Shopify’s growth story may be coming to an end

Share

It takes guts to publicly short a stock, but it requires a special set of cojones to invoke the name Herbalife in your campaign.

That's because investor William Ackman's crusade against the nutritional-supplement seller, now approaching its fifth anniversary, is widely regarded as one of the least-successful short efforts in history. No matter: Citron Research's Andrew Left dropped the H-bomb in his Wednesday missive against Shopify Inc., anyway.

That connection may be enough for investors to dismiss Mr. Left's claims and jump on in to Shopify after two days of declines. After all, at least one analyst says it "opens the door for long-term investors."

Beware: A closer look at the Herbalife history, and some of Mr. Left's points, suggests this is the end of the rapid ascension of Shopify's stock price.

Mr. Left is saying that Shopify is less a software company than the promoter of a get-rich-quick scheme, what with its rewards for "partners" to sign up other partners. Shopify's messaging and opportunity is, Mr. Left says, worse than Herbalife, which has engaged in successful "multi-level marketing" for years, despite occasional brushes with regulatory authorities, including the U.S. Federal Trade Commission. It is the FTC, Mr. Left says, that can and should crack down on Shopify. ("We vigorously defend our business model and stand resolutely behind our mission and the success of our merchants," the company said in a statement on its website Thursday.)

I've read Mr. Left's presentation, and I think Shopify has a lot more explaining to do. Whether Mr. Left or the company is correct, however, the key is "a lot more," as in both explaining, and the time it could take for this to play out.

Mr. Ackman's case against Herbalife was notable for his angry rhetoric (he called it, at one point, "a criminal enterprise") and for his assertion that the stock can and should go to zero as the company got shut down for its behaviour. Because a number of big investors piled in on the other side of the trade, buying in, and the stock has periodically zoomed up, not down, Mr. Ackman's quest is widely viewed as foolish and quixotic.

However, this is important for investors to consider: Few people remember that the first shot at Herbalife was taken by another short-seller, David Einhorn, on May 1, 2012, when he asked a probing question on a company conference call. The shares fell roughly to $56 (U.S.) from $70 that day. Mr. Ackman only went public later, in December, 2012.

Herbalife closed Thursday at $67.70, essentially identical to its dividend-adjusted share price from the day before Mr. Einhorn's question. It didn't go to zero, by any means, but long-term investors are looking at zero gains more than five years after the short war began.

Along those lines, the fight has contributed to permanent damage to Herbalife's multiple. According to S&P Global Market Intelligence, Herbalife traded at an average forward price-to-earnings multiple between 16.5 and 18 in the two quarters before Mr. Einhorn's question. The forward P/E hasn't averaged 15 in any quarter since, and it spent four consecutive quarters below 10 from 2014 to 2015.

Which brings us to another point: Shopify's remarkable run – it was the best-performing stock in the S&P/TSX composite in 2017 until this brouhaha – has helped give it a multiple far in excess of companies considered to be offering "software as a service" or SAAS. Since Shopify is unprofitable, Mr. Left used a measure of price-to-sales that shows Shopify trading at 27 times 2016 revenue, versus an average of 10.2 for five SAAS companies. Shopify's multiple based on 2017 sales estimates approaches twice those peers.

Mr. Left points to Workday Inc., a widely admired provider of human-resources software that he placed in the peer group. Workday had a price-to-sales ratio topping 20 in its first year as a public company, but most of the great advance in the share price came early, as investors dreamed of what would come next. Workdays' sales are still growing rapidly – up fivefold in four years – but its price-to-sales multiple has compressed to just more than eight, according to S&P, and the shares currently trade below their February, 2014, peak.

"Everyone knew that Workday was best [in] class SaaS but the bulls got carried away and bought the stock too much too fast," Mr. Left wrote in his Shopify report. "Over the next 4 years Workday's revenue increased 400 per cent but the stock performance remained flat … and trust us, Shopify ain't no Workday."

You can argue, then, that Shopify is "priced to perfection," vulnerable to any little sales blip that the market sees as a sign the growth story is dented. You don't need an FTC investigation to slow or reverse the momentum – but we very well may see one after Mr. Left's compelling report.

Congratulations to investors who've been on the Shopify ride so far, but this may be the time to say goodbye to this money-making opportunity.