The core of "Alipay", the valuation of SaaS, is Shopify expensive or not?

In our analysis of Shopify in the first article and second article, we discussed the following: ① The history of Shopify's development and its revenue composition, concluding that Shopify is actually a company with financial payments as its true core; ② Describing Shopify as a fintech company with independent e-commerce as its advantage track, its positioning and uniqueness in the entire financial payment industry, and why independent e-commerce thrives in Europe and America, becoming a mainstream format of e-commerce, thereby validating the feasibility of Shopify's advantageous business model.

As the final chapter on valuation, we will attempt to identify the key driving factors affecting Shopify's development and performance, and discuss each one by one. Ultimately, we will assess the range within which Shopify's current valuation lies.

The following is the detailed content of the main text:

I. What are the key drivers of Shopify's performance?

As the final chapter of our valuation series on Shopify, before discussing how much Shopify is worth, breaking down and identifying the key factors that drive the company's business and revenue growth is a crucial preliminary step. Based on the source of company revenue, it can be divided into 2+1 points:

① Firstly, there is Subscription revenue, which is the subscription fee that merchants need to pay regularly for using Shopify's software & service solutions. This can be expressed as Subscription revenue = Number of merchants * Average subscription price, where the growth of the number of merchants or an increase in subscription prices are the two main factors that drive growth.

Furthermore, the change in the structure of merchants subscribing to different levels (prices) of services drives the increase in the average subscription price, which may be healthier than a straightforward price increase. In other words, the price factor is actually influenced by the number of merchants.

② The main part of Merchant service, which accounts for over 70% of total revenue, is the payment-related income associated with merchant transactions and payments. This can be simplified as Merchant service revenue = Number of merchants * Average sales amount * Payment fee rate. It is evident that the key driving factors include: "growth of merchants," "impact of merchant structure on average sales amount," "Shopify's bargaining power with merchants regarding fees, and the impact of merchant structure on average realization rate."③ Another part of the merchant service mainly consists of financial & management services, such as Buy Now Pay Later (BNPL) for consumers, operating loans, management tools, marketing tools, and logistics tools for merchants. Although this innovative business has a certain synergistic relationship with the main business, it is considered good to have, not a must-have, and currently accounts for approximately 15% of total revenue. However, due to insufficient disclosure, it is difficult to quantitatively measure this part separately, and it is more seen as a space for performance imagination and call options. This article does not elaborate on this.

In summary of the above three points, after peeling off the key factors affecting Shopify's performance, the core ultimately lies in 2 points - the number of merchants and merchant growth. The next is Shopify's bargaining power with merchants and pricing.

II. Number of Merchants -- The Fundamental of Everything

1. Small and medium-sized merchants still make up 99% of Shopify

Since the number and structure of merchants are the most critical factors for Shopify, let's get straight to the point. Shopify's merchant group can be roughly divided into two categories: the core group of merchants where Shopify excels, namely small and medium-sized independent store merchants (SMEs), and the other category is larger individual Plus merchants (distinguished by the criteria of a subscription fee of over $2000 for the Plus service plan).

According to foreign research, as of 2023, the total number of merchants served by Shopify slightly exceeds 2.3 million, with Plus merchants accounting for less than 1% (about 22,000). It can be seen that in terms of quantity, small and medium-sized merchants are still indisputably the core user group of the company. Therefore, the first key question is whether Shopify's market share in its core small merchants (core merchants) has saturated, and how much growth space is left?

2. Penetration of small and medium-sized merchants is already high

This question can be answered from two perspectives. If we define Shopify's core merchants as independent e-commerce merchants, we can measure how much growth space there is in this advantageous track by Shopify's existing market share in the independent e-commerce format. From this perspective, in 2023, the total online retail sales in the United States were approximately $1.1 trillion, excluding Amazon and the top ten merchants accounting for about 38% and 22% of the market share, optimistically assuming that the remaining 40% of the market share belongs to Shopify's potential market, then in 2023, Shopify's GMV in the United States is equivalent to 11% of the total online retail in the U.S., and 28% of the potential market in the independent e-commerce format.

