November 7th, 2022: Shopify’s earnings, Disney+ expands, CB Insights valuations report, and Amazon Q3 earnings
It’s November 7, 2022 and this is the Watson Weekly - your essential eCommerce Digest!
Today on our show:
Shopify Earnings Show Strength of Plus Offering
Disney Plus Expands Into eCommerce
CB Insights Valuations Report Reveals Troubling Late-Stage Trends for Startups
Amazon Q3 Earnings Reveal Growth But Also Profit Concerns
- and finally, The Investor Minute which contains 5 items this week from the world of venture capital, acquisitions, and IPOs.
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BUT FIRST in our shopping cart full of news….
Shopify Q3 2022 Earnings Show Strength of Plus Offering
In the last two weeks, Shopify reported Q3 earnings and I listened in. Of course, I listen differently than a financial analyst.
I am really listening to learn about management, strategy, leadership, as well as execution. I could mostly care less about estimates and expectations. While analysts loved what they saw today, I did see a few dark clouds.
Here are the big themes:
1 - Shopify Plus is now 33% of Monthly Recurring Revenue.
That is significant and 18% growth y/y MRR for Shopify Plus.
MRR was $107M in the quarter, up 8%.
What this means is that Shopify Plus is growing twice as fast from a total MRR point of view as lower versions (Basic/Advanced)
This is also what is driving the attach rate of other Shopify offerings like Audiences and Payments.
2 - Shopify’s new operating margin drops from flat y/y in 2021, to now -25%.
What does it mean? Everytime Shopify makes one dollar, it actually loses twenty five cents providing its service.
While there are a lot of SaaS companies look like this, it's not a good look. And Shopify has not had such terrible net operating margins since before 2018 when I clocked it at -20%.
3 - So where are all these expenses coming from? Shopify didn’t lose money last year of course.
I took a look below the gross margin line and here’s what I found:
* Research & Development spending increased 86% y/y. Almost double!
* General & Administrative spending increased 62% y/y. Literally this is overhead.
* Sales & marketing spending increased 27%
Keep in mind top-line revenues only increased 22% year over year and gross margins went down from 54% to 48%. So less profitable per item you sell, and you increased expenses 3-4x the rate of your revenue growth. Not the formula for entering economic uncertainty.
I would love to say I see no issues here, but that is not the case. It’s really hard NOT to predict a major restructuring coming as they integrate Deliverr. Clearly these trends cannot continue indefinitely.
4 - They touted their Shop Promise badge which is aimed at the heart of Amazon.
Shopify Fulfillment Network merchants now have Shop Promise (no word on Deliverr yet) on their Shopify stores
I looked at a Shop Promise badge in the wild and even the core value prop screams "you get fast 2-day shipping without a subscription"... meaning Prime.
It couldn't be more on the nose. So we have Shop Promise in one corner and Buy With Prime in the other.
5 - Shopify overall subscription growth has slowed down
12% year over year growth. In past years, subscription revenue growth had been like 45%.
They say this is because of app store revenue changes. But this doesn’t make sense to me. I thought subscription revenue was about the platform, and merchant services revenue was more or less everything else?
Doesn't this mean BigCommerce is growing subscription revenue faster? (Like 3x faster? I have them at like 35% y/y subscription growth)
Look, Shopify still has a very strong position in the market and has largely eliminated the need for RFPs for most brands. But it’s financial performance matters because it needs to attract and retain innovative employees that power its growth.
[References:]
Our Second Story
Disney Plus Expands Into eCommerce
TechCrunch and the Wall Street Journal reports that Disney+ is rolling out exclusive merchandise through an exclusive shop linked to their streaming service, which will link users off to an online experience.
A few elements I picked up on:
* Shop exclusive and early-access merchandise from their brands directly from detail pages on the streaming service.
* In order to access it you need to hold your phone up to the screen and snap the QR code.
Ugh.
