Motley Fool Hidden Gems Investing - A Shopify Takeover

Episode Date: February 11, 2025

We’re diving into Shopify’s earnings and long-term vision with President Harley Finkelstein. He joined Ricky Mulvey and Asit Sharma to discuss: - Shopify as a 100-year company. - What a change in de minimis rules would mean for merchants. - Shopify’s growth levers. Company discussed: SHOP Got a question for the show? Email us at [e-mail] Note: Ricky Mulvey has a position in SHOP Host: Ricky Mulvey Guests: Asit Sharma, Harley Finkelstein Producer: Mary Long Engineer: Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

You've got to try breakfast at A&W. You've got to try breakfast at A&W. And what better way than with the delicious Pret Organic Coffee? Starting with just one dollar, all day, every day, now until December 31st. You've got to try breakfast at A&W. At participating A&W locations in Ontario. it's a shopify takeover you're listening to motley fool money i'm ricky mulvey joined today by asit sharma asit it's good to see you thanks for being here

ricky thank you for having me and we also have harley finkelstein he's the president of shopify to talk about the quarter and some long-term vision stuff harley appreciate you joining us on the show. Hello, Ricky. Hello, Asit. It's good to be here. It's an honor to be on your show. So we're going to talk a little bit about the quarter. We're going to talk about some longer term trends. Harley, I don't want you to prime Asit, though. Maybe we'll have Harley bounce off Asit as I go through the quarter. Asit, no pressure. But here's some big takeaways from Shopify's quarter. One trillion in gross merchandise volume crossed the platform. They reached that goal this quarter. Free cash flow hitting about 1.6 billion. That's picking

up steam from last year, and we're also seeing a lot of growth coming from offline and international. Asit, what's your big takeaway, your headline for the quarter? So my headline for the quarter is we're developing our total addressable market everywhere in our funnel. Shopify has been really impressive in many quarters recently, Ricky, but particularly this quarter, it just feels like whether they're going after enterprise business small mom and pops middle market companies they're on fire everywhere any notes harley any big takeaways for your long term wow i was gonna say it's like aussit gbt or something uh that was that was really good i mean certainly international is something that i talked a lot about on the call

it's an area of growth for us we sort of historically were e-commerce for north america and now and small businesses there and now we're sort of commerce everywhere across the world for across every single channel, online, offline, and everywhere in between. So I thought Authentic did a great job there. You also talked about Shopify is a 100-year company. And while you're giving projections for next quarter, next year, how about the vision for Shopify five to 10 years from now? This idea, I mean, Shopify started as effectively the answer to the question, what would happen if anyone who wanted to or needed to start a business were able to do so? What if we sort of democratized entrepreneurship to the extent that anybody can do it? You have

an idea in the shower in the morning you come out of the shower you set up a store shop if i knew you go and built and what we sort of have realized over over you know we've been at this now for about 20 years is that one uh we can service merchants of all sizes i mentioned on this past call in particular some of the largest brands on the planet are now coming to shop like i've been warner music and west wing and champion and gamestop and carl augerfield and david's bridal and Goop and Hunter Douglas, all these big companies. So one is that we actually have built software that can serve even the largest merchants on the planet. But the second thing is retail will be everywhere. And if you think about the evolution of retail, historically,

it's always been about merchant choice. The merchant dictates to the consumer how a transaction should happen. It's going to happen. I'm going to open my store at this particular time. You're going to line up here to check out. You're going to only be able to use this credit card. It was effectively this list of rules that was predicated or that was assembled by the merchant. And the big shift that's happened in the last decade or so, some people sort of call it, you know, like the emergence of direct-to-consumer. All that really is happening is the shift has now been where consumers are dictating to the merchants how they want to purchase. I want to buy on Instagram, or I want to buy on TikTok, or I want to buy offline, or a pop-up shop, or I

