Novice Investor #5 - Is Shopify Overvalued?, Berkshire Hathaway and a New Crypto Fund
Happy June everyone!
Many people have told me how great the London summer is - full weekends spent in the parks basking in the latest heatwave. Until this sunny bank holiday, I was re-adjusting my weather expectations. Let’s hope we have many more sunny weekends like this one ahead. In any case, now that the summer is upon us, I am keen to kick up face-to-face networking a notch. If you are founder or investor (or know any) based in London and think a face-to-face coffee / lunch / dinner would be beneficial, please get in touch.
We had a very busy H1 2021 at Kennet with 7 exits and 4 new investments announced - Provar, Scoro, Loyalty Lion and Nudge. Most of my time over the past two months has been consumed with our 5th investment of the year, which I am excited to announce soon. Stay tuned.
Is Shopify Overvalued?
These days I cannot help but feel that technology company valuations are frothy. I am seeing high growth SaaS companies receiving terms sheets at 30x ARR and above. Public market revenue multiples are mouth-watering and the recent explosion of SPACs seems like a bit of a bubble indicator.
Have technology company valuations gone completely out of control and lost all connection to fundamentals? Or is there is an argument that these valuations are true representations of future cashflows? I am sure plenty of research analysts have completed this exercise in much more detail, but I have done my own high-level analysis on whether there is any fundamental value left in public market technology companies.
Shopify’s 44x LTM / Revenue valuation makes it the perfect candidate to put to the test. I am a big fan of Shopify. I get immense value from the platform with a side project I run. It is hard not to admire a company arming small businesses to combat the growing power of Amazon. Here is the analysis to understand if my favourite software company is overvalued.
In summary, my opinion is that Shopify is overvalued. Current prices already factor in Shopify achieving a dominant market share of eCommerce sales (>30%). To see any value, an investor would need conviction that the company can increase their current take rate by at least 2x.
The big learning from completing this exercise is market size. When I previously thought of Shopify’s market size I drew contrast to Amazon, who are generating $216bn revenue in the same market. It was easy to think Shopify who are only at $3bn in revenue have plenty of room to grow. However, Shopify’s take rate on GMV is a fraction of Amazon’s. Amazon generated $216bn in net product sales from a GMV of $490bn in 2020 (c. 44%), whereas Shopify generated just $3bn off a GMV $190bn in 2020 (c. 2.5%). In reality, Shopify’s target market is 18x smaller than Amazon’s. Unless Shopify can drastically increase their take rate, their growth will be constrained by market size over the next 10 years.
There is a bull case of market dominance and an increased take rate as Shopify expand their offering to become the one-stop-shop for entrepreneurs. However, there is considerable risk to this story and prices today already reflect c. 88% of this value. If you are chasing fundamental value, there are less risky bets out there.
Interesting Companies
Simão Cruz, a friend I met through my investing career is in the process of a raising a crypto focused fund, Lightshift Capital. Simão, who previously worked in the innovation team of a Portuguese bank, has taken the leap to raise a $25m fund to invest in innovative digital assets within the financial services industry. His team have a strong background in the space which they are leveraging to provide value-add services to token projects and invest at an early stage. The investing strategy is to focus on fundamental value and find projects that can create legitimate applications, as opposed to loading up on meme coins (Dogecoin).
Taking the leap to start your company / fund is a high risk move and is something we should all do our best to support. If you know anyone who could help Simão on his new project, please let me know and I can field an introduction.
Books & Podcasts
A Guide to the Good Life - Martin B Irvine
This book dives into the history and application of the ancient Stoic School of Philosophy. It is fascinating to see how popular different schools of philosophy were in ancient Greek and Rome. People devoted their entire lives to studying how best one can live their life. This obsession with philosophy has been lost in modern Western Culture.
There are some useful nuggets of wisdom in here such as negative visualisation (to increase gratitude) and focusing your goals on only things within your control. While the book has not convinced me to convert to a devout practising Stoic, it has inspired me to do some study and reflection on other philosophies. Spending time to codify your own philosophy to motivate and guide your actions towards a content life is a useful exercise. Following this book, it is something I have embarked on. The next school of philosophy I will be reading up on is Epicureanism.
Acquired - Berkshire Hathaway Part I & II
With both episodes 3 hours long, and a Part III on the way, this is more of an audio book then a podcast episode. Ignoring the length, this is the best podcast I have listened to this year. Ben and David from Acquired delve into the history and developments of Warren Buffet’s investing career. From his early days focusing on cigar butt investing, to value investing in great companies. The overriding thesis of Warren’s career revolves around reinvesting positive cashflows to harness the power of compounding returns. It is an incredible story that is very well articulated by The Acquired team. The episodes have plenty of nuggets of wisdom for anyone in an investing career or for anyone thinking about personal wealth accumulation. Very highly recommend.
Best of YouTube
How Tiger Global is outpacing VC with fast, cheap capital ft. Founders Fund’s Everett Randle | E120
Tiger Global are making moves in the US and European VC market. In Q1 2021, they invested in 60 private tech companies and are now outpacing all of the largest VC funds. This 1-hour video interview dives into their suspected hypothesis.
Tiger Global have entered the space with a compelling competitive proposal to founders - (1) materially higher valuations and (2) faster term sheets (light diligence). The strategy is clearly working for winning deals, but how can they do it?
On valuations, if you look at the leading growth tech funds in the past ten years, they have materially outperformed, with average fund returns of 3.0x, 5.0x and above. Even if you overpay there is clearly still value on the table for investors willing to take increased risk with higher entry valuations.
On diligence, Tiger Global can rely on reputable VC firms who have already invested at an earlier stage to remove the need for deep diligence. Plus, if a tech company is still growing at over 100% at >$10m ARR, the failure rate reduces substantially.
Ultimately, Tiger Global sees fast growing private tech companies as highly valuable assets and are willing to absorb increased risk to own them at an earlier stage. The strategy is paying dividends from a portfolio construction point of view. I am interested to see how the light diligence thesis holds up as they invest in earlier stage companies where failure rates are considerably higher.
The entrance of an aggressive player like Tiger into the market forces the questions to all investors - if you cannot compete on price and speed, what are you truly offering founders? Without a compelling answer you might be left struggling to win deals in the near future.
Kennet Partner’s Investment Target
Kennet Partners is a Growth Equity investor with over 20 years’ experience partnering with European and US SaaS companies. If you know any companies which fit our criteria, please reach out.
Investment size: $8m - $30m
Maturity: Over $3m in ARR
Growth: > 30%
Type: Bootstrapped and capital efficient B2B SaaS businesses
Geography: Europe & US