However, it is somewhat optimistic to consider the potential market outside the Top 10 platforms/brands as independent stations. In a more precise calculation, eMarketer estimates that the market size of the direct-to-consumer (D2C) model in the United States in 2022 is about $150 billion. In this context, Shopify's market share in the narrow brand direct sales model has exceeded 70%. In another context, Shopify's self-disclosed market share at the end of 2022 is close to 50%, with the second largest player holding around 25% (but it is not clear whether this is based on revenue or GMV scale market share).

Combining the above scenarios, it can be seen that Shopify's share in the online independent station format ranges from conservative to optimistic, at around 30% to 70%. However, Dolphin Research believes that the main reason for the difference in the above share forecasts is whether the top brand merchants are also considered as potential target groups for Shopify. Therefore, we believe that Shopify's market share among small and medium independent station merchants in the United States is more likely to be in the higher range of 30% to 70%. In other words, the number of core merchants of Shopify (in the United States) has probably passed the high-growth period, and future growth is likely to gradually slow down.

3. Offline expansion is not easy, Shopify has no advantage

If we expand Shopify's advantage track from the narrowest sense of online small and medium independent station merchants in two directions: ① Incorporating offline small and medium merchants into the channel, that is, omnichannel, ② Incorporating overseas online independent merchants into the geographical scope, that is, globalization. How has Shopify performed in these two directions and what are the prospects for future growth?

Firstly, Shopify launched Shopify POS as early as 2013, which can be considered early in terms of online penetration into offline payment channels. According to Credit Suisse's research, after 9 years of development, Shopify's GMV in the offline channel in 2022 is approximately $19 billion, accounting for less than 10% of the company's total GMV. Although the volume is small and the base is low, the 3-year CAGR of the offline channel from 2019 to 2022 is approximately 47%, which is slightly lower than the 48% CAGR of the online channel. In summary, Shopify has not achieved a significant scale in the offline channel, nor has it shown extraordinary growth, indicating that its expansion towards offline has not been successful.![] (https://pub.lbkrs.com/cms/2024/0/r9JMKBUbHrnfFxPs7YMq2roeiyc57hQt.jpg)

Dolphin Research believes that offline payment functionality is a relatively simple and homogeneous function. Without differentiated products/services, the main competitive points often lie in price advantages and network scale advantages. Compared to Shopify and the leading offline payment vertical leader Square:

In terms of price, Shopify's pricing for offline basic and standard "packages" is higher than its competitor Square's. In terms of the selling price of POS hardware, Shopify does not have an advantage compared to Square.

In terms of professionalism, Square has been deeply cultivating offline channels for many years, forming dedicated sales teams and customized services in segmented industries and consumer scenarios such as catering, retail, beauty care, and professional services. In this regard, Shopify lags behind and does not seem to have promoted similar professional and customized capabilities.

In terms of scale, as of 2022, Shopfiy's offline GMV is less than $20 billion, corresponding to slightly over 210,000 offline merchants. In comparison, Square's GMV is nearly $190 billion with over 2 million merchants, the majority of which come from offline channels. In other words, Square's scale in offline payment business is nearly 10 times that of Shopify.

Taking into account the above points, Shopify lags significantly behind Square in terms of price, professionalism, and scale in offline payments. Compared to Square, Shopify still has significant differences, not to mention dominating traditional payment channels. Therefore, Dolphin Research believes that there should not be too optimistic expectations for Shopify's development in offline channels in the short to medium term.

4. International expansion has yielded good results, highlighting the scalability of the online economy

Shopify's performance in overseas expansion is better than offline. Shopify disclosed at Investor Day that the proportion of GMV in non-North American regions had reached 25% in 2015, and is expected to reach 36% in 2023. In contrast, the offline-focused Square's overseas gross profit margin in 4Q23 was only 13%. According to our calculations, the compound growth rate of non-North American GMV between 2019 and 2023 is nearly 47%, significantly outperforming the approximately 37% growth rate in North America during the same period**

It can be seen that overseas business not only contributes more in terms of proportion, but also has a more significant impact on growth. Logically, Shopify focuses on online channels, which are naturally easier to expand internationally due to the borderless nature of the Internet, while Square, which focuses on offline payments, faces challenges in expanding offline due to different consumer habits, payment methods, and regulations in different regions. Therefore, it is indeed difficult for Square to expand internationally. Considering this, it is obvious that the overseas market is a more accessible source of incremental growth for Shopify, especially since the e-commerce market in emerging markets such as Southeast Asia, South America, and the Middle East is growing at a relatively faster pace compared to mature markets like Europe and America. Even if Shopify simply rides with the market, it can bring about growth that outperforms the North American market. Furthermore, with the potential to increase market share in emerging markets, the potential growth becomes even more substantial.

