CA - Make No Mistake Shopify's AI Opportunities Are Massive (Rating Upgrade)

2023-08-13 04:30:57 ET

Summary

• Shopify has already introduced numerous AI-enabled features that boost its revenue growth prospects, as well as bottom line profitability. But there are grander opportunities beneath the surface.
• Make no mistake, Shopify’s AI advancements enhance the tech giant’s ability to attract merchants from its biggest rival, Amazon.
• It is ironic how Amazon’s ‘Buy with Prime’, which is meant to threaten Shopify could in fact help Shopify attract merchants in the AI revolution.

As the AI revolution gains momentum, every industry and company is destined to be transformed, and Shopify (SHOP)(SHOP:CA) is no exception. The software giant has already started rolling out new AI-powered features to enhance the value proposition of its platform. But the opportunities don’t stop there, as the opportunities are indeed massive, conducive to revenue and profitability growth going forward. Nexus Research is upgrading the stock to a ‘buy’.

Before we delve into the AI opportunities, let us first revisit the reason Nexus Research had downgraded Shopify stock to a ‘hold’ rating. In a previous article, we covered the threat Amazon’s ‘ Buy with Prime ’ posed to Shopify. The program essentially enables non-Amazon sellers in the US to reach Amazon Prime members, as well as encourage independent merchants to use Amazon’s suite of e-commerce services like fulfilment and Amazon Pay. This essentially threatened Shopify’s ability to optimally monetize its merchant base through its own suite of merchant solutions like Shopify Payments.

Nevertheless, Shopify has continued to deliver solid merchant solutions revenue growth since the rollout of ‘Buy with Prime’. Furthermore, ‘Buy with Prime’ may actually end up encouraging Amazon sellers to become Shopify merchants, especially as AI makes it increasingly easier to run stores independently.

Before we cover Shopify’s AI opportunities, it is important to understand how Shopify makes money. The software giant has two revenue segments, subscription solutions revenue and merchant solutions revenue.

Subscription solutions revenue derives from monthly or yearly subscription fees for Shopify’s plans to enable merchants to build their own stores. This segment also consists of revenue earned from commission fees charged to partners on the Shopify App Store.

Merchant solutions revenue is earned from the supplementary services that Shopify offers its merchants, such as Shopify Payments and Shopify Capital. This makes up majority of Shopify’s total revenue.

Earlier this year, Shopify introduced Shopify Magic , “a suite of free AI-enabled features that are integrated across Shopify’s products and workflows to make it easier for [merchants] to start, run, and grow [their] business”.

Offering advanced AI tools to facilitate easier construction of businesses on Shopify opens the doors to various avenues for revenue growth. Firstly, it enables existing merchants to run their businesses more seamlessly, and thereby focus more on business growth, as well as enabling them to reach wider and more relevant audiences more easily. This ultimately should boost merchants’ sales, growing Shopify’s merchant solutions revenue through services like Shopify Payments.

One of its first AI-enabled features includes AI-generated product descriptions. By simply inputting a few keywords and details about a product, the AI feature generates a compelling product description. Keep in mind that Shopify is a data juggernaut, and holds a massive reservoir of intelligence regarding what kind of phrasing and description is conducive to higher conversion rates for a broad range of products. This means that Shopify Magic should be able to drive sales higher for merchants, again leading to merchant solutions revenue growth for investors.

In fact, Shopify has also introduced an AI-powered shopping assistant in the Shop app, where shoppers can discover and buy products from Shopify merchants. This conversational chatbot essentially allows people to describe in human language what they are looking for, and the assistant finds relevant products for them. This could indeed be a goldmine for Shopify.

It enables Shopify to learn in detail about shoppers’ preferences and trends, and this data would ultimately feed into Shopify Magic and the subsequent AI-features oriented towards merchants. For example, we mentioned earlier the AI tool that generates product descriptions for merchants. As the shopping assistant in the Shop app learns more about how shoppers describe the products they are seeking, it would in turn enable Shopify Magic to produce more compelling product descriptions with higher conversion potency.

This creates a win-win situation for Shopify. On the one hand, it should help drive sales higher for Shopify merchants, leading to more merchant solutions revenue for Shopify, as well as potential subscriptions solutions revenue growth as merchants could be willing to pay even higher prices for Shopify plans in the future.

On the other hand, as the AI-powered shopping assistant in the Shop app becomes increasingly better at serving shoppers’ needs, it could increase the recurrence of shoppers and the wider popularity of the app. More shopping activity through the Shop app means greater monetization opportunities, such as greater use of the ‘Shop Pay’ payment solution. The eventual evolution of the Shop app into a wide digital platform will ultimately create new revenue opportunities for Shopify. The point is, the growing popularity of the Shop app through such AI advancements should translate to higher merchant solutions revenue for Shopify shareholders.