want to buy online. I want to pick up in-store but have it shipped to me, or I want to buy it online and pick up in store. And so what you end up with is this really interesting new era of commerce where it happens everywhere. And the reason you see Shopify integrating and becoming the commerce partner for things like Roblox, for example, or Spotify, for example, or YouTube, for example, is that we want to make every surface area where consumers are spending their time a place where they can meet and transact with their favorite brands. And we have about a couple million stores on Shopify today. I said this on the earnings call this morning. We're now about 12% of all e-commerce in the U.S. flows through Shopify. So if you were to pretend that Shopify

was a single retailer, we'd be the second largest online retailer in America after Amazon. I say that not as a flex or anything. I say that because it shows the scale of having, you know, there's a long tail of SMBs on Shopify and also some very large brands using us as well. And I would say that it's a long answer to a short question. In the future, we want more people to try their hand in entrepreneurship. We want more consumers to vote with their wallets to buy from brands they love. And more and more, the brands that you love, Asit and Ricky, they're on Shopify. I mean, if you're buying something that is something you want as opposed to something you need like, you know, detergent or toothpaste, you can go to the marketplace for that. If you're buying something you want from Viore or Allo or James Purse, which is my favorite company, or ButcherBox or any of these great Mattel, those are all Shopify powered stores. I love this story, Harley, and I think it really builds the picture for investors who may not be as familiar with Shopify. I'm saying that a bit tongue in cheek because at this point, I think you all are sort of like the incumbent, one of the incumbents, and that's great for the business. So I want to tie this to financials. If the theme for the quarter was about execution across the spectrum of your customers, I think the theme for the year was sort of we showed you what we could do. We told you we would be able to generate a lot of free cash flow. We would have great margins. We would grow revenue at a nice double digit clip. And we delivered on that.

So looking forward five to 10 years, as we think about this company that is spread across commerce, which is meeting the customer where it wants to be, empowering merchants, what can this business ultimately do in free cash flow generation? Now, we did 18% of free cash flow margin over the past 12 months. That simply means that for every revenue dollar that Shopify took in, you took in 18 cents of free cash flow. So where does this peak out? What could you sustain over the long term?

I said this in one of the Q&A sessions today after the earnings call that we actually really like where our free cash flow margin is, you know, 18%. So on $8.9 billion of revenue, having annual free cash flow of about 18%, which actually is up about five points from 2023. We also had operating income surpass a billion dollars, which actually is 4x more than our our previous peak, which was in 2021, and 12x more than the crazy COVID year of 2020. We actually like where our free cash immersion is right now because it allows us to do two things. It allows us to grow the business. Ultimately, Shopify is still a growth company. And I want

to talk a bit about some of the growth vectors, where we're going. But the fact that we can be a growth company, but also can have really strong and consecutive and predictable free cash of margins. I think that's the way you become a very durable long-term company. It's how you become a hundred year company. But I think it's also, you have to have the right team, the right product, the right business model, and you have to have all those things sort of coalesce together. And I really believe that 2024 was sort of emblematic of that. It was one of our, I think it was our strongest year actually in our 20 year history. You know, the market position keeps getting better. Operating model is working and we continue to have this great, you know, bottom

line profitability. So this is sort of peak performance, and I think we can continue to do that. But I suspect for the next while, that free classroom margin will stay around where it is right now. And Asit, we're hearing a lot of green flags. Things are growing. The number two e-commerce platform after Amazon, that's great. But you, the analyst, Asit, when you're looking in this earnings report, are there any yellow flags that we need to address for the investors listening right now? Tons of them, Ricky. Well, not tons, a few. And actually, I should say here, I think yellow flags are good for a business. You don't want all green flags because... I mean, we can improve. I mean, obviously, this is, you know, that's the good stuff. It shows your dynamic.

So let's go through a few. These aren't ones that give me really great pause, but I was curious about them anyway. So let's start with what you're investing in the business. There's a really a sort of a nice trend of declining capital expenditures. A few years ago, you hit a trend of about $50 million annualized investment in the business. I think the year after that, it was $30 million in capital expenditure, and we're at, I think, $19 million over the last trailing 12 months. So this shows, in one respect, that Shopify is extremely efficient. It's a company of people who program great products that reach the customers. But at the same time, I'm curious, Might we be under-investing here?

