Etsy.com is a global online destination for unique and creative goods, as alternative to mass produced goods. The niche goods version of Amazon. The company put out interesting statistics, for example, saying that 88% of buyers agreed that Etsy has items you can’t find anywhere else. Personally I can’t verify that. But the fact that it has become the 4th largest e-commerce site by monthly visits in the US behind only Amazon, eBay and Walmart says something.
The most interesting thing about the company is that, unlike Amazon, Chewy and others, it is not a retailer! It is a two-sided online marketplace or platform that connects millions of passionate and creative buyers and sellers, and facilitates transactions between them. A typical retailer has to deal with inventory, PP&E and retail footprint. Etsy has none of that. The company has been profitable since IPO in 2015. As of last year 2020, the company raked in north of 30% EBITDA margin!
Business Model
In essence, Etsy takes in a spread on the merchandise sold on its platform. Etsy charges 5% transaction fee that seller pays for each completed transaction, plus listing fees, and fees for payment processing on the platform. Etsy further provides other services to sellers, from advertising to shipping labels. Overall the total revenue take rate (as percentage of gross merchandise sales) has been around in the mid-to-high teens, which I think is reasonable, with room for further increase.
Furthermore, the revenue comes in with a fairly high gross margin in the 70s% range. Accounting for sizable marketing expenses, product development and G&A, the company is able to do 30+% EBITDA margin. All the while it spends minimal CapEx. This is a far cry from many unprofitable tech / e-commerce businesses, yet commanding tens of billions of dollars in valuations.
Financial Performance
Now, let’s take a look at performance of the business. 2020 was a truly breakout year for the company. Prior to that, it had been growing at say 20% a year. In 2020, both the gross merchandise sales and its revenues grew over 100%, to $10bn and $1.7bn, respectively. Excluding the significant benefit from mask sales as result of the pandemic, the company was still growing at 70-80%!
The pandemic has not only accelerated e-commerce adoption on the buyer side but also the entrepreneurship on the seller side to sell their own craft and unique items on the platform. Most importantly this growth seems to be sticking around. In 1Q 2021, the company recorded another 140% growth in revenue, essentially leveling up last year quarter’s revenue to the post-pandemic levels. The company did expect growth to slow down significantly from this heightened level for rest of this year.
Valuation
Let’s say the company goes back to historically more normalized growth of 20%. For reference, total retail grows at 4% a year; online is expected to continue to grow at 15% a year. By say 2025, the gross merchandise sales could be ~$30bn. This compares to the $100bn TAM that the company currently estimates. It’s not too unreasonable given brand recognition at this point, especially when the TAM should continue to grow over time.
At a 20% revenue take rate, that would be ~$6bn revenue. As the company scales, margin should continue to improve. At 40% EBITDA margin, that would be $2.4bn EBITDA. And at 20-30x multiple, that’s a $48-72bn valuation, versus current enterprise value of low-$20bn. That’s 2-3x over next 3-5 years. Alternatively, current valuation implies ~10% free cash flow based on this forward EBITDA, which is quite attractive in today’s environment.
Strength of Moat and Risks
The company has absolutely established itself as leader in the niche market for unique and creative crafts and products. Some may assert that the company has even built a strong moat by virtue of a network effect. More sellers attract more buyers, which in turn attract more sellers. Personally I wouldn’t go so far. The still fairly low switching costs of both buyers and sellers to other platforms weaken any network effect that they may have. That being said, the brand recognition and economies of scale are still tremendous value in and of itself.
Finally, last week they announced acquisition of this company called Depop, a community-driven, 2-sided online marketplace for fashion and apparel e-commerce, for $1.6bn. Apparently it very much appeals to the Gen Z generation. In 2019, Etsy acquired another company called Reverb in the music niche category for $275mm, paying ~5x revenue. This time, Etsy is paying over 20x revenue. Although Depop is growing at 100+% this past year, it can be hard to tell how these acquisitions will perform over time. Until next time..
