Shopify: Buy the Dip?

Markets Motley Fool

Shopify (NYSE: SHOP) was crushed by allegations it was little more than a get-rich-quick scheme. Shares that had nearly tripled over the past year have tumbled 20% since the critique broke in early October. That naturally leads an investor to wonder whether the e-commerce storefront will overcome these charges and make its stock a buy, or they'll prove true and buying now will be like catching a falling knife.

Continue Reading Below

What we know

Famed short-seller Andrew Left at Citron Research issued a scathing rebuke of Shopify, alleging the platform routinely violates FTC marketing guidelines and was "dirtier" than Herbalife (NYSE: HLF), the multi-level marketing company that was required to pay a $200 million settlement with the regulatory agency.

There are several aspects to Left's accusations. On the one hand, he contends Shopify is violating FTC regulations by promising people if they use its product they could become millionaires. He also says people promoting the service aren't disclosing they're being compensated for their endorsement by the outfit. Although other, larger marketers may also do something similar, it's still an illegal activity, similar to Herbalife, which was slammed by the FTC for advocating "members can 'quit their job' or otherwise enjoy a lavish lifestyle" by using its products. Left says Shopify even has a form letter on its website that platform users can use to send to their bosses when they quit their jobs.

Comparing the company to Herbalife seems to fall short, since people aren't directly selling Shopify products like they do with the supplement distributor; users are using its platform to sell their own goods and services (Left does note bloggers and other sites can make money referring people to Shopify, and notes that is akin to affiliate marketing rather than an MLM scheme).

Still a good value?

Continue Reading Below

There appear other, more problematic accusations that Shopify will need to address. The Citron report has a lot more teeth when it accuses the company of being highly overvalued. At 20 times sales, it is valued about twice as much as other leading SaaS companies like Salesforce.com (NYSE: CRM) and Workday (NASDAQ: WDAY), and Left contends Shopify's far richer than it has any right to be considering there is little known about the vast majority of its 500,000 customers.

He also notes that only 50% of Shopify's revenue comes from subscription fees while other, better SaaS businesses are reporting 85% of their revenues come from subscriptions. Left notes Shopify is an $11 billion business trading at nosebleed valuations. He suggests the stock could and should sit at about half its current price and then still have much more room to fall if and when the FTC gets involved.

The dust is still settling

In cases like this, there is often a lot of confusion, and Shopify posted a note on its website stating "We vigorously defend our business model and stand resolutely behind our mission and the success of our merchants."

The platform provider offers its customers the tools they require to meet the needs of consumers who expect to be able to transact anywhere, anytime, on any device. There's a lot of blowback from analysts and customers to the Citron critique, saying it is way off-base.

With the company reporting earnings at the end of the month, it may be that its actions will end up speaking louder than Left's words. The short-seller has been right before, and his point on the company's valuation certainly does have some merit. For cautious investors, I'd caution against jumping into the stock just yet.

10 stocks we like better than Shopify
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Shopify wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of October 9, 2017

Rich Duprey has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Shopify and Workday. The Motley Fool recommends Salesforce.com. The Motley Fool has a disclosure policy.