Consider that while competitor Amazon could introduce a similar chatbot on its own e-commerce platform, the company faces a dilemma regarding whether to use the collected data to inform enhance its own products and selling strategies, or help its third-party sellers. Amazon already has already faced antitrust litigation over using third-party seller data to boost its own private label business. Hence, the introduction of such AI-enabled chatbots on Amazon could potentially drive further distrust among Amazon sellers, which could potentially benefit Shopify if they decide to set up their own store instead.

Furthermore, in July Shopify also introduced ‘Sidekick’, a conversational chatbot that can assist merchants with every task related to commerce and running their business.

Sidekick will undoubtedly enhance the stickiness of the Shopify platform, in several ways. Sidekick is personalized for each Shopify business, enabling merchants to gain quick insights and relevant ideas tailored to their specific business needs.

Shopify holds an enormous amount of data about merchants’ businesses on an aggregate basis, how shoppers interact with its merchants’ products & product descriptions, which business strategies work well across the different product categories/ industries, how successful merchants make optimal use of Shopify’s various tools to drive sales higher, and many more similar insights.

This intelligence can now be leveraged to empower Sidekick to assist merchants with growing their businesses. If deployed successfully, it should help drive sales higher for merchants, conducive to more merchant solutions revenue. Furthermore, as Sidekick becomes better and better at serving merchants though self-learning over time, merchants are unlikely to migrate to another platform given how well-versed Sidekick would be in their individual businesses. This further augments the value proposition of the Shopify platform, enhancing Shopify’s pricing power to drive revenue growth for shareholders.

Furthermore, Sidekick can help merchants discover new functions and capabilities through Shopify that they weren’t even aware of before. As merchants come across various new tools that help them run their businesses better, it will augment their perception of the Shopify platform, which can further enhance Shopify’s pricing power. Hence, these revenue growth opportunities enable Shopify stock to command a higher price to sales multiple.

Moreover, Sidekick could also foster Shopify’s upselling strategy towards higher subscription plans. For instance, as merchants ask Sidekick for help to complete certain tasks, or ask for insights/ advice relating to their business, Sidekick could be programmed to upsell towards features that are only available in higher-end subscription plans, thereby encouraging merchants to upgrade. As part of this upselling strategy, Sidekick can offer insights into how these exclusive features have helped other merchants drive sales higher, for example. Merchants upgrading to higher plans would indeed drive subscriptions solutions revenue higher.

On the previous earnings call, Shopify executives made clear that more AI-enabled features will be rolling out over time. The AI opportunities for Shopify are indeed as wide as the horizon, with grander opportunities lurking underneath the surface.

The most exciting opportunity lies in being able to design a digital storefront by simply having a conversation with a generative AI-enabled chatbot. Shopify already built a reputation for itself in offering merchants the ability to easily build e-commerce websites with low-code/no-code tools. Now, the software giant has the opportunity to take this to another level through Shopify Magic.

As AI makes it increasingly easier to build and run businesses on Shopify, it can indeed encourage more potential entrepreneurs that were on the fence about whether to start their own business due to time-consuming tasks and complexities, to actually start their businesses using Shopify.

In fact, on the last earnings call , President of Shopify shared:

With Sidekick, no matter your expertise or skill set it allows entrepreneurs to use everyday language to have conversations that jump start to the creative process, tackle time-consuming tasks and make smarter business decisions.

Sidekick and other Shopify Magic-powered tools can help attract nascent entrepreneurs who are still learning about the business and commerce world. Hence generative AI tools should spur merchant growth, conducive to subscriptions solutions revenue growth for investors.

In fact, not only could generative AI help attract nascent entrepreneurs, but also acquire competitors’ customers by simplifying the migration process. Shopify already proclaims its easy migration process and how they continue seeing competitors’ customers switch to Shopify. Generative AI tools like Sidekick can further accelerate this process, and should enable the tech giant to more easily convince merchants to make the switch to Shopify.

This could be particularly valuable in convincing Amazon sellers to become Shopify merchants. As mentioned earlier, Amazon rolled out ‘Buy with Prime’ to all US merchants earlier this year, enabling independent merchants to reach Amazon Prime members, while threatening Shopify’s ability to optimally monetize its merchant base through its suite of merchant solutions.

Though ironically, Amazon’s move could also end up helping Shopify, as Amazon Sellers now have a way of reaching Amazon’s loyal customer base through running their own websites. As it becomes increasingly easier for Amazon sellers to set up and run stores on Shopify using various generative AI tools, it could indeed be conducive to higher subscription solutions revenue, advantaging Shopify shareholders.

