Last December, Shopify (NYSE:SHOP) announced a $400.4 million offering of SHOP stock. This was after SHOP CFO Amy Shapero said the company had no current intention to undertake an offering during the company’s second-quarter earnings call. I suppose investors overlooked the word “current.” And Shopify did use the cash to help fund its growing fulfillment business.
However, on Sept. 16, the company announced plans for a second stock offering. At current prices, this offering will raise an additional $693.7 million. The company said it will use the additional cash to strengthen its balance sheet. Management also said the offering will provide flexibility to fund its growth.
Shopify is one of the more impressive growth stock stories of 2019. SHOP stock is up over 116% year-to-date. The idea that a company like SHOP would use a high stock price to generate capital is not news. However, in its last earnings report, SHOP reported a $2 billion cash position and no debt. So why issue not one, but two stock offerings, to fund growth that it could pay for in cash?
Shopify Is Changing its Business Model
In an effort to compete with Amazon (NASDAQ:AMZN) and other retailers, Shopify is investing heavily into fulfillment solutions. This will allow SHOP to offer tools such as warehousing over its web platform. But building the infrastructure for this capital-intensive business will not be cheap. In fact, analysts estimate it will require $1 billion of additional investments over the next five years.
A secondary offering will typically cause a company’s intrinsic value to move lower on a per-share basis. This is because when a company announces its offering, the current share price becomes the ceiling. To entice buyers, the company must offer shares at a discount to its current price. In the end, the company has more outstanding shares, but each share is worth slightly less than before the offering was announced.
When you look at it that way, the stock offering can be a prudent move. The company is selling shares when its shares are at an all-time high. It sells fewer shares to raise the money it needs, which reduces the impact on current shareholders. And the company maintains its strong cash position.
Are Investors Overvaluing SHOP Stock?
On the other hand, the move to sell additional shares may be the company’s way of signaling that it is not expecting to be profitable any time soon. The long-term story for Shopify stock goes beyond revenue. The company is forecasting 42% revenue growth in 2019. However, its trailing price-to-sales ratio of 25.7 is high. If the company believes that investors may soon be looking to take some profits, now would be a good time to issue an offering.
Why Does Shopify Need to Strengthen the Balance Sheet?
But the bigger question for investors is what does the company mean when it says the offering is intended to strengthen an already strong balance sheet? In addition to its strong cash position, the company’s adjusted net income in the last quarter was positive.
It’s not too much of a leap to suggest that the company is not expecting to be profitable for some time. Shopify’s fastest growing business, its merchant segment, is less profitable (gross margin of 64.7%) than its subscription segment (gross margin of 91.8%). Yet revenue in the merchant segment is growing almost 50% more year-over-year (55.6%) than the subscription segment (38.2%).
When you factor in the rising cost of building out its fulfillment business, it isn’t a stretch to say the company will not be profitable in the near future. This could mean that Shopify is using its share offering to raise capital in preparation for several years of future losses.
None of this is to say that Shopify stock is a bad investment. But as an investor, you have to ask yourself, “Why should I buy if the company itself is saying now is a good time to sell?”
As of this writing, Chris Markoch did not have a position in any of the aforementioned securities.
