Shopify’s governance move is unfair, this investor says

The stock may be down by plenty so far this year but the new move being proposed by Canadian e-commerce company Shopify (Shopify Stock Quote, Charts, News, Analysts, Financials TSX:SHOP) only adds to the worry about the company, according to portfolio manager John O’Connell.

Shopify announced on Monday a proposed governance change which would issue a new non-transferable founder share to company founder and CEO Tobi Lutke, one that would represent a variable number of votes to give Lutke 40 per cent voting power regardless of future changes in the overall share count. 

Shopify said the move will allow the company to progress in its buildout along its (and Lutke’s) vision for the future, which will involve a huge spending outlay to grow its network of fulfillment hubs.

“The proposal, if approved by shareholders, will modernize Shopify’s governance structure and allow Shopify to remain mission-driven and merchant-obsessed while sustaining an innovative culture. The proposal will also strengthen the foundation for long-term stewardship by Mr. Lütke, a proven leader who has delivered significant shareholder value since the Company’s IPO. This stability of leadership is expected to cement the Company’s focus on the long-term to the lasting benefit of merchants, employees and shareholders,” Shopify’s press release said.

The proposal notably features a sunset clause that would come into effect if Lutke is no longer an executive of the company and specifies Lutke needs to keep a 30-per-cent stake in the company. 

Shopify announced at the same time a proposed ten-for-one stock split, even as shares in SHOP have lost over 60 per cent over their value in recent months.

But even with the drop in share price O’Connell says SHOP is too expensive from a valuation perspective.

“Shopify is a high growth company and it trades at very, very high valuations,” said O’Connell, CEO of fund management company Davis Rea, who spoke on a BNN Bloomberg segment on Monday. “Just because a stock is traded at $900 at one point doesn’t mean that it has to go back $900. The stock owes you nothing,”

“If you were to extrapolate Shopify revenue growth rates at the current rate five years in advance and you were to assign it similar kind of margins and valuation techniques that you would apply to, let’s say, one of its major competitors like Amazon, you would probably find the stock to be trading at significantly lower prices than what it’s trading at today,” he said.

For years, Shopify was a monster of a growth stock to own and SHOP even ramped it up a few notches over the pandemic where the stay-at-home economy fit well with SHOP’s aim to provide every business owner with an online presence. The money certainly has been flowing over the past couple of years, with Shopify’s revenue up 86 per cent to $2.930 billion in 2020 and then up a further 57 per cent in 2021 to $4.611 billion. Profits were also on the rise, with SHOP hitting $6.41 per share in adjusted net income for the 2021 year.

All that good mojo impacted Shopify’s share price, which zoomed ahead in 2020 for a return of 178 per cent, and the stock was up another 40 per cent by mid-November of this past year when the market started turning against growth names in sectors like technology. Shopify was clearly a target, as shares dropped from a high of over $2,000 to $700 by early March of this year, aided, it seems, by poor investor reaction to the company’s yearly guidance delivered in February which called for more muted growth as the world returns in some measure to shopping on the outside once again.

“Oftentimes, stock prices are discounting very, very optimistic projections about where companies will be be trading in the future,” O’Connell said. “And while the growth projections may turn out to be true the valuations may be something quite different.”

O’Connell is not a fan of Shopify’s new governance plan either, saying the announcement was a disappointment.

“Quite frankly, Shopify is announcing a stock split, which doesn’t add any value to the business whatsoever, but they’re also trying to entrench the founder and his ownership position, giving him a golden share so that regardless of how much stock he owns he will still control and basically have complete control of the whole company,” he said. “I just don’t think that’s right.”

“All of us, if you own a stock should have equal rights determined by how many shares you own and this guy is trying to grant himself king status. I just don’t think that’s appropriate,” O’Connell said.

Shopify said the founder share proposal came about via a “careful and thorough” board process under advisement from a special committee of independent directors. 

“Taken together, these changes will enhance Shopify’s strategic flexibility and ability to pursue value-enhancing organic and external opportunities,” said Robert Ashe, Lead Independent Director, in the press release. “Tobi is key to supporting and executing Shopify’s strategic vision and this proposal ensures his interests are aligned with long-term shareholder value creation.”