How do you see going forward this trend line moving? Let's first talk about sort of the cost side of it, then we'll sort of go to the opportunity or the growth side of it. On the cost side, in early 2023, we began to talk with this new shape of Shopify. We brought the company size from around 14,000 down to around 8,000, which is where we are now.

We really began to focus on what we call our main quests and effectively remove all of our side quests. So one of those side quests that I think people know is Fulfillment, where we had Shopify Fulfillment Network, which we ended up selling to a company called Flexport, a great company. And I think this new shape of Shopify is far more focused. We think we can continue to grow the business

while keeping our headcount relatively flat and around where it is right now. Obviously, performance management helps there to make sure we have the best people, and those best people keep requalifying every single year. But we think from a headcount perspective and from a focus perspective, we're now looking at all the right things and anything that's not, any distractions are gone. That means that sometimes, you know, we decide to build things ourselves. Shopify Capital, for example, we built ourself.

But Shopify Payments is built on Stripe Rails, and now we're also working PayPal on that. Or, you know, our Buy Now, Pay Later product, Shop Pay Installments, is built on a firm. We have a product called Shopify Markets, Markets Pro, which is built with our friends at Ed Globally for cross-border checkout. So when we believe we can build something that is better than anything that exists in the market, we do it ourself, especially when it's very advantageous and where we have an unfair advantage. Where we can partner or collaborate with an existing product or company we think that is doing it exceptionally well, we will always look to that as well. Now, let's talk sort of on the other side, the opportunity side. There are a couple

areas, a couple key drivers of growth. I want to talk about marketing too, but let me get to that a little bit later. There are a couple areas where we think there are these sort of these new on-ramps into Shopify. The first one is offline. Now, offline, our offline products are now powering much larger, more complex multi-location merchants. In fact, offline revenue for 2024 was about $588 million, which is up 33%. And Q4 alone, GMV for offline is like up 26%. So we're seeing much, you know, I mentioned the call Karl Lagerfeld coming to us now with 70 global point of sale locations. We have companies like Sperry and Alda that just signed up, which we're going to power 400 physical locations for them. So point of sale and offline retail is really important for us

because one, it allows us to serve existing merchants in a new way. So you're just using Shopify online. Now we can also power your physical retail. But it's an on-ramp because some of these brands are coming to us specifically for point of sale. The second one is B2B wholesale. So B2B has been a new area for us. We've had merchants on Shopify that historically focused on direct-to-consumer, but also had a B2B or wholesale business as well, where they sold to retailers. Well, now we kind of bring that all together. And B2B, I mean, it's crushing right know, six straight quarters of over 100% year-over-year growth on B2B. Maybe the third one, which I think is important, is enterprise. We talked about a couple of those names, but

you're really seeing us not just focus on the go-to-market, but also on the product stuff and the product suite of Shopify enterprise. We think helping much larger retailers that historically either built their own in-home systems, like Glossier did when they moved Dover or Supreme, which is behind me, Mattel, Staples, these companies are coming to Shopify. But we think there's a real opportunity for us to go after them. In fact, two companies, Crocs and GameStop, recently signed up for Shopify specifically for one of our commerce components for ShopPay. I know I said three, but I'm going to add a fourth one, which is something we talked about earlier, which is international. International growth for us is remarkable. Q4

