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Reviewing a busted recommendation
The last 13 months have been a humbling experience. I feel bloody but try to remain unbowed. It has been next to impossible to make successful recommendations-at least as I define successful. Even companies that I have recommended on SA such as Adobe (ADBE), Wix (WIX), Trade Desk (TTD) and Arista Networks (ANET) whose shares initially appreciated have eventually faded although they are still up from the price at which they were most recently recommended. The risk-off bias of the market is so pronounced that even companies who have avoided reducing revenue growth estimates, and have reset their profitability/free cash flow expectations higher haven’t been able to withstand massive investor disenchantment with the IT sector.
Currently, the valuation of the shares of most IT/ecommerce companies are far more tethered to macro issues, particularly the outlook for inflation, a potential Fed pivot and the likelihood of a recession or a landing either hard or soft than they are to company specific developments. I get that. Recommending, or re-recommending buying the shares of Global-e (NASDAQ:GLBE) at this point is for the patient, and for those readers wanting to anticipate an ultimate Fed pivot. This is NOT an article trying to forecast when that might occur or when investors will start realistically anticipating one.
This is NOT an article bemoaning the Fed policy statement or what I believe was the misbegotten press conference of the Fed chairman after the last Fed board meeting. One strategist recently, in the wake of a rate decision by the Bank of Japan asked rhetorically why a Fed pivot should be anticipated. Another, equally convincing strategist from BofA wrote his belief that the Fed and other central banks would be adopting pro-growth expansionary policies before the end of 2023. JP Morgan thinks the Fed pivot comes at mid-year as the board tries to make up for its current restrictive policies. The chief economist at Goldman Sachs believes there will be no recession and no Fed rate cut. It may be a bit hard to square that later assessment with the sharp fall in leading indicators released on 12/23.
While I am far more inclined to believe pivot scenarios for many reasons, this article is about GLBE, the company, its outlook and its valuation, and not about the macro environment, while acknowledging that the shares are unlikely to sustain the kind of substantial and long-term appreciation I expect until macro issues are positively resolved and investors return to high growth companies.
I initially recommended the shares of Global-e more than 14 months ago. That was near the top of the valuation peak for high growth IT companies. Needless to say, the recommendation hasn’t worn well; the shares are down more than 70% since my recommendation. That is actually a hair less than the decline in the WCLD ETF, which has fallen 73% over the same span and the 74% decline in Shopify (SHOP) shares which are often viewed as an analog investment (all share prices comparisons and valuations as of 12/23/22). The irony, so to speak, is that the investment thesis, in terms of the company’s operational performance is alive and well. The company has continued to grow at elevated rates on an organic basis. The company is generating cash and its adjusted EBITDA margin has been increasing.
Global-e does use a modest amount of SBC; last quarter the ratio of SBC as reported to sales was less than 9%. Dilution last quarter was 1.2% sequentially which is how I account for SBC. The company has a significant commercial agreement with Shopify which has warrants to purchase about 12 million shares as well as a current ownership position of 17.4 million shares. The implied value of the warrants is being amortized through the balance sheet. That said, the current outstanding shares now include all contingent shares which is a change since the time I first wrote about this company.
The investment case for Global-e shares
For readers unfamiliar with Global-e, its business is the facilitation of international business to consumer (b to c) ecommerce. It allows brands to offer customers a direct to consumer experience in 200 different destinations. While there are other vendors who do some of what this company does, it enables brands with all of the solutions that they need to facilitate cross border commerce directly with their customers. The specific offerings of Global-e include software to facilitate localized browsing, i.e. a localized web site, a localized checkout capability with a pricing engine that converts to local currency, global logistics, localized marketing capabilities and capabilities to guard against fraud and local currency fluctuations. In many ways, Global-e is the pick and shovel vendor of cross border, direct to consumer ecommerce. It benefits in an outsize fashion as cross border ecommerce becomes widely adopted. It is, in my opinion, the best way to invest in the rising trend of cross-border, direct to consumer, e-commerce.
