sagged at much as 13 per cent in early morning trading Tuesday following the company’s posting of third-quarter financial results. It finished the day at $128.26 on the TSX, down 8.5 per cent.

Why such a steep decline? After all, the seller of e-commerce technology on Tuesday published better-than-expected revenues of $171.5 million (all figures U.S.) for the quarter ended Sept. 30 — well in excess of analysts’ projections of $166 million.

The continuing presence of Citron Research managing editor Andrew Left almost certainly had much to do with the share price weakness.

But a company forecast of slowing revenue momentum combined with continuing losses also factored in.

Left, who makes money targeting companies he believes are over-valued, alleged early last month that misleading marketing is the catalyst behind Shopify’s recent jump in revenues and market value.

Shopify’s share price slumped 20 per cent over the following days and has yet to recover to the $145.70 close the night before Left issued his report.

At several points during the Tuesday conference call, analysts called upon Shopify executives to defend themselves.

In response to Left’s claim that third-party affiliates exaggerate how easy it is to set up a business on Shopify chief executive Tobias Lütke noted: “Most of our (web) content is about how hard entrepreneurialism is.”

STRICT VETTING PROCESS

Lütke characterized as “preposterous” Left’s general allegation that Shopify’s marketing practices are “dodgy.”

Shopify’s chief operating officer Harley Finkelstein noted the vetting done on affiliates, who get paid for referring wouldbe entrepreneurs to Shopify’s e-commerce platform.

“There’s a fairly strict process,” he noted, adding that affiliates who don’t conform to Shopify’s terms and securities regulations “are kicked out.”

Lütke confirmed that his company had received no calls for information from oversight from U.S. consumer or securities watchdogs.

It’s been a frustrating period for Shopify’s executives who would prefer that attention focus on the company’s core business and technology, which even Left acknowledged Tuesday “is effective for small and medium-sized businesses to launch e-commerce platforms”.

However, Left published a note saying he was “unimpressed” with Shopify’s defence of its marketing regime. Left said outside investors can’t understand Shopify’s underlying business without more detailed data on the firm’s 500,000 plus online merchants — how many leave or go bust each quarter, for instance.

While Left offered few details of his own, Shopify would prefer to keep proprietary information about its customer base in-house. Lütke defended his reticence in part by noting, “The best companies don’t engage in short-term stock price management.”

Will that be enough to satisfy investors? Tom Forte, the New York-based senior research analyst for investment firm D.A. Davidson & Co., said Shopify did a “brilliant” job Tuesday explaining how its marketing is in compliance with regulations and “best practices.”

However, he added, “The more disclosure the better.”

INVESTORS UNEASY

Forte suggested Shopify should give investors a much clearer snapshot of its base of merchants, perhaps dividing them into small and large categories if it’s concerned about giving away too much information to competitors.

There seems little question investors are a little uneasy about the ongoing deficits.

Shopify lost nine cents per share in the third quarter compared with 11 cents per share during the same period a year earlier. The Ottawa firm has been pretty consistent in telling everyone it intends to invest heavily in both its technology and marketing. Shopify said it expects to post a fourth-quarter operating loss of between $12.5 and $14.5 million — a likely decline from the third quarter deficit of $12.7 million.

“Our focus is not on profitability,” company chief financial officer Russ Jones said. “It’s very much on growth.”

But even revenues are experiencing slowing momentum.

Shopify said it expects fourth quarter revenues should total between $206 million and $208 million. If they do, that would represent year-over-year growth of less than 60 per cent.

Pretty good by most standards, but not when you’ve just done considerably better in the quarter just finished. And not when your stock is trading at a sky-high multiple of more than 15 times revenues per share.

Assuming Shopify’s growth continues somewhere close to its recent pace, its revenues will eventually be large enough to bring that multiple down to more conservative levels. But meantime, the company is vulnerable to attacks from short sellers, whether truly informed or not.

Our focus is not on profitability. It’s very much on growth.

Shopify Inc. chief executive Tobias Lutke addressed criticism from short-seller Andrew Left on Tuesday, denying his claims that the company uses illegal marketing tactics to drive growth.

In a conference call following the release of the Ottawa-based e-commerce software company’s third-quarter results, Lutke opened by saying “this is going to be a fun one.”

He called Left’s claims “preposterous” and said outside legal counsel has assured him they are unsubstantiated.

Lutke said Shopify complies with the U.S. Federal Trade Commission’s rules and keeps its affiliates up to date about their legal obligations. He said Shopify has not been contacted by the FTC since Left released his report. “We do not sell business opportunities. We sell a commerce platform,” Lutke said. “Implying these businesses are somehow illegitimate is an insult to their hard work.”

On Oct. 4, Left’s Citron Research accused Shopify of promoting a “get rich quick scheme,” saying it made misleading suggestions in marketing materials that merchants could quit their jobs and become millionaires by setting up e-commerce stores using the service. He compared the company to Herbalife Ltd., which agreed in 2016 to restructure its business and pay $200 million to settle allegations made against it by the FTC.

Shortly after the conference call ended, Shopify’s shares fell 13 per cent from Monday’s closing price of US$109.37 to US$95.54, recovering somewhat to US$99.49 by the close of trading.

Analysts asked for metrics that would provide more information about Left’s claims on the call, but executives did not disclose that information in detail.

Left responded to Lutke’s comments in a release posted online mid-day Tuesday. He said he was “unimpressed” by the response and called on Shopify to disclose its churn rate, or the number of customers who quit the platform after their first year.

“Churn needs to be analyzed, so investors can discount or strip out the dirty/illegal part of their business that will inevitably be curbed by regulators,” Left said. “Citron has assembled a comprehensive folder, which we have forwarded to the FTC, and we are certain that the company will face an investigation for selling business opportunities.”

Left brought particular attention to Shopify’s affiliate marketing program, which gives partners a cut of sales made through links they post to Shopify online.