ETSY, INC. 
By 
The news landed like a bomb on Etsy's share price, which has halved in the space of just two months. It's always worth a look when a former high-flyer flames out on such dramatic fashion. Especially when, like Etsy, it is used to ranking so high on MarketScreener's quantitative, fundamentals ratings — even though the shares never joined our U.S. portfolio due to a lack of clear momentum and consensus among analysts.
Etsy is the 4th largest e-commerce site by monthly visits in the U.S. It is gaining traction in Western Europe. The site connects sellers with buyers on the lookout for creative, handmade, vintage or differentiated goods, from clothing to jewelry, homeware and personal care. Artisans and small boutiques form the bulk of the sellers cohort; generations X and Y the vast majority of active buyers. The promise of the marketplace is that it provides unique items amid an online shopping landscape saturated with low-quality, standardized or soulless products.
After a successful takeoff followed by an IPO in 2015, board member and e-commerce veteran Josh Silverman was appointed as head of the company. As a former chief executive of Skype and key member of eBay leadership, Mr. Silverman brought a wealth of experience plus the much needed adult supervision Etsy required to evolve into a mature player. Results were immediate, with revenue and operating margins doubling between 2016 and 2019.
Then Etsy went on the path of acquisitions, taking over used music gear specialist Reverb for $275 million; the "Etsy-like", fast-growing Brazilian marketplace elo7 for $217mil; finally, in a bid to expand in Europe and open the door to social selling, the UK-based, hugely popular marketplace Depop for $1.6bn. Of Etsy’s six retail categories, apparel is the one that has the largest TAM and that will benefit the most from the Depop takeover. The latter also gives Etsy an opportunity to tap into a younger demographic.
Depop recorded $70mil in revenue in 2020, twice what it did in 2019. Albeit impressive, this means that Etsy paid a lofty multiple of 23 times revenue. Such willingness to shell out top dollars underscores either an industry-wide race to scale or a desperate attempt to revive a business that plateaued before the pandemic. Both options are on the table, and Etsy's prospects as an investment will hugely depend on the returns it extracts from these acquisitions.
That being said, the bull case is easily wrapped up. Etsy's differentiated, personal and engaging experience is what young shoppers crave. The company has already demonstrated the power of the so-called "flywheel effect" — when a growing number of buyers feed a growing number of sellers, and vice-versa, reinforcing the platform's attractiveness for all — in addition of successfully resisting to Amazon, who has also launched its own handmade marketplace. No small feats.
Secular tailwinds and a capital-light model coupled with virtually unlimited TAM should fetch a high multiple for the company, provided of course that it delivers on growth. So far numbers in the rearview mirror speak for themselves. Over the last nine years, revenue grew from $74mil to $2.3bn, and cash earnings — a.k.a free cash-flows — from $3mil to $600mil. With higher sales also come higher profits from the lucrative seller services business — shipping labels, payment processing, paid promo listings, etc.
Current entreprise value of $20bn means that Etsy trades for x33 last year free cash-flows. That doesn't look excessive for a fast growing entreprise, but numbers should perhaps not be extrapolated, as there is some concern that the pandemic distorted reality. Take masks sales for instance. Just by themselves, they accounted for $133mil in April 2020 — that is, almost a quarter of annual revenue. Latest numbers — q3 2021 — show that ex-masks, marketplace sales are up 24% on a year-to-year basis; and +138% on a two-years basis, but that's with $2bn spent on acquisitions.
At only 10%, Depop’s take rate is lower than Etsy’s, so there is definitely an under-monetization opportunity here. But investors should not forget that young people can be a fickle bunch. Hopefully management did not overpay for this prized asset. This risk is real, and colliding with worrisome signals from the number of active buyers, which has been stalling, very much like operating earnings. The bull case is easily wrapped up indeed — but so is the bear case as well.
On the capital allocation front, debt grew by $2bn to fund acquisitions over the last four years. Meanwhile, cash earnings were entirely directed to stock buybacks. The rationale behind these buybacks executed at much higher valuations than today isn’t obvious. Here, too, unless growth proves organic and continuing, value destruction could be substantial. On the other hand, what is not obvious today may prove formidably beneficial tomorrow, as we've seen recently.
Bulls will maintain that Etsy has an attractive, niche business that can grow many multiples of where it is today. Bears will call the business model unproven and underscore the potential incongruity in paying x33 pandemic-induced cash earnings when stalwart eBay trades at less than x15 said cash earnings. The latter is also aggressively buying back its owns shares, but to the scale of $5bn per year — at run rate, twice the revenue that Etsy generates. Besides, there have been no insider buying on share price weakness; prospective investors certainly would like to see some committment from management.
For all these reasons, MarketScreener remains on the sidelines for now. However, a good earnings release followed by an upwards revision of analysts' consensus — surveyed in real-time by our quantitative tools — could trigger an addition of Etsy's shares into our U.S. portfolio.