As mentioned, Global-e shares have fallen substantially over the last year and more while the company has grown. That by itself is certainly not a reason to buy the shares-lots of IT equities have fallen by 70% over the same time span. But part of the investment case is now valuation. At this point, the EV/S ratio has fallen to less than 4.9X. With profitability and free cash flow margins rising significantly, even with a growth rate that will be lower next year than in the recent past, the Rule of 40 metric is substantially greater than 50. At one point, Global-e shares sported what many considered to be a set of elevated valuation metrics. At this point, its relative valuation has fallen to about 20% below average for its growth cohort. Just by way of comparison, Shopify (SHOP) has a higher EV/S ratio (about 5.7X), is growing more slowly and continues to burn cash.
Over the past several months, as the probability of a recession has loomed ever larger, many commentators have expressed concern about how macro headwinds might impact many different companies and there have been many downgrades based on results expected during the probable recession. Amazon’s (AMZN) ecommerce business has seen declining growth trends for much of this year, and while Shopify recently reported a decent growth quarter, its percentage growth rate has fallen substantially. BigCommerce (BIGC) has also seen its growth rate shift to a lower gear.
Global-e is growing more rapidly than other e-commerce companies, it is far more profitable even at its current scale compared to the other prominent e-commerce vendors, and while the macro environment certainly poses a threat to its growth, that threat is noticeably less than is the case for other ecommerce vendors. At the time Global-e reported its last set of quarterly numbers in November it provided somewhat muted guidance. I will detail the results later in this article, but there are some macro headwinds here. In the wake of the earnings release, the analyst consensus organic revenue growth for 2023 is in the mid 30% range.
My view is that essentially all software vendors and vendors of ecommerce services-Global-e is both-actually-are already facing noticeable macro headwinds. And every investor interested in Global-e and the ecommerce sector already knows that and presumably has made decisions based on that knowledge. Perhaps if the shares weren’t down 70%, or there was some more uncertainty than already exists, that would be a risk to consider. But after the shares reacted to the release of Q3 earnings by falling almost 20%, I think much of the cyclical risk has already been discounted. The company has a significant short interest ratio; as of the end of November, a bit more than 6 million shares were short out of a float of 57 million shares.
Cross border e-commerce is in its infancy. Most brands, even some of the largest, simply cannot afford the costs of creating a direct to consumer experience for potential customers. It isn’t just a matter of engaging a web designer and creating a local web site, or even getting a pricing engine to convert currencies at the time a potential customer browses. What works in one geo, will not work in another, and acceptable business practices in the EU, may not be considered reasonable in Japan. Brands need domain expertise is they are going to sell directly to consumers in different countries, and Global-e has the domain expertise to make that possible.
It can be difficult to estimate the size of the market that Global-e is pursuing. The overall cross-border e-commerce GMV for 2022 has been estimated in the linked study to be around $900 billion and is forecast to enjoy an elevated 26% CAGR through 2030. In terms of revenue for cross border software and services, Global-e has been able to turn about 15% of its GMV into revenue which suggests that the TAM for Global-e is as much as $135 billion currently and can rise to impressive levels over the length of the forecast period. Other studies have far different numbers in terms of the ecommerce market size; much of the difference is a function of the definition of the space. The actual TAM for Global-e is probably much lower; not all brands are going to outsource all of their cross border functionality to 3rd parties and many brands and merchants will forego the opportunities to sell directly to consumers in a multiplicity of geos. But given the size of Global-e and the market potential for global B to C e-commerce, its growth runway is long and substantial. Although perhaps a bit of a commercial, the following survey from Shopify is of some interest in defining the market.