5. Only 1% of Plus merchants are the key to victory

Based on the above discussions, it can be preliminarily concluded that ① Shopify's market share in the most advantageous track of online small and medium independent merchants is already quite saturated, with limited room for high-speed growth; ② The progress in expanding offline is not good, and may not contribute much in the short to medium term; ③ The past performance in internationalization and the potential for future growth are still decent.

However, beyond these three points, Shopify actually has another key growth direction, which deserves a separate discussion - that is expanding upwards to enterprise-level and even large corporate-level merchants.

Although it has been mentioned earlier that the number of Plus merchants (reflecting large merchants) at Shopify is just over 20,000, accounting for only 1% of the total number of merchants, in terms of quantity, they are not even considered as "marginal." However, Plus merchants actually contribute to nearly half of Shopify's business volume.

In terms of subscription services, according to the company's official website, under annual payment plans, the monthly subscription fees for regular Shopify merchants range from $20 to $299, while Plus merchants start at $2300. In terms of pricing, a Plus merchant can contribute the equivalent of 8 to 115 regular merchants' monthly fees.

Based on the Monthly Recurring Revenue (MRR) metric disclosed by the company, it broadly reflects the fixed subscription income collected by the company each month. After breaking down by merchant type, the average monthly fee for small and medium merchants (core merchants) fluctuates around $40±5, while the average monthly fee for Plus merchants has remained above $2000 since 2019. In other words, **just one Plus merchant can contribute to approximately 50 regular merchants' monthly fees, and Plus merchants actually contributed to 31% of the overall MRR in 2023

In terms of merchant service business, the cornerstone of all monetization, the GMV indicator, is also split by merchant type. The average annual transaction volume of small and medium-sized merchants is only $49,000, while the average annual GMV of Plus merchants is over $5 million. The difference in GMV volume between Plus merchants and small and medium-sized merchants reaches 100 times, with the 1% of Plus merchants contributing over 50% of the GMV.

Combining the above two points, Plus merchants can be described as "few but refined." Roughly estimating, around 21,000 Plus merchants contribute approximately 40% of Shopify's revenue. In other words, adding just 10,000 Plus merchants could bring about a 20% increase in total revenue. It is evident that the growth of large merchants represented by Plus merchants has a significant impact on Shopify's performance elasticity.

Given this, how is the space and difficulty of developing large merchants for Shopify? Dolphin Research believes that, simply put, there is a lot of space but also considerable difficulty.

Firstly, in terms of space, according to our statistics, there are approximately 950,000 businesses in the US with annual sales exceeding $1 million (roughly matching the threshold of Plus merchants). Assuming that 30% of them have a demand for operating online stores, there are around 285,000 potential large merchants. Assuming a ratio of 4:6 for potential large merchants between international and US markets, there are approximately 480,000 potential users for Shopify Plus globally. Currently, Shopify's penetration rate is only around 4% to 5%, indicating a considerable space for developing merchants.

As for the difficulty of acquiring large merchants, it is a problem that is difficult to quantitatively describe through data. Historically, in the early development stages of Plus merchants from 2017 to 2020, there was an average annual increase of around 1,700 to 1,800 merchants, while in the past 2-3 years, the annual increase in Plus merchants has been around 4,000. From 2017 to 2023, the total number of Plus merchants has increased by about 5 times, but the annual addition of Plus merchants has only slightly more than doubled. Although the volume of the Plus business has expanded significantly over the years, the speed of customer acquisition has not increased significantly.

It is not easy for Kankan Plus merchants to acquire customers.

Logically, the fundamental source of attractiveness for Shopify to small and medium-sized merchants is that most of them do not have the ability or resources to build effective online stores on their own. Coincidentally, Shopify can provide simple-to-use tools at a "low" price to meet the above needs, achieving supply and demand matching.

