Machine learning is transforming Shopify, says Paradigm Capital

While many companies talk about the potential for Machine Learning to transform business, Shopify (TSX, NYSE:SHOP) is already reaping its considerable benefits, says Paradigm Capital analyst Kevin Krishnaratne.

Last week in Toronto, Krishnaratne attended a series of meetings with Shopify’s SVP of Data & Analytics, David Lennie. Those meetings, says the analyst. gave him a much better understanding of the Machine Learning and Artifical Intelligence tools being used at the Ottawa-based company he describes as the world’s leading commerce platform.

Krishnaratne notes that Shopify has been employing Machine Learning since at least August of 2016 on its Merchant Cash Advance Program, which was launched in April of the same year. He points out that this program is now driven 100 per cent by Machine Learning models that can assess the risk of all eligible U.S. merchants and create customized offers in less than one hour versus roughly one month when done manually.

The analyst says Machine Learning and Artificial Intelligence are now a presence in many aspects of Shopify’s business, giving the company a potential leg-up on its competition.

“Shopify has been generating large volumes of data across a variety of data types and at significant velocity, as the company saw +12B interactions on its platform in Q1/17 versus +35B in 2016. In our view, Shopify’s use of this growing data asset to solve merchant pain points will serve as the foundation of its deepening moat versus other competing solutions,” says the analyst.

Krishnaratne’s meetings with Lennie exposed him to Shopify’s efforts in fraud detection, where the company has been able to reduce the number of of false positives by 90% and increase true positives by 15%, which has helped merchants capture market value they would have otherwise lost.

But the analyst says there are still many aspects of Shopify’s business that could reap huge gains from the introduction of Machine Learning.

“ML algorithms see the greatest benefits when the number of data points used is very large, so solving merchant pain points that address all merchants has been Shopify’s main focus to date. We view Marketing as the next logical area to see ML benefits given its importance for merchants large and small, but opportunities on the horizon for larger merchants include Inventory Management, Product Sourcing, Merchandising, and Product Recommendations. We also think potential exists longer term for Shopify to sell data analytics and ML services as a third business alongside existing Subscription and Merchant Solutions services,” he says.

In today’s research update, Krishnaratne maintained his “Buy” rating and one-year price target of (All figures USD) $100.00 on Shopify, implying a return of 3.1 per cent at the time of publication.

Krishnaratne thinks Shopify will post Adjusted EBITDA of negative $1.9-million on revenue of $636.6-million in fiscal 2017. He expects those numbers will improve to EBITDA of positive $33.9-million on a topline of $901.1-million the following year.

“SHOP,” the analyst cautions, “is not an inexpensive stock, but we continue to believe a premium is warranted for its leading role in the disruption of retail, with market penetration still in the low single digits.”