Many investors these days are concerned about the ecommerce market in general. Ecommerce has obviously taken a step back from the growth that it achieved during and immediately after the recent pandemic although the survey linked here suggests 2022 growth was still above 15%. That will probably prove to be too high; Mastercard’s (MA) holiday sales report indicates that the growth in ecommerce sales in the US was a bit less than 11%. Ecommerce is now a substantial component of overall retail sales-22% of the total according to the MasterCard report.. Even with a recession, overall ecommerce growth next year is estimated to be about 12%. But cross-border ecommerce is only about 20% of total ecommerce so it can show significant growth even as total retail ecommerce revenues experience a declining growth trend.
Another key component of the investment case for Global-e relates to its pivot away from reselling logistic services and toward an emphasis on software. This is best seen in the steadily rising trend of gross margins. Last quarter non-GAAP gross margins were 41.4% compared to 38.5% in the year earlier period. The main reason for that is that fulfillment fees, or the revenue derived from reselling logistic services has gone from over 60% of revenues to 55% of revenues year on year, while service fees, which include software to localize web sites, the pricing engine to compute local currency costs and the compliance services have risen to 45% of revenues. Gross margins are far higher on services than on pass through logistics services.
As many readers are aware, Shopify both has a significant equity holding in Global-e and also has a partnership arrangement in which Global-e provides cross-border B to C ecommerce services to Shopify users. Shopify merchants can contract directly with Global-e; that integration is now the default for all new Shopify merchants, or they can use a white box solution called Shopify Markets Pro which is still in beta. Obviously, the opportunities with Shopify are substantial and one reason that Global-e should be able to grow next year despite recessionary pressures is that its merchant growth with Shopify should be significant.
Global-e also has a partnership in place with Meta (META). In addition to those partnerships, Google (GOOG) (GOOGL) has initiated a referral partnership agreement enabling Google based merchants to work with Global-e for their direct to consumer cross border requirements. The company acquired a business called Borderfree from Pitney Bowes (PBI) earlier in 2022. Borderfree, in addition to its customer base, had significant technology, particularly in terms of logistics and demand generation software that GLBE is integrating into its stack. Further, PB has become another marketing channel for GLBE in which PB sells its logistics capabilities and GLBE sells its localization, payment and compliance software.
Another part of the investment case relates to profitability. The company, as did quite a number of IT vendors, wound up raising its margin guidance for the coming quarter. It has been achieving better synergies than initially anticipated when it bought Borderfree, as well as Flow, a company it bought at the end of 2021, and as a result, it has made some workforce reductions. The company does not report non-GAAP earnings, but instead reports adjusted EBITDA. The adjusted EBITDA margin was 12% last quarter which was constrained due to expenses involved in integrating the Borderfree and Global-e operations. The revised company guidance, incorporating cost synergies and payroll guidance is for the non-GAAP EBITDA margin to reach 14% next quarter; that is probably more than a bit conservative since sequential quarterly revenue, due in part to holiday seasonality is expected to show a 35% increase.
Free cashflow was negative last quarter although in line with adjusted EBITDA level for the first 9 months of the fiscal year. Operating cash flows vary quarter to quarter due to the cadence of changes in the flow of funds receivable from and payable to customers in a given period. Cash flow last quarter was constrained due to merger integration expenses along with a currency related write-down in the value of funds due from customers.
Global-e’s competitors and its competitive moat
The largest competitor for Global-e is obviously internal capabilities of brands and retailers to set up their own cross-border ecommerce capabilities-or even a decision by a brand not to try to sell directly to consumers on a cross-border basis. Large brands and large stores who want to sell locally can either do themselves or look to a cross border commerce provider who can provide the service. That said, Global-e does have some significant customers such as Disney (DIS), Marks and Spencer, Rag & Bone, Adidas, Ralph Lauren and many of the brands of LVMH (OTCPK:LVMUY) amongst others. Most of the other competitors that say they are in this space simply do not offer the range of services and software that Global-e enables. Many of them have pricing engines enabling brands and smaller stores to calculate their customer check-out in local currency.