Additionally, AI will inevitably also give rise to new breeds of apps on the Shopify App Store. Therefore, as Shopify’s third-party partners continuously introduce new AI-powered services that serve merchants’ needs, it will also boost commission-based revenues for Shopify, which further contributes to its subscription solutions revenue. For context, Shopify charges 0% commission on the first one million dollars earned by partners on the Shopify App Store, and then 15% commission on the revenue earned after that.

Risks to Consider

Competition will intensify : Shopify’s AI transformation is indeed promising from a revenue growth perspective. Though competing e-commerce website builders, like BigCommerce and Wix, can indeed introduce similar AI functionalities as well to stay competitive in the AI race. This may undermine the exclusivity of Shopify’s AI features, and therefore could subdue its pricing power to drive revenue and profitability growth.

Don’t underestimate Amazon : while AI fosters Shopify’s ability to monetize its own merchant base, ‘Buy with Prime’ still poses a risk to eating into Shopify’s merchant solutions revenue. In an attempt to dissuade merchants from using ‘Buy with Prime’, last year Shopify highlighted data privacy concerns for merchants wanting to join ‘Buy with Prime’. On the last earnings call , when asked about the ongoing discussions with Amazon on the issue, CFO Jeff Hoffmeister shared that “conversations with Amazon remain productive, but no news to share right now”.

With Amazon continuing to persuade Shopify merchants to use its own services like Amazon pay solutions, it indeed eats away at Shopify’s own financial growth prospects. Nonetheless, despite the ‘Buy with Prime’ threat, Shopify seems to have been able to deliver solid merchant solutions revenue growth, as the CFO shared on the earnings call :

“Q2 Merchant Solutions revenue was $1.3 billion, increasing 35% year-over-year with nearly half the increase due to the growth in GMV. Additionally, growth was driven by continued penetration of Shopify Payments”

That being said, while Amazon has not been as swift in introducing AI-enabled features on its platform, investors should not underestimate its potential in this space. The e-commerce giant will definitely be fighting back to sustain the popularity and value of its e-commerce platform.

Financials & Valuation

The Year-over-Year (YoY) revenue growth rate for Shopify jumped to 31% in Q2 2023, led by the growth rate for Subscription solutions revenues rising to 21%. This was indeed due to the price hikes for Shopify’s subscription plans (except Shopify Plus) that took effect in April.

Shopify had been investing in continuous product innovations over last decade to enhance the value proposition of its platform.

Last quarter, Shopify proved to shareholders that these investments are paying off in the form of stronger pricing power, as CFO Jeff Hoffmeister proclaimed on the last earnings call:

We are seeing our merchants, continue to remain on the platform rather than using the price change to move off-platform and largely remain on monthly plans versus moving to annual. For Shopify it provides us with more gross profit dollars to invest back into the business balanced with improved profitability. For the rest of the year, we expect these pricing changes to continue to benefit our Subscription Solutions business

The successful price hikes not only foster Shopify’s revenue growth potential, but also its bottom-line profitability. And here’s the best part, Shopify’s AI-powered transformation has hardly begun. AI features like Sidekick and auto-generated product descriptions will further augment the value proposition of the subscription plans and keep merchants deeply imbedded into the Shopify platform. This should further strengthen the company’s pricing power in the form of future price hikes, leading to further revenue growth.

Furthermore, as Shopify uses the power of generative AI to innovate new merchant solutions, Shopify shareholders should witness continued growth in its largest revenue segment, merchant solutions, which made up 74% of total revenue in Q2 2023.

Last quarter, Shopify’s gross margin increased to 49%, mainly due to the gross margin of Subscription solutions segment jumping to 81%, thanks to the price hikes.

Aside from revenue growth, Shopify’s AI-led innovation should also induce further profit margin expansion, as merchants become increasingly willing to pay higher prices for software services that make it progressively easier to start and run businesses.

That being said, the merchant solutions segment will indeed have a larger impact on company-wide profitability, given that this is where majority of the revenue derives from. Amid intensifying competition, Shopify will need to prove it can offer new AI-powered merchant solutions with higher profit margins. To achieve this, Shopify can leverage its cross-selling power, whereby the use of multiple merchant solutions together can yield advantages for merchants, allowing for potential pricing power.

The point is, the Shopify’s AI-powered growth prospects are massive, which should facilitate continuously robust revenue growth for the commerce-driven growth stock.

Shopify currently trades at a price-to-sales ratio of over 11x. For historical context, it traded at over 40x in November 2021 amid the pandemic-era benefitting stay-at-home stocks.

Nexus Research believes AI will be a powerful revenue growth driver for the company going forward, and that 11x sales is an attractive multiple to pay for the stock. Nexus Research is upgrading the stock to a ‘buy’ rating.

For further details see: