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Dax Dasilva, founder and CEO of Lightspeed, with their new app outside their offices in Montreal on July 20.Christinne Muschi/The Globe and Mail

A short-seller report may not have produced the “smoking gun,” as one analyst put it, to crush the stock of Lightspeed Commerce Inc . But the questions it has raised about the company are sufficient for shareholders to consider locking in their remarkable gains, rather than holding on in hopes that Lightspeed will fulfill its lofty expectations.

Things played out according to the short-selling script when Spruce Point Capital Management released its attack on Lightspeed in late September. The New York firm released one of its hard-to-digest 100-plus-page reports as the market opened on Sept. 29. The company scrambled to respond by the end of the day, but could only dismiss Spruce Point as someone who would profit from the allegations and said there were “numerous important inaccuracies and mischaracterizations,” without actually saying what any of them were. Analysts with “buy” ratings said they saw no reason to change their views, and retail investors decried the big, bad Americans beating up on a Canadian company that should be championed.

While Spruce Point had a home run with its short of Maxar Technologies Inc. in 2018, it’s misfired badly with its recent Canadian ideas, particularly underestimating Canadians’ desire to shop at Canadian Tire Ltd. and Dollarama Inc. Both, as well as waste-management company GFL Environmental Inc. , have not only gone up since they were shorted by Spruce Point, but have also beaten the S&P/TSX Composite.

So far, though, it has drawn blood from Lightspeed. Its shares at Tuesday’s market close were down 22 per cent from the day before the report’s release, and down 33 per cent from the 52-week high the stock had set on Sept. 22. The investor reaction is likely because Lightspeed is a wildly expensive, unprofitable “story stock,” and Spruce Point has raised just enough concerns for investors to question whether Lightspeed’s tale will come true.

The company sells point-of-sale systems for retailers and restaurants to manage inventory and sell their goods to customers. Lightspeed has positioned itself as a modern, cloud-based software-as-a-service provider.

Lightspeed’s niche is retailers with extensive inventory, such as bicycle retailers, and one of the keys to its business is winning the favour of suppliers that will demand retailers use Lightspeed in order to stock their wares. Lightspeed says less-complex merchants – say, a website selling 10 T-shirt designs in three sizes – could simply use the systems of Shopify Inc., suggesting the merchant-services juggernaut is a Lightspeed competitor. Lightspeed’s latest initiative is payment processing, trying to capture extra dollars from its customers. Lots of potential customers, new product offerings for existing customers – it’s a big-time growth story.

At the stock’s recent peak, investors were paying an astronomical 65 times reported sales to buy into that story. No earnings-based valuation is possible because the company has nothing resembling profits. Even after the recent declines in Lightspeed stock, it trades at roughly 40 times sales.

And that could be okay if the Lightspeed story holds true. Spruce Point, which in its report throws as much as possible at the wall and sees what sticks, raises what it perceives, without proof, to be possible accounting issues that question whether Lightspeed’s organic growth numbers are correct.

Yet much of what Spruce Point casts in a nefarious light could have perfectly reasonable explanations. And Lightspeed, while not explicitly addressing most of Spruce Point’s allegations, reiterated its revenue-growth numbers in its brief response to the short-seller, and urged shareholders to refer to Lightspeed’s own financial statements. (The company has said it will not be commenting further on this matter, but it plans an investor day in November.)

In Lightspeed’s own numbers, interestingly, are some data highlighted by Spruce Point that speak to the broader issue of what Lightspeed will face by taking on payment processors, Shopify and even more competitors. As recently as six quarters ago, Lightspeed reported 20-per-cent profit margins on hardware sales – the equipment its customers use to run the point-of-sale systems. In its most recent quarter, it reported a 20-per-cent loss on hardware. That’s a downward swing of 40 percentage points in a year and a half.

Lightspeed boosters dismiss this as irrelevant for a cloud company and part of the overall plan to win new customers. But here are two points that should make investors wary. First, the losses in hardware sales have eroded the company’s gross margins, which are worse than prepandemic levels. That’s blunted the advantage it’s shown from adding more revenue to its fixed selling costs. Lightspeed has tripled its revenue over this period, but its operating profit margins are only slightly better than in early 2020.

And secondly, the hardware losses speak to the rapidly changing environment for Lightspeed. The company is doing expensive acquisitions to improve its capabilities to win new customers in e-commerce as well as serve its existing ones as they make the online shift. The economics of its e-commerce sellers, as measured by revenue per location, are less compelling than those of its bricks-and-mortar retailers – but Lightspeed, as Toronto’s Veritas Investment Research observes, isn’t disclosing the mix of e-commerce sellers versus bricksand-mortar retail locations.

Lightspeed portrays all these changes as part of the master plan, an uninterrupted growth strategy from even before its Canadian initial public offering in 2019. From the outside, though, it looks like a company that’s racing to adapt to the future, rather than powerfully charting its own course.

The analysts at Veritas, who have written about Lightspeed skeptically but more tactfully than Spruce Point for some time, framed the Lightspeed question this way earlier this year: What is possible, and what is probable?

Investors continue to price Lightspeed shares as if nearly everything possible is probable as well. With the stock still trading at almost three times its 52-week low, those who recalculate those probabilities and trim their Lightspeed holdings will likely be better off.

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Follow David Milstead on Twitter: @davidmilsteadOpens in a new window

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