Some investors consider DLocal, (DLO) as an analog company. The analog is quite weak. DLO operates a payment platform that allows merchants to get paid and to make payments online and in local currency. It really does not facilitate cross-border, b to c ecommerce.
Probably the best known of the competitors listed in the link are Digital River and FedEx (FDX). Neither of these vendors offers users the ability to create a localized web site, or to provide their customers with localized marketing capabilities. Global-e has developed AI capabilities that provide brands with market-specific insights which help the brands improve their conversion rates. Harvey Nichols is a well-known UK department store chain. I think the following quote is representative of one of the most significant differentiators of the Global-e offering.
“One of the key factors that makes Global-e stand out it their unparalleled local market best practice and know-how, which alongside their technology and experience, has led to fantastic boost in our international conversion rates.”
James Henry, Head of Multi-channel Operations | Harvey Nichols
Global=E, through its acquisition of Flow at the end of last year offers potential clients two levels of service, Pro and Enterprise. This is useful in providing different customers the specific capabilities they need and can pay for.
While it may seem obvious, a direct to consumer cross border experience needs to have an enabled return capability. Global-e offers that; its competitors, at least currently, do not. And while reselling logistics is not likely to be the key differentiator for all time, the company has a multi-vendor capability that resonates with many users at this point.
Many readers, in looking at the above differentiators may feel that there is nothing here about some key technology that Global-e has and no one else can replicate. In that regard, GLBE is not anything like GitLab (GTLB) or Elastic (ESTC). In my view, nonetheless, it is extremely difficult, expensive and time consuming to create the level of domain expertise this company has, and which its competitors lack. And it would be difficult for any potential competitor to attempt to build the kind of reference base this company has. Finally, this company’s partnerships, which include Shopify, as described earlier, as well as with Google and Facebook (META) give it a powerful advantage in the space.
Reviewing the company’s results from the last quarter
As mentioned earlier, the company enjoyed very strong results last quarter that exceeded prior expectations. The shares fell significantly based on company guidance, although company guidance was really not something that might have reasonably shocked investors. The headline numbers for the company were revenues of $106 million, up 79% year on year, GMV of $621 million up 77% year on year, non-GAAP gross margins of 41.5% compared to 38.5% in the year earlier quarter, and adjusted EBITDA of $12.5 million up by 62% year on year. The company, perhaps because of its Israeli domicile, does not report non-GAAP earnings.
The company exceeded expectations for all guided metrics. Revenues had been forecast to be $102 million, GMV has been forecast to be $610 million and Adjusted EBITDA had been forecast to be $11 million.
For the first 9 months of the year, the company generated $13 million of free cash flow, up from a burn of $9 million in the first 9 months of 2021. Excluding asset revaluation and merger expenses, free cash flow is running at between 110%-120% of adjusted EBITDA.
Free cash flow last quarter was a burn of $5.5 million compared to generation of $5 million in the prior year. The company incurred about $10 million of one-time costs related to the Borderfree merger, and it also wrote down about $11 million of financial expense due to the impact of the USD revaluation of non-USD balances. These items are excluded from adjusted EBITDA; thus that metric diverged from free cash flow this quarter. Given the nature of the services offered by Global-e, it does not generate deferred revenues. Over the course of a full year, and excluding any significant merger transactions, operating cash flow is likely to be pretty close to adjusted EBITDA, possibly a little bit higher over the course of a year.
Although Global-e is headquartered in Israel, much of its initial sales activity was in the UK. Until the last couple of years, it had focused on the UK and continental Europe. It began its pivot to a focus on US merchants and brands starting in 2017, and much of its current growth is a function of the company’s expansion within the US. In Q3, partially because of the merger with Borderfree, outbound US revenues grew 184%. At this point outbound US transactions make up 46% of revenues, up from 29% the prior year and up from 39% the prior quarter.
Borderfree had a revenue run rate of about $40 million/year. It is also contributing about $130 million of GMV. Thus on an organic basis, in the company’s Q3, GMV grew a bit less than 60%, while revenues grew by 63%.
