Why Shopify, Canada’s tech darling, is under attack by short-sellers

Ottawa’s e-commerce champion Shopify is fending off accusations Citron Research, the activist investment fund that brought down Valeant Pharmaceuticals

Tobi Lutke, CEO of Shopify, an online store, is seen in the company's Montreal office, Wednesday, February 18, 2015. (Paul Chiasson/CP)

Tobi Lutke, CEO of Shopify, an online store, is seen in the company’s Montreal office, Wednesday, February 18, 2015. (Paul Chiasson/CP)

This week was supposed to be a triumphant one for Shopify Inc., the Ottawa-based tech star. The company announced an expanded partnership with Instagram to allow users to purchase items (clothing, toys, food, etc.) without having to leave the app. It’s a seemingly small change, but potentially a profitable one for both companies. Instead of basking in good news, however, Shopify found itself in the crosshairs of a notorious short-seller alleging the company is a “completely illegal get-rich-quick scheme.”

Shopify occupies a privileged place in Canada. After the collapse of Nortel Networks and the shrinking of BlackBerry, Shopify has emerged as the country’s best hope for a global tech giant. Founded in 2004, Shopify allows anyone to set up an online store and start selling immediately, no tech expertise required. Most of its customers are small- and medium-sized businesses and entrepreneurs. Shopify boasts more than 500,000 merchants, 2,000 employees and a market value close to $12 billion. For those hoping that Shopify would defy the odds and become a lasting global success in tech, the accusations of fraudulent activity are enough to strike fear in their hearts.

The short-seller in this case is Andrew Left, the founder of Citron Research. In 2015, Left published a scathing report on another Canadian company, Valeant Pharmaceuticals, likening it to Enron. Valeant was already under intense scrutiny from investors and regulators, and Left said his report contained no new revelations. Nevertheless, Valeant’s stock plummeted nearly 30 per cent.

By now, Left has a pattern when launching a short campaign. He started Wednesday morning with a pair of incendiary tweets teasing at the release of a bombshell report on Shopify. A YouTube video soon followed in which Left, wearing a mauve shirt with one too many buttons undone, excitedly talks through his case against Shopify, often referring to written notes. A report, long on bombast but short on details, was then published on Citron’s website.

Essentially, Left alleges that Shopify is a pyramid scheme of sorts, promoting the idea that anyone can become a “millionaire” on its platform, when the failure rate of the merchants is high. His report contends Shopify uses an extensive network of affiliate marketers—a sundry mix of bloggers, influencers, and promoters—to tout the idea that Shopify can help make people rich and quit their jobs. There’s nothing unusual about affiliate marketing, but Left alleges Shopify’s financial relationships to its affiliates are not disclosed, running afoul of the Federal Trade Commission in the U.S., which has made a big push for transparency in advertising.

As is short-seller tradition, Left compares Shopify to another problematic company, claiming it’s “dirtier” than Herbalife. He later appeared on television, telling Bloomberg he plans to stay short the stock. “This stock is expensive, it’s illegal, they have heavy competition,” he said. “This has got a lot more way to go on the downside.” Shopify is only worth half its current value, he contends. Since Wednesday, the company’s shares have fallen more than 16 per cent.

Shopify did not immediately respond to the report, but put out a terse statement on Thursday. “We vigorously defend our business model and stand resolutely behind our mission and the success of merchants,” the statement read. Shopify did not address any specific claims.

Shopify is just the latest Canadian company to find itself the target of American short-sellers. In addition to Valeant, Sino-Forest Corp., CGI Group, DH Corp and Home Capital Group have been on the receiving end of accusations in recent years. Sometimes short-sellers dig up legitimately fraudulent activity, as was the case with Sino-Forest. This can partly be chalked up to the insularity of the Canadian finance industry. Equity analysts charged with evaluating publicly traded companies can fall victim to herd mentality, and by slapping a “sell” rating on a company or issuing a critical report, an analyst risks getting cut off by management. There’s also a reluctance in Canada to criticize our successes. American investors and analysts generally turned bearish on BlackBerry before their Canadian counterparts, for example. Outsiders bring a healthy skepticism.

That’s helped Marc Cohodes, an American short-seller, to wage campaigns against Canadian companies Concordia International and Home Capital. “Everyone has this arrogance in Canada that everything is foolproof,” he told Maclean’s earlier this year. “You know what? It’s not. It’s a fucked-up place.”

As for Shopify, it’s not surprising that success would bring greater scrutiny. Its share price is up roughly 110 per cent this year, it trades at a much higher multiple than its peers—and it’s yet to turn a profit. Tech stocks tend to be volatile and sensitive to bad news, a trait that short-sellers can easily exploit. And one of the big questions about Shopify is the churn rate, or how many merchants fail and shut down their stores. Shopify does not disclose this number, though analysts and journalists keep asking. In the absence of disclosure, short-sellers can sow doubt. “What is the churn???” Left asks in his report. “Needless to say, Shopify does not disclose the churn—why would it??” The implication is that churn is high, and that’s bad for Shopify.

Raising questions like this is a common tactic for short-sellers. “Success comes for activist short sellers even if they can create the appearance that there are factors that are not being disclosed and reflected in a company’s valuation,” according to a report last year from Kingsdale Advisors. “Shareholders will flee their positions based on rumours and the perception of what is going on instead of facts.”

Analysts who follow Shopify are largely dismissive of Left’s report. According to Bloomberg, 18 of 30 analysts rate the stock a “buy” while rest have a “hold” rating. Richard Tse, an analyst with National Bank Financial, put out a research note this week estimating that Shopify’s churn rate is 25 per cent, and that “transient subscribers” account for between 5 per cent and 10 per cent of revenue. “Even if Shopify had to change its marketing approach, we doubt it would have a considerable impact on the revenue base,” he wrote. Annualized revenue per merchant is rising, too, easing the pressure to sign up new customers to some extent. Tse isn’t writing off consequences entirely, though: “We can’t unequivocally rule out that this negative report will not surface some regulatory scrutiny even if we think it’s remote.”

Samuel Kemp with Piper Jaffray wrote in a report that some of Shopify’s promotional language is “aggressive” and “could be seen as being in violation of the FTC’s guidelines.” Even so, Kemp notes that Shopify has instructions on its website for affiliate marketers to disclose their relationships and the worst-case scenario is that the FTC instructs Shopify to better regulate its partners. While he concedes the company’s referral network potentially contains “some members operating mini pyramid schemes” there’s no evidence the issue is endemic. “Shopify’s merchant base is likely not churning at extraordinary rates, unsustainable, or at risk of deterioration,” Kemp wrote. Another analyst emailed by Maclean’s wrote back, “We don’t grace rumors with notes.”

It’s worth noting not all of Left’s short campaigns have been successful. In 2015, he issued a critical report on Wayfair, another ecommerce firm. This year alone, Wayfair shares have rallied 99 per cent. Left appears to be digging in for a long campaign against Shopify. When stocks so often trade on sentiment and emotions, much depends on who investors choose to believe. At the very least, Left is forcing investors to take a harder look at the company. Should Shopify emerge unscathed, this event may prove to be just another rite of passage for a rising tech firm.