Anytime an investor participates in an IPO, it can be a serious roller coaster. A year ago, Shopify Inc. (TSX:SH)(NYSE:SHOP) went public and the price increased by nearly $20 a share within the first couple of months of being on the market. Then it dropped, rose, and dropped again, falling close to $26 per share. Now the company is on the up and up, which has many potential investors, including me, questioning if this stock is still a buy. To answer that, it helps to understand what kind of business Shopify runs. Recognizing that there was a problem with launching online stores for…
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Anytime an investor participates in an IPO, it can be a serious roller coaster. A year ago, Shopify Inc. (TSX:SH)(NYSE:SHOP) went public and the price increased by nearly $20 a share within the first couple of months of being on the market. Then it dropped, rose, and dropped again, falling close to $26 per share.
Now the company is on the up and up, which has many potential investors, including me, questioning if this stock is still a buy.
To answer that, it helps to understand what kind of business Shopify runs.
Recognizing that there was a problem with launching online stores for businesses, the founders of Shopify created an easy-to-launch product whereby small businesses can sell their goods online in days. In the past, businesses would have to pay a developer thousands of dollars to get the site built and then pay more when they had new products available for sale to add to their site.
In exchange for a monthly fee, any business can get set up online. This business model has me very intrigued. When a business signs up for a basic online store, they have to spend US$29. And then each month that business gets charged again. What Shopify effectively has is a predictable and scalable solution; it knows exactly how much money is going to come in each month.
Further, because of the nature of the technology, once a business signs up, it’s not likely that they’ll leave and go with a different vendor. While other vendors may launch cheaper solutions, the hassle of migrating data to a new provider makes the extra cost worth staying, thus providing a level of stickiness to the business that makes revenue even more predictable.
On top of this, Shopify also has its Merchant Solutions segment, which provides shipping services and a payment platform that it can generate revenue on as well. Essentially, its service helps businesses manage their online business from end to end, minimizing the need for other vendors to offer their services.
Finally, with its recent acquisition of Kit CRM, businesses on Shopify will be able to do one-on-one customer service with potential customers using SMS and social media. To take it a step further, Shopify has integrated with Facebook Messenger, the chat platform from Facebook Inc. This will allow it to also offer one-on-one customer service to its clients on one of the largest chat platforms on the planet.
But all of this is nothing if the company can’t sign new businesses up.
Fortunately, that’s not a problem. According to its recent quarterly results, Shopify had 243,000 merchants on the platform. In the previous quarter, it only had 200,000. This is part of the reason why the stock price is up. As I said above, the more subscribers there are paying monthly fees, the more predictable the revenue becomes.
The company has seen a serious drop in its operating costs as a percentage of revenue. In 2012, it paid 84%. In 2013, it dropped to 79%. And in 2014, it dropped to 73%. In the first nine months of 2015, it dropped to 20%. A big reason why the operating costs continues to drop is because the amount Shopify is spending to bring in new customers has been dropping. In the past, Shopify would spend $1,000 per new customer that singed up; that has now dropped to about $500.
All told, this company has the potential to continue growing significantly over the coming years. Even at $40 a share, I still think it has plenty of room to grow. In my eyes, this stock is definitely a buy.
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Fool contributor Jacob Donnelly has no position in any stocks mentioned. David Gardner owns shares of Facebook. Tom Gardner owns shares of Facebook. The Motley Fool owns shares of Facebook. Shopify is a recommendation of Stock Advisor Canada.