As mentioned, while the quarterly results were obviously strong, and exceeded expectations, guidance, along with overall investor sentiment, was the issue that led the shares to fall noticeably. The magnitude of the revenue guidedown was far less substantial than the share price implosion. Specifically, the company is now forecasting revenue this quarter of about $140 million; the prior implied forecast had been about $147 million. Of that $7 million, or 5% guide down for the current quarter, half has been attributed to increased FX headwinds, and half has been attributed to the delay of a major customer in going live on Global-e; it can be difficult for Global-e’s customers to go live during their holiday season, and a 3rd party provider of this particular large customer apparently was late in completing part of the software integration necessary to implement the project.
The company increased its forecast for adjusted EBITDA by a about 3% at the midpoint; it now expects full year adjusted EBITDA margins to be 11% compared to its prior forecast for that metric of 10.4%. Some of that improvement is the realization of greater cost synergies than forecast from the company’s two mergers. Part of the increase relates to a more favorable mix between services and fulfillment services (logistics).
Consensus revenue for next year is expected to be about $565 million, or 38%. Adjusted for the impact of the acquisition of Borderfree, organic revenue growth expectations are for 31%. Growth of 31% is going to stand out noticeably in the ecommerce space; for example Shopify’s growth is expected to be 20%, while Big Commerce is expected to grow by 15%. Even Lightspeed (LSPD), hereto one of the growth stars in the ecommerce space is expected to see revenue growth fall to 27%-and of course Lightspeed still is still reporting adjusted EBITDA losses.
Looking at Global-e’s business model
Global-e is not a software company per se, although it does sell some software solutions. Thus its cost ratios are not particularly comparable to the cost ratios of many other IT vendors. It still derives over half of its revenues from fulfillment services, primarily logistics, which have much lower gross margins, but also don’t have much in the way of development and sales and marketing expenses. I usually try to look at sequential comparisons but in this case and at this time, such comparisons aren’t totally meaningful because of the impact on expenses of the Borderfree merger which took place on 7/1/22.
As mentioned earlier, adjusted gross margins for the quarter reached 41.5% last quarter, up from 38.6% in the year earlier period. The growth in gross margins is likely to continue as the company’s revenue base moves further toward service fees/basically what the company calls its multi-local offering. Research and Development expense was just short of 16% last quarter, up from 11% in the year earlier period. Overall, research and development spending doubled year over year; much of that growth was the function of absorbing developers from Flow and from Borderfree. The company expects to remediate some of that sharp expense increase by reducing headcount where possible-part of the justification for both mergers relates to expected cost synergies.
Adjusted sales and marketing expense, which excludes the amortization of the Shopify warrants was about 8.5% of revenues, down marginally from year earlier levels. If anything, based on the success this company has had in attracting new brands and merchants, and entering new geos, it would seem that this expense ratio could be profitably increased, although that is not what is expected.
The general and administrative expense ratio at just less than 6% was essentially flat year on year. There will probably be further cost synergies that will positively impact this ratio as the integration with Borderfree progresses.
Overall, last quarter the company’s adjusted EBITDA margin was about 12%, compared to 13% in the year earlier period, mainly driven by the spike in research and development costs, offset for the most part by the improvement in gross margins. The company is now forecasting an adjusted EBITDA margin for Q4 which has significant seasonal factors to reach 13.5% compared to 14% in the year earlier period. That will bring the full year EBITDA margin to around 11% compared to 13% in 2021. The historical record suggests that these are conservative forecasts. My expectation is that in 2023, the company will likely see substantial growth in the adjusted EBITDA margin to the range of 13%-15%. That would yield free cash flow for 2023 of about $80-$90 million.
Wrapping up-Looking at GLBE’s valuation and reiterating the case to buy the shares.