International and GMV actually outpaced North American. If you look at the entire Shopify a merchant base right now, about 50% of our merchant base are actually international merchants with about 33% revenue growth in 2024. And specifically, Europe, at least in Africa regions, are seeing growth in the 30s consistently. So we're not just looking at the next quarter. We're actually really dedicated to building this durable company for 100 years. And these sort of new on-ramps, these new growth factors are going to be incredibly important. Maybe the only other thing I'll say before I turn it back over is on the marketing side. You will have a tough time finding a company that is more thoughtful around performance marketing than we are. We make these

incremental investments into products that help merchants succeed, which in terms help Shopify succeed. And it's sort of this self-reinforcing cycle, and we don't intend to slow that down. But what we've said in the last 12 months or so is that these areas, like I mentioned, offline, international, enterprise, we are going to spend money there, but it's going to be returns based, it's going to be data driven, and it's going to have appropriate guardrails and payback periods. And I think you're seeing the results of some of that marketing spend in the results this past quarter. So I'm going to... double espresso with ginseng extract. Whatever lies ahead, don't change your morning. Let your

morning change you. Discover Coffee Plus on Nespresso.com. Or go a couple of rather boring other yellow flags in the interest of one follow-up question. So you mentioned commerce components, and this is sort of interesting. So this is where an enterprise business, a really large business, might have built out its own commerce infrastructure, but they come for you for one thing. Now, in past quarters, you've talked about companies that pick up one component from Shopify and then after some iterations and some time start to buy other components. But I heard you talk this morning about just in the conversation phase when an enterprise business comes to you, let's say for one feature, just in the conversations with your engineers, they just

sign up for much more. Can you talk a little bit about that? Yeah. So historically, if you wanted to use Shopify and you're a larger retailer, a larger merchant, we had sort of this all-in-a-box Shopify Plus, everything you need to sell at scale. And what started to happen in the last couple of years as we really became more dominant in enterprise is that merchants said, well, what if we just took your checkout? Or what if we just use ShopPay? And we began to think about the implications of that. And ultimately, we created something called Commerce Components by Shopify, which effectively modularizes the best of Shopify checkout shop pay inventory management point of sale all the different components that people use usually they use an aggregate of the larger

suite of products but just allowing to use that particular one and we had great brands my citizen last call but Everlane for example and Victoria's Secret GameStop Crocs come to us and say we just want to use shop pair we just want to use your Shopify checkout which is the highest converting check it on the internet. What we started to see though, is that our initial assumption was they would start with a component and if we were good and we were thoughtful about it over time, they would sort of expand kind of the land expand model. And that was the case of some of those early adopters of CCS. Everlane would be a good example of that. But then something else happened, which is we started getting calls from these very large retailers like Aldo, which one of the largest

retailers in Canada here, who came to us for one component, but through this conversation said, why don't we just do the entire suite? Why don't we take all of Shopify? So the way that we think about commerce components is, one, it allows us to build a relationship with merchants and retailers that otherwise may not be ready to fully adopt Shopify. But second, it also gives us sort of a starting point in the conversation. It allows us to sort of start giving them some breadcrumbs of value. And if they like those breadcrumbs, what we're seeing now is they'll often take more from us. Harley, recently you started a store from scratch on Shopify selling tea. I did. Which is interesting because you've gone from the top level right back to the beginning. Throughout that

process, what did you learn about your platform and how is it impacting your work at the top level of Shopify? You know, it's interesting. My history of Shopify started back in 2005 or so. I was born in Montreal. I grew up in South Florida. I went to McGill for college here in Montreal, where I live now. And I went to Ottawa for law school in 2005, not to actually become a lawyer. I went to law school to become a better entrepreneur. A mentor of mine convinced me that law school would be like finishing school for entrepreneurship, which was totally accurate. And I didn't have any friends or family there, but I ended up having the really amazing opportunity of meeting a recent immigrant to Canada named Toby. And Toby had just moved to Canada a year earlier and he was selling

snowboards on the internet, frustrated by the software that was available to build a simple, elegant, beautiful, scalable online store. He wrote a piece of software to sell his snowboards and very quickly realized that the software was a great idea, even though the snowboard business may be a good idea. And so he stopped selling the snowboards and focused on the software, which would become Shopify. I met Toby around that time and I ended up becoming one of the first merchants to use Shopify and nice little t-shirts on Shopify. So my history with the company as really merchant first, as a user of the product years before I even joined. And what I felt was two things were happening around 2020. One is that it had been 15 years

