Soaring 20% overnight, what’s driving Shopify's success?

On the evening of November 12, Beijing time, the leading independent e-commerce company in the U.S., $Shopify (SHOP.US), announced its financial report for the third quarter of 2024. In summary, this quarter saw accelerated revenue growth and a significant improvement in profit margins. However, the more surprising aspect was the guidance for Q4, with the key points detailed as follows:

1. In terms of core operating metrics, the total sales volume (GMV) facilitated by the Shopify ecosystem this quarter was $69.7 billion, a year-on-year increase of 24%, with an acceleration of approximately 1.8 percentage points compared to the previous quarter. Market expectations were for GMV growth to decline to 20.6% quarter-on-quarter, so the increase in GMV growth rate was one of the core beats this quarter. Based on research and third-party data, Dolphin Investment Research found that the number of merchants on the Shopify platform continues to grow rapidly, and the increase in market share is an important reason for this beat.

The total payment amount completed through Shopify Payments was $42.9 billion, a year-on-year increase of 30.8%, with the payment penetration rate continuing to increase by 0.3 percentage points to 61.5%. However, the increase in penetration rate was slightly lower than expected.

Reflecting the subscription business situation, the MRR (Monthly Recurring Revenue) this quarter was $175 million, a year-on-year increase of 24.1%, also showing an acceleration compared to the previous quarter (+2.5 percentage points). The average subscription price increase of over 30% announced in Q2 contributed significantly, but the actual performance was generally in line with expectations.

Overall, the beats in GMV, GPV, and MRR metrics were not large compared to expectations; the key point was the acceleration in growth trends.

2. In terms of revenue, merchant services revenue this quarter was $1.55 billion, a year-on-year increase of 26.4%, significantly outperforming the market expectation of 23.8% growth. The acceleration in merchant services growth greatly outpaced GMV and market expectations, as the monetization rate of merchant services (the proportion of GMV) increased by 4 basis points year-on-year after declining for three consecutive quarters. This reversed some of the trend of declining monetization rates caused by the expansion into enterprise-level clients and opened up space for market predictions on future monetization rates.

Subscription service revenue was $610 million, a year-on-year increase of 25.5%, which was 2.2% higher than the market expectation for growth, also impressive. Overall, thanks to merchant services, Shopify's total revenue reached $2.16 billion, better than the expected $2.12 billion. The actual revenue growth rate reached 26.4%, showing a significant acceleration compared to the previous quarter's 20.7%. 3. From the perspective of gross profit, due to the increase in monetization rate, the gross profit margin of merchant services has also increased by 0.6 percentage points to 36.7% quarter-on-quarter. However, unexpectedly, in the subscription business, despite the increase in charging standards, the gross profit margin has decreased by about 0.5 percentage points quarter-on-quarter.

When combining the two businesses, the total gross profit has increased by 24.1% year-on-year, which is higher than the expected growth rate of 21.8%. However, affected by the unexpected decline in gross profit margin of the subscription business, the growth rate of gross profit has slowed down by 1 percentage point compared to the previous quarter, and it has underperformed the total revenue growth rate of 26%.

4. From the expense perspective, Shopify's total operating expenses amounted to $835 million, accounting for about 39% of revenue, significantly lower than the company's previous guidance of 41% to 42%. This is mainly due to marketing expenses and research and development expenses being lower than expected. For example, the actual marketing expenditure was $330 million, which declined quarter-on-quarter and was significantly lower than the expected expenditure of $360 million.

Previously, management had indicated that the company would undergo a small peak in investment, so one of the market concerns was whether the expansion of expenses would squeeze profits. However, in reality, the actual marketing and R&D investments have declined quarter-on-quarter, which has basically alleviated the aforementioned market concerns.

5. In this quarter, Shopify's core operating profit margin (excluding only the usual three expenses, not excluding loan losses) increased by 6.7 percentage points year-on-year to 15.8%, reaching a historical high and significantly exceeding the market expectation of 12.5%. The actual core operating profit was $340 million, far exceeding the market expectation of $270 million. The company's more focused free cash profit for this quarter was $420 million, also exceeding market expectations by about 23%.

6. As seen from the above, all performance indicators in this quarter performed well, but aside from the naturally volatile net profit indicator, the actual beat on expectations was not very large. The business, revenue, and gross profit indicators beat expectations by about 2% to 3%. The more surprising point lies in the guidance for the next quarter.

In terms of revenue, Shopify guides revenue growth in the mid-to-high twenties, specifically between 25% and 29%, far exceeding the market's previous expectation of 23%;

In terms of gross profit, the guidance for year-on-year growth in gross profit is close to that of Q3, around 25%, higher than the market expectation of 23.7%;

In terms of expenses, the guidance for expenses as a percentage of revenue is only 32% to 33%, much lower than the market expectation of 36.5%;

In terms of profit, the guidance for FCF as a percentage of revenue is close to that of Q4 2023, around 21%, significantly higher than the market's previous expectation of 18%.

The guidance is comprehensively above expectations, and the beat is quite considerable.

Dolphin Research Perspective:

After the earnings announcement, Shopify surged over 20% overnight. As analyzed above, the quarterly performance was impressive, with all indicators exceeding expectations. Although the beat was not substantial, the key point is the accelerating growth in business scale and revenue, while the previously concerning increase in expenses has been disproven, eliminating the risk of profit suppression. The company is currently in a sweet spot of growth enhancement and expanding profit margins. More importantly, the guidance for Q4 has once again significantly exceeded expectations, indicating that growth enhancement and profit margin expansion will likely be repeated in the next quarter. In the currently exuberant environment of the U.S. stock market, such a surge is not surprising.

