ETSY, INC. (NASDAQ: ETSY)

Overview: Etsy, Inc. operates an online marketplace that enables buyers and sellers to connect directly with each other to create handmade products built to customer specification. As the eCommerce industry becomes more and more automated, Etsy strives to “Keep eCommerce Human” through its two-sided business model. Etsy.com is currently the 4th largest eCommerce site by monthly visits in the U.S. and has experienced significant growth from pre-COVID levels. 

While there are other eCommerce companies that have been popular among investors as the world begins to reopen, there is a unique investment opportunity with ETSY.  This opportunity arises mainly from the flywheel network effects, strengthening moat and expanding TAM as evidenced by Etsy’s recent acquisition of Depop (a London-based resale fashion site) as well as convincing evidence that the online crafts market is here to stay and grow exponentially. Etsy, Inc. also owns Reverb, a musical instrument resale site. 

Core Business Growth: The pandemic strengthened Etsy’s business as evidenced by Q1 YoY GMS growth of 128% vs. $1.3B in 1Q20. Q1 take-rate was 17.5%, up from 16.9% in the year ago quarter. The company’s core business is expected to grow another 27% in Q2 versus last year against what CFO Rachel Glaser has said is “an enormous comp”. In March 2019 the company thought long-term compound annual growth would be 16-20% over a 5yr period and clearly the core business is growing faster than that now. 

Etsy’s “habitual buyers,” or buyers that come to Etsy six or more times in a year and spend $200 or more, are up over 8M. According to Glaser at a recent conference, this number was up 205% in Q1 and is easily Etsy’s most valuable consumer group in terms of expanding their business.

Along with the growth of habitual buyers, Etsy also witnessed a growth in its regular active buyers. This number is up over 90 million and grew over 90% YoY, bringing Etsy’s total buyer count to 160 million. The GMS per active buyer is also accelerating as shown below: 

 Active sellers grew over 70% YoY to 4.5M as well. You can see below that as the company has grown, its operating margins have expanded, and take-rates have also grown:

Unlike a company whose marginal utility begins to decrease when the network becomes too large, Etsy is showing evidence of actually accelerating as its flywheel network effects begin to turn and more buyers and sellers are added to the marketplace. We believe this has even more opportunity to continue to expand the company’s reach and TAM as a result of its recent acquisition of Depop.

Depop Acquisition: Depop operates as a marketplace that also includes a social network. Depop allows users to see what their friends, as well as other people they are inspired by, are liking, buying, and selling. This creates a global marketplace for unique items that is very connected and personal. The site has over 30 million stylists, designers, artists, collectors, sneakerheads and more and its business model creates its own community that is driven by a new generation’s drive for self-expression. Depop reports that 46% of Gen Z say “self-expression” is very important to them and marketplaces like Depop and Etsy make it easy to be yourself. 

In a deal expected to close in Q3 of 2021, Etsy is acquiring 100% of Depop for $1.625 billion primarily with cash. On the surface, Depop’s acquisition is expected to add to top-line growth, as the company experienced $650 million in GMS and $70 million in revenues in 2020, each increasing >100% YoY and have CAGR’d at ~80% from 2017-2020. 

We believe the real opportunity lies in Depop’s customer base. 

• ~90% of Depop’s active users are under the age of 26; the second-hand fashion industry is being adopted by young consumers faster than all other audiences. 

• 10th most visited shopping site among Gen Z consumers in the U.S.

Depop has an early advantage in the rapidly growing apparel resale industry by already having a loyal customer base built of Gen Z consumers, registering ~30 million users in 150 countries. Gen Z is leading a new wave of social change and expression and with Depop’s consumer engagement and seller creation, Etsy will be able to tap into a very valuable market.

Depop’s focus on sustainability and entrepreneurship will also appeal to newer generations that want to have their own business and will allow the company to gain recognition. 90% of Gen Z believe firms should address social and environmental issues and 50% want to have their own businesses.

TAM: Outlined in Etsy’s most recent investor presentation, the Depop transaction will extend Etsy’s total addressable market to a massive $1.7 trillion. Of Etsy’s six retail categories, its apparel market, which is projected to have a TAM of $543 billion in 2025, will benefit the most by the Depop Acquisition. Etsy also saw YoY Q1 2021 international GMS growth of 169%. With Depop being a UK based company, Etsy will experience a jump in its international reach; another reason why Etsy’s TAM will continue to expand.

Older generations might not use or understand Depop, but Gen Z and young consumers are at the heart of this business, providing the company with a head start in an industry projected to grow to $64 billion at a 39% CAGR until 2024 in the U.S. alone. 