Does anyone remember the 80s when certain shows distributed red/blue glasses for special 3D events and you were amazed but yet wondering what the hell the whole family is doing in the living room wearing strange glasses for questionable effects? Who remembers Monster from the Black Lagoon? This is the era I feel like we are in with QR codes.
In the future we could have something like a digital link been your authenticated real-world presence and a connected device (whether that is your TV or AR device) already present. What form this will take is up for debate, however.
Two camps definitely working on these ideas are Meta and Apple. Most people are betting on what seems to be Apple's AR-focused approach whereas Meta is more focused on VR.
I can see this coming, but it sure seems to be happening extremely slowly.
Wrapping up on streaming.... The streaming services that can establish new revenue streams (ads or merch) will definitely have an advantage in the future. Other streaming services feel like they are destined for another cable-like consolidation play.
The advantage Disney has over anyone else is of course the incredible fan base which completely gobbles up any merchandise the company offers, so this is a great idea to drive more value from Disney+ membership.
[References:]
Our Third Story
CB Insights Valuations Report Reveals Troubling Late-Stage Trends for Startups
I received a copy of a CB Insights report that showed a few trends that I thought other Watsonians would like to hear about.
First, while valuations declined across many stages of venture capital, they declined most in the late stages, with Stage D and later valuations falling 27+% quarter over quarter.
This makes sense to me because not only are there fewer deals happening, but earlier in the cycle most venture capital-backed companies don’t have to care about their valuation too much. High valuation, low valuation, doesn’t matter, as long as there is cash in the bank.
It’s in later stages prior to an acquisition or IPO that valuation is critical. And the late stage venture investors are most in tune to the prices that the public and private markets are paying for IPOs and acquisitions.
Second, the number of seed deals is not bad off as the number of seed deals is expected to be flat to full year 2021 this year, with increased valuations year over year. This is great news for entrepreneurs because funds have capital to deploy, and despite that fact that early stage deals are the riskiest part of the portfolio, they also don’t need to produce results soon.
Later deal stages like Series A and B are off too but not as nearly as much as Series D and later.
A final trend to consider is that as investors become more cautious particularly in later stages, they are demanding more preferences and participation rights if things go south. For founders with great businesses, remember to hold firm as one investor can really screw up your entire cap table in the event things go wrong, or make it harder for you to attract your next investment.
[References:]
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And Our Last Story
Amazon Q3 Earnings Reveal Growth But Also Profit Concerns
Amazon recently announced their Q2 Earnings and with it helped us reveal a little bit more about the eCommerce and retail outlook going forward.
Analysts were expecting much faster AWS growth and better profitability, and Amazon’s European exposure caused it to miss those forecasts in the face of a European recession. Another thing that analysts did not like was their muted guidance for Q4.
I’m definitely more positive than the stock market on Amazon, but let’s get into it. Ultimately the good news for Amazon is they have multiple levers to help their business grow. First-party, third-party, AWS and now Ads.
First, growth is up.
The company reported 19% constant currency sales growth. Better than I expected really.
The major Prime Day in July was in these numbers, but the second Early Access event in October was not.
Just to give you a comparison point for that 19% to Shopify, Harley on the Shopify earnings call mentioned 15% year over year sales growth.
I do think marketplaces will benefit in this environment.
Second, the company’s Productivity and Cost Savings Improvements were not all realized
The Amazon team shot for $1.5B in improvements in Q2 but Reached only $1B.
If a normal person misses a sales quota by one-third, someone gets fired! Anyway you slice it, this is not great achievement to plan.
Of course Prime Day will depress margins, so that is one factor. Amazon also mentioned on the call that Q4 isn't going to help because it is harder to recover costs during a peak season when all personnel is otherwise occupied.
This is why analysts are up in arms. The cavalry is not coming this year.
Third, there appear to be no reasonable explanations on what is happening with space restrictions on Amazon right now.
Follow me for a moment.