since I really had used Shopify from startup to scale, actually building a brand new store. And so I wanted that experience. But the second one was in 2005 and 2006, when you were building an online store, there was really one acquisition channel for customers, which was like Google AdWords. And so much had changed. We had content became a thing. Social media is a thing now. Drop shipping, 3PLs. And so I wanted to put myself in the shoes of merchants that use Shopify. And so we built firebellytea.com, my best friend and I, David. He's a big tea guy and I love drinking great high quality tea. And it was an amazing opportunity because I got to actually not just send feedback to the product teams about what it's like for me to start from scratch. But

now today because fire belly still you know it's it's doing pretty good and it's still a very much an active company when i want to experiment with one of our products or i want to learn more about it either for an earnings call or because i'm just curious i get to actually implement it for my store so for example i'm using shopify's b2b product i'm using shopify audiences for ad product i'm not using shopify capital but i'm able to actually try to use a lot of these things and i would encourage anyone listening that's running a company whether a small company or a larger company, to actually spend some time, even if you say, well, I know what the product does because I used it years ago. I think this idea of reintegrating yourself into the actual

cycle that your customers have to go through is invaluable. And it's been an amazing experience. I love having a little tea company on Shopify on my own. Can you share any, maybe an experiment that you've run or a change to the platform that's happened because of your experience now as a user? I will tell you that just next to me right here, I have the original screen print that Ben Francis sent to me from Gymshark. Gymshark is now a billion dollar company. Ben Francis started it in 2012 in the UK. And Ben's a good friend. And as a present for me a couple of years ago, he sent me the original screen that he used to print that first t-shirt. I think a lot of people look at Gymshark today and see the massive amount of influencers and

celebrities and all these people they work with and say, well, I can never achieve that success because I cannot afford those major celebrities. I can't afford to pay them. Shopify actually has a product called Shopify Collabs, which connects brands and basic content creators. And some of these content creators are not very big. I mean, they have a couple thousand, but what it does, it's like a matchmaking service

that really connects merchants to people that are talking about that vertical. So a good example is if you are R-House or you're Hexclad or you're one of these amazing direct-to-consumer kitchenware companies. You have all these people making amazing cooking videos on YouTube, but they don't know each other. So Shopify Collabs actually connects you with them and helps you facilitate some sort of dynamic or some sort of fee-based relationship where they'll talk about your products, they'll get a sale, you ship it, and then you'll pay them a

commission. What I noticed about FireBelly was when we're getting started, a lot of people knowing it was me behind it was like, you got to get the biggest tea people in the world, the people that are writing the books on tea, and we actually resisted that and actually used Shopify Collabs instead, which is far less expensive, and it's been incredibly valuable. Basically, what we now have through Collective is, in pretty much every one of our major markets, I don't mean countries, I mean cities, actual cities and towns, we have someone that we've met through Collabs that helps to talk about Firebell, that helps to describe the product, what flavors work, why it's good value, how the packaging works, all the accessories.

having that information and knowing that information now when i meet or mentor or talk to entrepreneurs either ones that are just getting started or much larger ones i often remind them that the game of influence is actually far less about having one or two people with a massive reach but rather a long tail of people that have more authentic relationships with their followers so rather than celebrities who have a bit of this superficial relationship find people who some person that's reviewing. I just saw someone on YouTube. He's built a massive audience. He reviews appliances like washers and dryers, like home appliances. It's all he does. And his follower account or his subscriber account on YouTube is not massive. I think it's 10 or 20,000. He's not

Mr. Beast. But you see the engagement that some of these people have, and it's remarkable. And that's one of the things that Collabs does. Maybe the second lesson that I learned was on shipping and fulfillment. We use a great 3PL. We use one in the US and one in Canada. and initially I hesitated to use it because I wanted to sort of control the experience of when you bought something from FireBelly, it has to come in a particular box, it has to look really beautiful.