Etsy provides unique items in an eCommerce industry that is oversaturated with similar versions of the same products. This provides an advantage for Etsy, as searches for personalized items are 20% more likely to result in a purchase.  We believe Etsy’s TAM will continue to grow as the company continues to reinvest in marketing and execution and the flywheel of the network effect continues to turn. As the company’s recent presentation demonstrates, marketing investments continue to have a very high ROI proving that Etsy’s capital light business model is still effective in producing the sales that they need to grow.

Etsy’s “house of brands” all work together to support different generations with different products. Etsy is more geared toward Gen X and millennials, while Reverb and Depop are heavily focused on Gen Z. Because of this, Etsy, Inc. can have the three companies work together to capture a wider audience and grow top-line numbers.

Management: There should be no doubts about Etsy’s ability to develop as a company because of its management. CEO Josh Silverman brings tons of experience in the consumer technology industry and has proven that he is able to scale all the companies he’s worked at. Silverman has previously served as President of Consumer Products and Services at American Express, CEO of Skype, and CEO of shopping.com. CFO Rachel Glaser also brings a lot of experience to Etsy, as she has held senior financial roles at Yahoo, Walt Disney, and Move, Inc. While Etsy’s growth relies heavily on its own buyers and sellers, the company’s execution relies on its senior management. With Silverman and Glaser at the head, there is no shortage of experience or success among Etsy’s leaders and investors should feel very comfortable investing in them. 

Skeptics: We believe the skepticism around ETSY primarily stems from it being such a unique business in a massive industry that has been dominated by companies like Amazon, eBay, and Alibaba for years. In 2015, Amazon launched Amazon Handmade, another marketplace for unique crafts that connects buyers and sellers. You would think Amazon, a mega-company with almost $500 billion in revenue a year, could easily take a smaller company like Etsy and shove it into the ground. However, Etsy has not only survived the Amazon competition since 2015, it has also thrived. This is because Amazon Handmade is less suited for the buyer/seller experience, and this is not what Amazon is known for. Reviews on Handmade reveal that its interface and selling process is much more difficult than Etsy. How can a two-sided marketplace survive when one side of it is not even seller friendly? Etsy will continue to grow at a faster rate than Handmade and will continue to grow market share as a result of their moat. However, if Amazon makes changes to Handmade, Etsy might run into more competition. 

There is also some concern regarding Etsy as strictly a “stay-at-home” company that only did well during the pandemic. With COVID-19, the popularity of custom masks immediately made Etsy the perfect marketplace and rightly so, there is some concern over whether Etsy can sustain growth as the grand reopening continues. However, Etsy’s mask sales as a % of GMS are down to 2.5% in Q1 from 14.1% in Q2 of 2020. During this same period, non-mask YoY GMS growth has gone from 93% to 138% in Q1. Despite a massive drop in mask sales, Etsy has continued to grow at a convincing rate. 

The personalized eCommerce market is misunderstood. Amazon and eBay have made shopping for commercialized products fast, efficient, and cheap. However, that method of shopping is undergoing a huge generational shift as U.S. and international demographics begin to change. There is a heavy focus on personalized items and unique style, two things Amazon and eBay have not completely capitalized on. Etsy, with the help of the Depop acquisition, is now able to take advantage of the opportunity that is coming with social change and with existing popularity and strong user growth, they are poised to be successful.

The Opportunity: While clearly the revenue profile of Depop will boost Etsy’s top line growth, Depop’s take rate is 10%, quite a bit lower than Etsy’s which may pressure margins in the short-term, impacting Wall Street estimates. However, we believe the company will be able to utilize its platform to increase Depop take rates, continue to grow overall revenues at least 20% per year and be able to expand operating margins to 28-30% in the next three years, which would create more than a double in operating profits by end of 2024.

The stock has been caught up in the hypergrowth stock selloff since February and been in a consolidation phase all year. However, when we think about valuation, we have a very similar view to what azia1621 said in October: 

I fear any number I offer here is false precision, at best.  It’s quite possible Etsy is fairly (or even slightly over-) valued today.  What I have more conviction about is the fact that intrinsic value will increase over time because of the nature of the business model.  A tier 1 marketplace with a highly defensible and scalable model, a growing TAM, low-single-digit market share despite being the leader in its niche, and a high ROIC model requiring little incremental capital to grow all make for a good recipe, even if one is paying a fair (rather than wonderful) price today.

We completely agree with this... our conviction is very high that Etsy will be substantially larger years down the road but putting a precise number on the valuation in any given year is challenging.

Disclaimer:This research report expresses our research opinions, which we have based upon certain facts, all of which are based upon publicly available information. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward-looking statements, expectations, and projections. You should assume these types of statements, expectations, and projections may turn out to be incorrect. This is not investment advice nor should it be construed as such. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. The author and his clients have a position in this stock and may add, reduce or sell out of the position completely without informing readers.