- You double your fulfillment network
- You are still cutting FBA seller storage and replenish limits actively.
- Inventories are up, but surely they are not double.
- Purchase Orders to first-party vendors are dropping consistently because "our warehouses are full"
You doubled your fulfillment network (they keep blaming costs on this) from one side of their mouth. From the other side of their mouth, your warehouses are full.
There are three likely explanations.
(a) These warehouses are not yet online and making a serious impact, and
(b) The ones that are, are not staffed. These are tough jobs to fill, despite the fact that Amazon pays above market. They need a lot of people, and half of the US has tried and quit an Amazon warehouse ;-)
Another explanation comes in from a friend of mine Jon Derkits at Forum Brands.
His answer is there are only so many docks in fulfillment centers, and most of them are set to outbound right now getting ready for the peak season. OK, I believe that could be true, but is it true across the entire network.
The one thing I don’t like about this is it still doesn’t answer the fact that they doubled the network but didn’t double volume. Also if this explanation were true, wouldn’t it be true most every year? And didn’t they double the network to quote remove space as a constraint?
It strains credibility to believe that docks would then become an unresolvable constraint and that Amazon wouldn’t think ahead of this.
Fourth, Third-Party units are up to 58% of total, from 56% at this time last year.
The star of the show at the moment is really the advertising business, up 30% year over year when you exclude currency. On a quarterly basis they reached $10B in revenue which is just a staggering number.
Wrapping up, I was impressed with their 19% growth this quarter, but unimpressed with the profitability achievements. Andy Jassy in one of his first letters said the team was on it, but obviously trying to run multiple Prime Days, deal with declining traffic and changed consumer spending patterns while at the same time reduce expenses is a tall order.
[References:]
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It’s That Time Friends, for our Investor Minute. We have 5 items on the menu today.
First
ARTA Secures $11 Million to Transform the Post-Purchase Experience for High-End Goods and Collectibles
I love this segment because it’s an area of fulfillment that most do not focus on - high value goods. The solution is already starting to be used by art galleries around the world.
Second
Katana, an ERP for SMB manufacturers, raises $34M
I wish them luck but there is a big category challenge here. ERP is complex software, which is expensive to produce and maintain. The SMB segment demands simplicity and low cost. I guess that’s why they are raising money!
Link: https://techcrunch.com/2022/10/12/katana-an-erp-for-smb-manufacturers-raises-34m/
Third
Luxury retailer Rue Gilt Group withdraws its $100 million IPO
I know this section is supposed to be investments but this seemed to fit here as well. I know a lot of the people at Rue Gilt and I wish them luck. It makes all the sense in the world if you have the cash to survive another year or two to delay an IPO to a different time.
Fourth
Sneaker Reseller Goat Set to Acquire Streetwear Site Grailed
This is another one of those acquisitions that would never have happened a year ago. Grailed would have just raised more money on its growth story. With venture capital becoming more difficult to come by, It remains to be seen if Goat itself can survive the next couple of years if it’s not already profitable.
AND FINALLY …
Buy Now Pay Later Provider Credit Key Raises $115M in debt and equity
The fact that debt is a component here is a big red flag for me. This means Credit Key is going to be lending money in a rising interest rate environment and hope the terms of its own debt will be less than the terms it can lend to others. All this in an industry which has historically not been great about collecting its debts.
Link: https://www.axios.com/pro/fintech-deals/2022/10/19/credit-key-nabs-150m-debt-facility
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That’s all for this week! Till next time Watsonians.....
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Hi, I’m Rick Watson, CEO and Founder of RMW Commerce Consulting and host of the Watson Weekly podcast - your essential eCommerce Digest.
Our production partner for the series is CitizenRacecar. The show is produced by Alex Brouwer; Production Manager, Gabriela Montequin.
To hear new episodes of the show every Monday morning, subscribe now at rmwcommerce.com/watsonweekly and wherever you get your podcasts.