And what I realized is the evolution and the innovation in 3PL land has become incredible where now you can do pick and pack and you can do custom kitting and you can do all these things. So when the customer receives your package, it just looks super customized. And there's a lot of great 3PLs that do that.

Those are probably my two largest sort of ahas. As we start to wrap up here, we got a topic that's hot in the streets that affects a lot of Shopify merchants, and that's the de minimis rule. Out here in the US, we're weighing getting rid of that, which allows low cost goods under $800 to enter the United States without taxes or tariffs. And the argument to do this is that bad actors take advantage of this loophole to bring in smuggled products, drugs. And also you have these large discount online retailers, including Timu and Shane, multi-billion dollar companies that use this loophole in order to basically pay absolutely nothing in taxes and edging out maybe in some cases, small entrepreneurs. I've heard the argument to keep this from Shopify is that you need open trade and global commerce and what you need to do is just sort of streamline what's going on. I'm wondering,

what is your response to those arguments and how do you keep trade in a way where you can block out maybe some of those bad actors and protect a lot of the small businesses that use Shopify? Yeah. Well, look, I think it's a tough time for merchants right now. Part of what we try to do at Shopify is to quickly and practically find ways we can make things better for them. So one example is, as sort of the tariffs conversations were happening, we immediately, you know, made it so that merchants can display and collect duties right at checkout. We have a tab now in the shop app where consumers can easily shop from their home country using our new search filters. So we're releasing all these new updates aimed at simplifying the handling of international sales.

When it comes to de minimis, I actually think de minimis protections are crucial for small businesses. Anyone that is doing any type of cross-border, it is important. You mentioned, they exempt low value shipments from taxes and duties, but they keep costs down. And I think they allow entrepreneurs to compete against some of the biggest companies. If you remove these protections, I think costs go up. You definitely disrupt some supply chains. And I think generally you hinder cross-border trade. So if you think about Shopify's merchants, our merchants move billions of dollars across the border. This will impact real entrepreneurs who are just trying to make a living. And we actually talked to a couple of companies. One of them is called Bloom,

which is a skincare company. And the other one's called Cauldron, which is a fragrance company who emphasize like how these tariffs are not just tough for them from a cost perspective. They're also very difficult for them from a complexity perspective, that they don't have large teams of people. There's no tariffs team inside of these small businesses. In many cases, it's one or two or three people operations, mom and pop operations in some cases, and they just don't have the capacity to do so. So we're obviously huge proponents of global trade. we think that one of the best things today relative to a hundred years ago is you started a business now in Canada or in South America or in Europe. Your total addressable market is not

your existing geography. It is anyone who wants that product on the planet. And now that, as you may have noticed, our Shopify press releases now say for our location says internet comma everywhere because more and more our company, but most of the companies we serve, they're global companies, whether they're based in some small town or some big city, it doesn't really matter. It's irrelevant. What matters is who are they selling to? So hopefully we'll have some clarity in the next couple of weeks. And more importantly, hopefully there's some thoughtfulness around how do we protect and also how do we foster more business for these small businesses? Because I read this recently that like two thirds of all employees work for small businesses. And pretty much if

you look at all new job growth that comes from the small business sector. So this is the engine into the economy. We'll leave it there. Asit Sharma, Harley Finkelstein, appreciate both of you being here. Thank you for your time and your insight. Thank you. If you've got a personal finance question for an upcoming mailbag, we're going to record one this Friday with Allison and Bro. Shoot us an email at podcastsatfool.com. That is podcasts with an S at fool.com. All right. As always, people on the program may have interests in the stocks they talk about. The Motley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. All personal finance content follows

Motley Fool editorial standards and are not approved by advertisers. The Motley Fool only picks products that it would personally recommend to friends like you. I'm Ricky Mulvey. Thanks for listening. We will be back tomorrow.