From a valuation perspective, Shopify currently has a market capitalization exceeding $140 billion, corresponding to the market's expected revenue for 2026, with a PS ratio above 10x and a PE ratio above 50x for the same period. Clearly, this is a valuation that is difficult to explain under normal circumstances. However, there are indeed SaaS-like companies in the market with even higher valuations (such as Palantir, Arm, etc.). It is challenging to assess the cost-effectiveness of the current valuation; it is more appropriate to adopt a cyclical investment approach—meaning as long as performance continues to beat expectations, a high valuation is not an issue in the medium to short term.

The following is a detailed interpretation of this quarter's financial report:

I. Subscription and Payment Operating Metrics Accelerate Growth

In the most important operational metrics, this quarter's total sales facilitated by the Shopify ecosystem (GMV) reached $69.7 billion, a year-on-year increase of 24%, with a sequential growth rate increase of approximately 1.8 percentage points. The market expectation was for GMV growth to decline sequentially to 20.6%. The trend of GMV growth increasing rather than decreasing is one of the core beat points.

The total payment amount completed through Shopify Payments was $42.9 billion, a year-on-year increase of 30.8%. On one hand, the GPV growth rate continues to outperform the GMV growth rate, indicating thatShopify's payment penetration rate is continuing to rise, currently reaching 61.5%.**However, compared to the market expectation of 61.7%,**the actual increase in payment penetration rate was slightly below expectations.**This quarter's penetration rate increased by 0.3 percentage points sequentially, while the previous quarter's increase was 1.7 percentage points, indicating that the increase in payment penetration rate this quarter was not significant.

The MRR (Monthly Recurring Revenue) indicator reflecting the subscription business situation this quarter is $175 million per month, a year-on-year increase of 24.1%, and it has also shown a significant acceleration compared to the previous quarter (+2.5pct). Among them, the average subscription price increase of over 30% announced in the second quarter should contribute significantly. Compared to the market expectation of $174 million, this can be seen as in line with expectations. The company did not disclose the MRR contribution from Plus merchants this time.

Overall, although the GMV, GPV, and MRR indicators did not significantly beat expectations, the acceleration in growth trend is the more critical point.

II. Monetization rate stops declining and merchant services growth significantly increases

In terms of revenue, merchant services revenue this quarter is $1.55 billion, a year-on-year increase of 26.4%, significantly outperforming the market expectation of 23.8%. The acceleration in merchant services revenue clearly outpaces GMV and market expectations, reflecting that the monetization rate of merchant services (the proportion of GMV) has rebounded by 4bps year-on-year after experiencing three consecutive quarters of decline. This reverses the previous trend of declining monetization rates due to the expansion into enterprise customers, and will open up space for market predictions on future monetization rates.

Subscription service revenue is $610 million, a year-on-year increase of 25.5%, which is 2.2% higher than the market expectation. This is also impressive, but compared to the merchant services business, the extent of beating expectations is relatively smaller.

Overall, this quarter's performance is mainly attributed to the significantly accelerated merchant services revenue, with Shopify's total revenue reaching $2.16 billion, better than the expected $2.12 billion. The actual revenue growth rate reached 26.4%, a significant increase compared to the previous quarter's growth rate of less than 21%.

III. Subscription business gross margin decline slightly drags down overall, but total gross profit growth remains strong

From the perspective of gross profit, as the monetization rate of merchant services increases, the gross margin has also increased by 0.6pct to 36.7%. However, the subscription business was somewhat unexpected; although the charging standard was raised, the gross margin decreased by about 0.5pct quarter-on-quarter. It is worth paying attention to whether there will be an explanation in the conference call.

Due to the rise and fall of profit margins, the gross profit amount for merchant services is 2.6% higher than market expectations, further amplifying compared to the revenue beat expectation (2.1%); while the extent of the subscription business beating expectations has decreased to 1.1% (with revenue beating by 1.8%) Overall, it shows that the merchant service business is relatively stronger, while the subscription business is slightly weaker.

Combining the two businesses, total gross profit increased by 24.1% year-on-year, with a slight slowdown of 1 percentage point compared to the previous quarter's growth rate, exceeding the expected growth rate of 21.8%. However, due to the unexpected decline in gross margin from the subscription business, the growth rate of gross profit slightly lagged behind the total revenue growth rate of 26%.

IV. Expense spending decreased instead of increasing; is there no need for increased investment?

From the expense perspective, this quarter Shopify's total operating expense was $835 million, accounting for about 39% of revenue, significantly lower than the company's previous guidance of 41%-42% and market expectations. This was mainly due to marketing and R&D expenses being significantly lower than expected. Specifically, actual marketing expenditure was $330 million, which declined quarter-on-quarter and was noticeably less than the expected expenditure of $360 million.

Since management previously stated that the company would undergo a small peak in investment to promote business growth, whether the expansion of expenses would squeeze profits has been one of the key concerns of the market recently. However, from this quarter's financial report, while the business scale accelerated growth, the actual quarter-on-quarter decline in marketing and R&D investment was also less than expected. It can be seen that Shopify is not forced to increase investment due to external pressure, and concerns about profit compression due to increased investment can basically be alleviated.

V. Increased acceleration, reduced expenses, and soaring profits

Due to the unexpected increase in revenue growth and the actual expense spending not rising as expected but rather declining, Shopify's profit margin continued to show significant improvement this quarter. The core operating profit margin (excluding only the usual three expenses, not excluding loan losses) increased by 6.7 percentage points year-on-year to 15.8%, reaching a record high and significantly exceeding the market expectation of 12.5%. The actual core operating profit was $340 million, far exceeding the market expectation of $270 million The company's focus on free cash profit this quarter is $420 million, exceeding market expectations by about 23%. Profit release significantly surpassed expectations.