However, this may not be the case for large merchants with sufficient scale. For example, large merchants theoretically have enough human and financial resources to build online stores on their own; or they may have stronger customization needs for external tools, unique operational requirements, or a greater emphasis on information security. Unlike small and medium-sized merchants who may only need to click a few times online to sign up on their own, signing contracts with large merchants will inevitably require more time, processes, negotiations, and a dedicated sales team. In other words, cooperating with large merchants naturally involves more traditional "corporate relationships" and may not fully reflect the borderless and easily expandable characteristics of the Internet. Shopify has historically focused on SMEs, and its connection with large enterprises is clearly lacking.

Furthermore, while Shopify is a leader in the small and medium-sized e-commerce service market, when it comes to e-commerce services for large enterprises, there are more "prestigious" competitors, such as Adobe, Salesforce, SAP, etc., and these traditional large SaaS companies obviously have close business ties with large enterprises.

In summary, penetrating large enterprises is a high-return endeavor, but it requires long-term cultivation and may not experience explosive growth in the short to medium term.

II. Apart from expanding to large merchants, does Shopify have a pricing logic?

Above, we discussed Shopify's main development direction and space from the perspective of increasing the number of merchants. Besides the "quantity" aspect of the number of merchants, what "value" factors have a significant impact on Shopify's performance? In general, we believe there are three main points: ① Shopify's general increase in subscription fees for different levels of merchants, ② the increase in the payment processing fees charged by Shopify to merchants, ③ the increase in the penetration rate of financial, fulfillment, marketing, and other additional services.

In the introductory paragraph, we mentioned that we consider the additional services in point 3 as extra call options, which are difficult to quantify and therefore will not be discussed in detail. We will mainly focus on the first two points.

1. There is the ability to raise subscription prices

Firstly, regarding the price of subscription services, historically, except for the year 2023, Shopify's average subscription price has not shown a continuous upward trend. Over a span of 6 years, it has fluctuated within the range of $48 to $50, and even experienced year-on-year declines in two years. However, in 2023, Shopify's average subscription price surged by nearly 28%, breaking through the previous range significantly

The above MRR anomaly is due to Shopify's first comprehensive price adjustment of subscription services in 2023-24. Specifically, at the beginning of 2023, Shopify raised the subscription prices for Basic~Advanced services for small and medium users by about 33%. Then, at the beginning of 2024, Shopify announced a 25% increase in the starting price for Plus merchants' subscriptions. (The prices in the table are for monthly payments, with discounts for annual payments)

Combining these, Shopify has not had a tradition of frequently and continuously raising subscription prices in its history, but recent cases in the past year or two have shown that Shopify does have the ability to increase prices. Looking ahead, does Shopify have the ability and will it continue to raise prices?

Although there is no definitive answer, this clearly depends on Shopify's bargaining power with merchants and the competitive situation within the industry. Based on the previous calculation of Shopify's market share, within all-in-one e-commerce service providers (excluding traditional SaaS giants), Shopify's Top1 position is relatively stable. As shown in the chart below, one of its main competitors, BigCommerce, basically follows Shopify's pricing strategy for its three tiers, rather than engaging in price wars through low-price competition.

For Shopify's over 2 million small and medium-sized merchants, Shopify's services are likely still best-in-class and an indispensable tool for operating online stores. In general, the party that is scarcer and more concentrated in a transaction has stronger bargaining power, so theoretically, Shopify is more dominant compared to small and medium-sized merchants.

Combining these, we believe that Shopify has relatively strong pricing power over the vast majority of small and medium-sized merchant groups, and should have the ability and space to increase subscription prices to some extent in the future.

2. Can payment rates be increased?

Regarding payment processing fees related to payments and transaction volumes, does Shopify have the ability to increase payment rates? Dolphin Research believes that this may not be as strong as Shopify's pricing power in subscription services.

Firstly, according to the payment processing fee rates disclosed by Shopify, it can be seen that whether it is the fee rate for using first-party Shopify Payment or the punitive additional fees charged for using third-party payments (in this case, the payment processing fees are paid to the third party rather than Shopify) The fees decrease as the merchant's subscription level increases.