I think Global-e represents an outstanding investment for those subscribers/readers who can withstand the pain of owning the shares, or almost any IT shares, in this extreme risk-off environment. Global-e is growing more rapidly than almost all other ecommerce companies, even such fast growing businesses as Lightspeed and MercadoLibre (MELI). I am all too aware that GLBE shares are highly unlikely to product positive returns until market sentiment becomes less toxic towards investments amongst high growth IT/ecommerce shares. Those considering these shares will need patience and some fortitude in dealing with current sentiment.
At one point it might be argued that the value of Global-e shares was extended. I am not going to try to relitigate that point here and it doesn’t much matter. Pendulums do swing and what was overvaluation 14 months ago has now become relatively attractive.
Based on the company latest guidance and the 1st Call consensus forecast for 2023, the shares now have an EV/S of 4.8X and that is actually below average for the company’s3 year growth cohort which I estimate to be 37%. That estimate is higher than the projected growth rate for 2023, and far lower than historical averages. Looking at the combination of the company’s free cashflow margin and its growth rate, the shares are valued at about a 25% discount to average.
With the increased non-GAAP margins the company is forecasting, and using a 9.57% weighted average cost of capital as projected by Gurufocus, the net present value of the company’s projected free cash flow is close to double the current quote. That is based on consensus growth coupled with a continued improvement in free cash flow margin. Another valuation metric that can be helpful is free cashflow yield. The current project free cash flow yield is a bit greater than 3%.
Global-e is the pick and shovel vendor of the cross-border, direct to consumer ecommerce space. That may not seem like the best place to invest during a global recession, and the company has modulated its growth forecast to take account of macro headwinds. But the space is in its infancy and brands and merchants will ultimately need a strategy to offer potential customers a local experience in order to maximize their revenue opportunities. Although the company hasn’t yet offered any guidance for 2023, the organic growth expected by the 1st call consensus of 31% for the period puts this company as the fastest growing ecommerce vendor based on 1st call projected sales growth.
Being a pick and shovel vendor means that some potential customers will choose to establish their own local presence. If brands and merchants are large enough, and don’t feel the need to move rapidly, or evaluate all of their costs, then Global-e will lose; most of the time, if it gets up to bat, I think it ought to be successful. Despite macro headwinds it has been able to build a substantial pipeline, and as that pipeline converts and customer go-live, the slower ecommerce growth can be overcome.
Global-e’s competitive moat is somewhat different than that of many IT vendors. It doesn’t have a unique software solution. What it does offer, however, is very unique. Basically, its competitive moat is deep domain expertise in terms of being able to localize experiences for consumers, and to provide specific marketing insights for its brands, significantly raising conversion rates for the brands and merchants that are its clients. And unlike many of its putative competitors, it offers all of the necessary ingredients for cross-border ecommerce on a single integrated platform. Personally, although it might seem like heresy, I think the kind of domain expertise that Global-e has built is probably more of competitive advantage than the proprietary technologies of many excellent technology vendors.
The company has a meaningful partnership with Shopify and it also has partnerships with Meta and Google. These partnerships, and the ability of the company to partner with additional brands and merchants will enable the company to continue its growth, albeit at less torrid levels, even during the expected recession and the slowdown in ecommerce growth.
Global-e often trades as though its business is an analog of Shopify. That isn’t going to stop because the analogy is quite weak. At some point the pendulum will swing and companies will be evaluated on their own merits. Should readers buy shares of Global-e at this point? Sustained appreciation for the shares will await a flip in market sentiment, and in turn that is more dependent on macro factors and when investors start to anticipate a Fed pivot for more than a few days at a time than it is the operational performance and outlook for the company, at least at this point. I think Global-e ought to be on the shopping list of any investor in high growth IT stocks, but I well understand that patience and fortitude may be required. But for me, at least, the upside potential is now far greater than the downside risks even though looking at downside risks being realized is frustrating and nerve wracking. I own the shares, and am willing to wait for what I consider to be the huge recovery potential.
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