Therefore, as the proportion of high-level service merchants' subscriptions increases, the overall payment-related monetization rate is likely to decrease.

Moreover, Shopify's differentiation in providing online store operation tools varies. We have emphasized multiple times that payments themselves are a very homogeneous function, and fee discounts are the primary means of attempting to gain market share in most cases. In the medium to long term, as economies of scale continue to increase and competition becomes more saturated, overall payment fees are likely to marginally decrease rather than increase. Therefore, we have not yet found any particular features in Shopify's payment function that would motivate or enable it to provide payment fee incentives.

III. High Growth and Higher Valuation

1. Performance Forecast

Based on the above discussion, we forecast the core driving factors of Shopify's performance as follows:

① The net increase in the number of core small and medium-sized merchants is expected to decline slowly from 150,000 in 2023 to 70,000 in 2028. Plus merchants' net increase in 2024 will slightly rise to around 4-5k, accounting for 1.5% of the total number of merchants by 2028.

② The average monthly recurring revenue (MRR) in 2024 is expected to grow by approximately 17% due to a 25% price increase by Plus merchants. Subsequently, Plus merchants will increase prices by 2% annually, while small and medium-sized merchants will increase prices by about 4% annually. (Price increases are equivalent annualized expectations, but actual increases are more likely to occur every few years)

③ Mainly driven by merchant growth, the expected growth in average sales per merchant is slightly higher than inflation. It is estimated that Shopify's overall GMV will grow by 20% and 16% in 2024 and 2025, respectively, gradually slowing down to the range of 12% to 15% thereafter.

④ Based on these key factors, we calculate that the compound revenue growth rate in the following 3 years from 2023 to 2026 will be 19%. The core operating profit (equal to gross profit minus operating expenses, excluding impairments) is expected to reach approximately $1.4 billion by 2026

2. Shopify enjoys a high premium, valuation is not easy to grasp

In terms of valuation, because Shopify has not yet achieved stable and traceable GAAP profitability, it is not easy to use DCF valuation. Profits in the range of $10-30 billion in the next 3-5 years correspond to the current market value of over $80 billion, and the PE valuation multiple is also high to the point of almost no reference value.

Dolphin Research observes that investment banks generally value Shopify using EV/S or EV/EBITDA ratios. Using a 25-year EV/S as a benchmark, the table below shows that the EV/S multiples for fintech or e-commerce SaaS service providers are mostly between 1x and 4x, with an average of 3.6x. Based on our calculations, Shopify's current EV/S multiple is around 7.7x, which is twice the average, indicating a significant premium.

In comparison, Shopify's valuation multiple is closer to hardcore SaaS companies like Confluent, rather than financial or e-commerce service companies. The average EV/S for hardcore SaaS companies in the table below is around 10x.

In Dolphin Research's view, Shopify's current valuation clearly deviates from a level that can be supported by visible profitability. Therefore, we also make a valuation judgment based on different scenarios of EV/S multiples:

Firstly, by referencing the average EV/S valuation of financial/e-commerce service companies, but considering Shopify's relatively high growth, a 30% premium is given, i.e., 4.7x EV/S, corresponding to a market value of $52.6 billion, with approximately 36% downside potential, considered a conservative valuation.

Additionally, based on our expectation of Shopify's 19% revenue CAGR over the next 3 years being closer to the average revenue growth rate of hardcore SaaS companies, we refer to the average valuation of such companies, giving Shopify 10x EV/S, corresponding to a market value of $106 billion, with approximately 28% upside potential, considered an optimistic valuation.

However, based on our judgment that the core of Shopify is in financial payments, as well as the core driving factors discussed above, Shopify's prospects are mixed rather than all positive. We still believe that approaching a conservative valuation is more reasonable.

Dolphin Research's Past Research on Shopify

In-depth Research:

January 19, 2024, First Coverage: "Shopify: Looks like 'Taobao', but is actually 'Alipay'"

May 29, 2024, Second Coverage: "Shopify: The shell of Youzan, the core of payment, how does it grow freely?"

Risk disclosure and statement for this article: Dolphin Research Disclaimer and General Disclosure